Split (1)

train · 657k rows

url stringlengths 56 59	text stringlengths 3 913k	downloaded_timestamp stringclasses 1 value	created_timestamp stringlengths 10 10
https://www.courtlistener.com/api/rest/v3/opinions/4336675/	ROBERT R. AND BARBARA A. TEUSCHER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentTeuscher v. Comm'rNo. 16288-05United States Tax CourtT.C. Memo 2007-247; 2007 Tax Ct. Memo LEXIS 249; 94 T.C.M. (CCH) 228; August 27, 2007, Filed249 Larry D. Harvey, for petitioners.Randall L. Preheim, for respondent.Vasquez, Juan F.JUAN F. VASQUEZMEMORANDUM OPINIONVASQUEZ, Judge: This case is before the Court on respondent's motion for summary judgment pursuant to Rule 121. 1 After a concession, 2 the sole issue for decision is whether petitioners can exclude from income wages earned during 2002 from working in Antarctica. BACKGROUNDAt the time they filed the petition, petitioners resided in Silver City, New Mexico. During 2002, petitioners performed services at McMurdo Station in Ross Island, Antarctica. On their 2002 Federal income tax return, petitioners excluded wage income earned and received during 2002 for services performed in Antarctica.DISCUSSIONI. Summary JudgmentRule 121(a) provides that either party may move for summary judgment upon all or any part of the legal issues in controversy. Full or partial summary judgment may be granted 250 only if it is demonstrated that no genuine issue exists as to any material fact and that the legal issues presented by the motion may be decided as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518">98 T.C. 518, 520 (1992), affd. 17 F.3d 965">17 F.3d 965 (7th Cir. 1994). We conclude that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law.II. In GeneralSection 61(a) provides that gross income means all income from whatever source derived. Accordingly, citizens of the United States generally are taxed on income earned outside the geographical boundaries of the United States unless the income is specifically excluded from gross income. Specking v. Comm'r, 117 T.C. 95">117 T.C. 95, 101-102 (2001), affd. sub nom. Haessly v. Comm'r, 68 Fed. Appx. 44">68 Fed. Appx. 44 (9th Cir. 2003), affd. sub nom. Umbach v. Comm'r, 357 F.3d 1108">357 F.3d 1108, 83 Fed. Appx. 274">83 Fed. Appx. 274 (10th Cir. 2003). Exclusions from income are construed narrowly, and taxpayers must bring themselves within the clear scope of the exclusion. Id.III. Section 911In Arnett v. Comm'r, 126 T.C. 89">126 T.C. 89, 91-96 (2006) (Arnett I), affd. 473 F.3d 790">473 F.3d 790 (7th Cir. 2007) (Arnett II), we addressed the arguments made by the parties 251 herein regarding section 911. The U.S. Court of Appeals for the Seventh Circuit agreed with our analysis of section 911 and affirmed our conclusion that Antarctica is not a "foreign country" pursuant to section 911 and the regulations thereunder. Arnett v. Comm'r, 473 F.3d at 799. We shall not repeat our analysis from Arnett I herein. We follow our analysis and holding in Arnett I and the analysis and holding of the Court of Appeals in Arnett II. 3252 IV. ConclusionAccordingly, for the reasons stated in Arnett I, Arnett II, and herein, we conclude that petitioners cannot exclude from gross income wages earned during 2002 from working in Antarctica.To reflect the foregoing,An appropriate order and decision will be entered.Footnotes1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the year in issue.↩2. Respondent concedes that no penalty pursuant to sec. 6662↩ is due from petitioners for 2002.3. In Arnett v. Comm'r, 126 T.C. 89">126 T.C. 89 (2006), affd. 473 F.3d 790">473 F.3d 790 (7th Cir. 2007), we concluded our Opinion with a citation of sec. 863(d) suggesting that sec. 863(d) provided an additional reason to rule against the taxpayer. Id. at 96 ("See also sec. 863(d) (providing that income earned in Antarctica by a U.S. person is sourced in the United States)."). In Arnett v. Comm'r, 473 F.3d at 797, the U.S. Court of Appeals for the Seventh Circuit addressed sec. 863(d) in greater detail, stating:At the outset, we think that it is important to note that considering Antarctica not to be a "foreign country" is compatible with the general statutory scheme. Notably, section 911 is found under subtitle A, chapter 1, subchapter N of the IRC, which is designated "Tax Based on Income from Sources Within or Without the United States." Part I of this subchapter, entitled "Source Rules and Other General Rules Relating to Foreign Income," deems any activity in Antarctica to be "space or ocean activity." In turn, the United States is designated the source country of income from such activity when earned by a citizen of the United States. 26 U.S.C. section 863(d). Although this provision does not provide a definitive answer as to whether Antarctica is a "foreign country," it supports the conclusion that section 911 is not intended to apply to income earned for services provided in Antarctica.We take this opportunity to state our agreement with the Court of Appeals' conclusion set forth above. See also HCSC-Laundry v. United States, 450 U.S. 1">450 U.S. 1, 6, 101 S. Ct. 836">101 S. Ct. 836, 67 L. Ed. 2d 1">67 L. Ed. 2d 1↩ (1981).	01-04-2023	11-14-2018
https://www.courtlistener.com/api/rest/v3/opinions/4623156/	Clinton Park Development Company v. Commissioner.Clinton Park Dev. Co. v. CommissionerDocket No. 31718.United States Tax Court1952 Tax Ct. Memo LEXIS 135; 11 T.C.M. (CCH) 768; T.C.M. (RIA) 52230; July 16, 1952135 Held, the expenses incurred in obtaining loans to finance the construction of houses are not deductible in the year that the owner of the houses enters into contracts for their sale, which sales remain executory during the year. Dougal C. Pope, Esq., for the petitioner. John P. Higgins, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion Respondent determined deficiencies against the petitioner as follows: Year EndedTaxDeficiencyAugust 31, 1942Income Tax$13,167.77August 31, 1942Declared Value Ex-cess-Profits Tax3,274.65The only question before us in this proceeding is whether the amount of $23,407.70 was deductible as expenses in the year in question, or whether this amount was a capital item to be amortized. Findings of Fact The Clinton Park Development Company, the petitioner, was organized in August, 1941 to build 533 houses in Clinton Park Addition, Harris County, Texas. The petitioner filed its income and declared value excess-profits tax return for the fiscal year ending August 31, 1942, with the collector of internal revenue for the first district of Texas. The petitioner financed136 the construction of houses through loans from local companies which loans were guaranteed by the Federal Housing Administration. Approximately 90 per cent of the sales price of the houses was borrowed by petitioner. The petitioner corporation executed individual deeds of trust to secure individual notes for the loans on each house. The petitioner constructed the 533 houses, and in the year ending August 31, 1942, entered into contracts for sale of 507 of these houses. During the following fiscal year, the remaining 26 houses were made the subject of similar sales contracts. The pertinent provisions of these sales contracts were as follows: "THIS AGREEMENT, made in the County of Harris, State of Texas, on the day of A.D. 194 , by Clinton Park Development Company, a corporation duly created and existing under, and by virtue of the laws of the State of Texas, and having its principal offices in the City of Houston, Texas, hereinafter called Party of the First Part, and residing at Houston, Texas, hereinafter called Party of the Second Part: "WITNESSETH: "For and in consideration of the sum of $ , receipt of which is hereby acknowledged, the party of the first part hereby sells137 to the party of the second part, and the party of the second part hereby buys from the the party of the first part, the lot and building located at Houston, Harris County, Texas, and known as Lot , Block , Clinton Park Addition, Houston, Harris County, Texas, subject to the following conditions and covenants: * "4. That the party of the first part hereby sells to the party of the second part, or his assigns, the above-described premises, together with the buildings thereon, and the personal property and equipment appurtenant thereto, which includes all additions and improvements thereto, if any, that may be made during the term of this Agreement, upon and subject to the following terms and conditions: "a. The purchase price of said building and lot shall be $ , of which $ has been received and acknowledged as hereinbefore mentioned. "b. This purchase agreement, although now operative, can only be competely consumated after the sum of $ has been in hand paid by party of the second part or his assigns, to party of the first part, or his assigns, irrespective, exclusive and apart from that monthly portion applied on the Federal Housing Administration loan, together with138 taxes, insurance and interest. That this purchase agreement is offered only upon the specific promise of the party of the second party [part] to make full and complete payment of this said sum of $ , to party of the first part, or his assigns, and is acknowledged by both parties hereto as valuable consideration therefor, and failure on part of party of the second part to make the hereinafter quoted weekly payment on this amount, as well as on his principal loan indebtedness, shall constitute a material breach of this Agreement and shall render same null and void and of no effect. "The payments on this building and lot shall be as follows: Weekly payments in the amount of $ are to be made by party of the second part to party of the first part, and party of the first part does hereby agree to promptly pay the amount of $ per month to the Federal Housing Administration, its agents or assigns, said amount of $ shall constitute the monthly installment payment on the principal indebtedness of $ , together with interest, taxes and insurance, and the party of the first part does hereby agree to furnish party of the second part with a tax and insurance dispensation statement upon the demand139 of the party of the second part for same. "The difference between the said $ per week to be paid by the party of the second part to the party of the first part, the amount of $ per month as paid by the party of the first part on the Federal Housing Administration loan (said amount also including payment of said interest, taxes and insurance), less the deduction of interest in the amount of six per cent per annum on that sum of $ , hereinabove memtioned, due the party of the first part, shall be credited to the account of the party of the second part and is here now and hereinafter referred to as party of the second part's Option Deposit. "When party of the second part's Option Deposit shall amount to $ and after the buyer has qualified for a loan under the Federal Housing Administration requirements and has been accepted by the said Federal Housing Administration, then a General Warranty Deed, subject to the then existing mortgage of record, shall be executed by party of the first part to party of the second part. * "7. The party of the second part shall have the right to possession and use of the above-described premises immediately upon the execution of this agreement, 140 which possession shall continue so long as no default or breach by party of the second part occurs. "8. Time and punctuality in making said weekly payments are material and essential ingredients and of the essence of this agreement and failure on the part of the party of the second part to make the installment payments as hereinabove set forth, and interest and other assessments promptly and literally as provided herein; or default in the performance of any of the other obligations enjoined upon party of the second party [part] by this Agreement, shall entitle party of the first part to cancel and void this Agreement and to take immediate possession of the abovedescribed premises and improvements thereon and party of the second part does hereby agree to give peaceable possession and does hereby waive notice by party of the first part of such default or breach; and all payments theretofore made by party of the second part, or assigns, under this agreement, shall thereupon be deemed and held to have been rental for the period of occupancy up to the time of forfeiture and cancellation, * * ." * The purchasers were required to make a down payment of $25.00. The purchase141 price of the houses varied, but the one sale contract in evidence discloses a sale price of $2,435. The purchaser's weekly payments were $4.90; the Option Deposit was $285. During the fiscal year ending August 31, 1943, the petitioner repossessed 68 of 507 houses. In the following year 27 houses were repossessed by petitioner. The only financial requirement to purchase a house in this development was an income of $18 per week. In its return for the fiscal year ending August 31, 1942, the petitioner sought to deduct $42,603.80 as finance charges in securing the mortgage loans. The respondent determined that $23,407.70 was not properly deductible in that fiscal year. Opinion VAN FOSSAN, Judge: The sole issue in this proceeding is whether the petitioner may deduct under the provisions of section 23 (a) (1) (A) of the Internal Revenue Code1 $23,407.70 representing finance charges incurred in securing loans. The expense of obtaining a loan lasting more than one year and secured by a mortgage on real property, should be capitalized and amortized over the life of the loan. S. & L. Building Corporation, 19 B.T.A. 788">19 B.T.A. 788, reversed on other grounds, 142 60 Fed. (2d) 719, reversed, 288 U.S. 406">288 U.S. 406. It was there held that when the mortgaged property is sold the unamortized portion of the fees and expenses should be charged off in the year of sale. In that instance the mortgages were assumed by the purchasers. The court said in reference to a hypothetic seller, " * * He, having shifted the burden of his mortgage to other shoulders, stands in the same situation as if he had paid it off and therefore should be allowed to deduct the remaining portion of his unamortized mortgage fees." In Metropolitan Properties Corporation, 24 B.T.A. 220">24 B.T.A. 220, unamortized discount on bonds was held deductible in the year of sale of mortgaged property subject to the lien of the mortgage. In that case the mortgage was not assumed by the purchaser and the petitioner remained primarily liable on the loan and was required to remit the trust deed payments to the mortgagee. The sale of the mortgaged property was consummated in 1926. Deduction of the unamortized portion of brokerage fees and commissions incurred in securing a mortgage loan was allowed in the year of dissolution of the petitioner in Longview Hilton Hotel Company, et al., 9 T.C. 180">9 T.C. 180.143 No distinction was drawn between the sale of the mortgaged property and the distribution to stockholders in liquidation. The Clinton Park Development Company seeks to justify the deduction of the finance charges on the ground that it sold the mortgaged property during the fiscal year in question. However, the contracts of sale remained executory in many respects. For example, the contract became null and void if the purchaser failed to make his payments. Failure to pay an installment would allow petitioner to cancel the agreement and to treat prior payments as rent. No deed would pass until the Option Deposit aggregated a specified sum. Before receiving a deed to the property the purchaser was required to meet Federal Housing Administration requirements. The contract, by its terms, became operative at once but was consummated only after the Option Deposit amount was reached. This method of conducting its real estate business enabled petitioner to protect itself. Quick repossession could be made upon the failure of the purchaser's payments in any one week. We are of the opinion that the contract, being executory, was not a completed sale as required for the deduction of finance144 charges. The execution of a contract of sale did not terminate the period in which the petitioner had the use of the borrowed money. The petitioner did not pass the burden of the mortgage to the purchaser as of the time the contract was signed. The petitioner corporation remained liable for the deed of trust installment payments. Unlike the Metropolitan Properties Corporation situation, the purchaser did not make payments to petitioner to be remitted to the mortgagee. In the present instance, the purchaser paid a greater sum than the amount remitted by petitioner. When the difference totaled a specified amount, the purchaser then received title to the property upon meeting Federal Housing Administration qualifications. The sale in the present instance remained executory, whereas the Metropolitan Properties Corporation case involved a completed sale of mortgaged property subject to a mortgage lien. The vendee of an executory contract may, as petitioner points out, receive an equitable title and interest in the property. In the present case the purchaser's interest included the right to possession and use of the premises as long as no breach of contract occurred. As above noted, despite*145 the transfer of possession and of an equitable interest in the property, the contract, by its terms, remained executory. For this reason it differs from the sales found in the cited cases. The burden of the mortgage was not shifted by petitioner to others. The petitioner's contention must fail and the expenses must be amortized over the life of the loan or until the mortgaged property is eventually sold to the purchaser. 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.—(1) Trade or business expenses.—(A) In general.—All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered: traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business: and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4562805/	Electronic Document Sep 1 2020 10:13:10 2020-M-00555 Pages: 5 Serial: 233504 IN THE SUPREME COURT OF MISSISSIPPI No. 2020-M-00555 SANFORD MASON Petitioner v. STATE OF MISSISSIPPI Respondent ORDER This matter is before the Court on the Application for Leave to Proceed in the Trial Court filed pro se by Sanford Mason. The Court finds that absent an exception, the petition is untimely and successive. Miss. Code Ann. §§ 99-39-5, 99-39-27 (Rev. 2015). The Court further finds that Mason's claims have been rejected in prior proceedings and are now barred by res judicata. After due consideration, we find that Mason has presented no arguable basis for his claims, that no exception to the procedural bars exists, and that the petition should be dismissed. See Means v. State, 43 So. 3d 438, 442 (Miss. 2010). Notwithstanding the procedural bars, the Court finds that the claims raised in the petition are without merit. The Court further finds that the claims raised in the successive petition are frivolous. Mason is warned that future filings deemed frivolous could result in monetary sanctions or in restrictions on his ability to file applications for post-conviction collateral relief (or pleadings in that nature) in forma pauperis. See Order, Dunn v. State, No. 2016- M-01514 (Miss. Nov. 15, 2018). IT IS THEREFORE ORDERED that the Application for Leave to Proceed in the Trial Court filed by Sanford Mason is dismissed. TO DISMISS WITH SANCTIONS WARNING: MAXWELL, BEAM, CHAMBERLIN, ISHEE AND GRIFFIS, JJ. TO DENY WITH SANCTIONS WARNING: RANDOLPH, C.J., AND COLEMAN, J. TO DISMISS WITHOUT SANCTIONS WARNING: KITCHENS AND KING, P.JJ. KING, P.J., OBJECTS TO THE ORDER IN PART WITH SEPARATE WRITTEN STATEMENT JOINED BY KITCHENS, P.J. SO ORDERED. 2 IN THE SUPREME COURT OF MISSISSIPPI No. 2020-M-00555 SANFORD MASON v. STATE OF MISSISSIPPI KING, PRESIDING JUSTICE, OBJECTING TO THE ORDER IN PART WITH SEPARATE WRITTEN STATEMENT: ¶1. Although I agree that Sanford Mason’s application for post-conviction relief should be dismissed, I disagree with the Court’s finding that the application is frivolous and with its warning that future filings deemed frivolous may result in monetary sanctions or restrictions on filing applications for post-conviction collateral relief in forma pauperis.1 ¶2. This Court previously has defined a frivolous motion to mean one filed in which the movant has “no hope of success.” Roland v. State, 666 So. 2d 747, 751 (Miss. 1995). However, “though a case may be weak or ‘light-headed,’ that is not sufficient to label it frivolous.” Calhoun v. State, 849 So. 2d 892, 897 (Miss. 2003). In his application for post- conviction relief, Mason made reasonable arguments. As such, I disagree with the Court’s determination that Mason’s application is frivolous. ¶3. Additionally, I disagree with this Court’s warning that future filings may result in monetary sanctions or restrictions on filing applications for post-conviction collateral relief 1 See Order, Dunn v. State, No. 2016-M-01514 (Miss. Nov. 15, 2018). in forma pauperis. The imposition of monetary sanctions on a criminal defendant proceeding in forma pauperis only serves to punish or preclude that defendant from his lawful right to appeal. Black’s Law Dictionary defines sanction as “[a] provision that gives force to a legal imperative by either rewarding obedience or punishing disobedience.” Sanction, Black’s Law Dictionary (10th ed. 2014) (emphasis added). Instead of punishing the defendant for filing a motion, I believe that this Court should simply deny or dismiss motions that lack merit. As Justice Brennan wisely stated, The Court’s order purports to be motivated by this litigant’s disproportionate consumption of the Court’s time and resources. Yet if his filings are truly as repetitious as it appears, it hardly takes much time to identify them as such. I find it difficult to see how the amount of time and resources required to deal properly with McDonald’s petitions could be so great as to justify the step we now take. Indeed, the time that has been consumed in the preparation of the present order barring the door to Mr. McDonald far exceeds that which would have been necessary to process his petitions for the next several years at least. I continue to find puzzling the Court’s fervor in ensuring that rights granted to the poor are not abused, even when so doing actually increases the drain on our limited resources. In re McDonald, 489 U.S. 180, 186–87, 109 S. Ct. 993, 997, 103 L. Ed. 2d 158 (1989) (Brennan, J., dissenting).2 2 See also In re Demos, 500 U.S. 16, 19, 111 S. Ct. 1569, 1571, 114 L. Ed. 2d 20 (1991) (Marshall, J., dissenting) (“In closing its doors today to another indigent litigant, the Court moves ever closer to the day when it leaves an indigent litigant with a meritorious claim out in the cold. And with each barrier that it places in the way of indigent litigants, and with each instance in which it castigates such litigants for having ‘abused the system,’ . . . the Court can only reinforce in the hearts and minds of our society’s less fortunate members the unsettling message that their pleas are not welcome here.”). 2 ¶4. The same logic applies to the restriction on filing subsequent applications for post- conviction relief. To cut off an indigent defendant’s right to proceed in forma pauperis is to cut off his access to the courts. This, in itself, violates a defendant’s constitutional rights, for Among the rights recognized by the Court as being fundamental are the rights to be free from invidious racial discrimination, to marry, to practice their religion, to communicate with free persons, to have due process in disciplinary proceedings, and to be free from cruel and unusual punishment. As a result of the recognition of these and other rights, the right of access to courts, which is necessary to vindicate all constitutional rights, also became a fundamental right. Joseph T. Lukens, The Prison Litigation Reform Act: Three Strikes and You’re Out of Court-It May Be Effective, but Is It Constitutional?, 70 Temp. L. Rev. 471, 474–75 (1997). This Court must not discourage convicted defendants from exercising their right to appeal. Wisconsin v. Glick, 782 F.2d 670, 673 (7th Cir. 1986). Novel arguments that might remove a criminal defendant from confinement should not be discouraged by the threat of monetary sanctions and restrictions on filings. Id. ¶5. Therefore, although I find no merit in Mason’s application for post-conviction relief, I disagree with this Court’s contention that the application merits the classification of frivolous and with its warning of future sanctions and restrictions. KITCHENS, P.J., JOINS THIS SEPARATE WRITTEN STATEMENT. 3	01-04-2023	09-03-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623158/	Leach Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentLeach Corp. v. CommissionerDocket No. 57494United States Tax Court30 T.C. 563; 1958 U.S. Tax Ct. LEXIS 163; June 12, 1958, Filed 163 Decision will be entered under Rule 50. 1. Held, that notwithstanding a high debt-to-capital ratio in respect of taxpayer corporation's financial structure, the indebtedness, when considered in the light of all the evidence, was bona fide, and interest with respect thereto is deductible.2. Held, certain expenses were incurred in connection with issuance of bonds and may therefore be amortized over the life of the bonds. John B. Milliken, Esq., and Harrison Harkins, Esq., for the petitioner.Sidney J. Machtinger, Esq., for the respondent. Raum, Judge. RAUM563 The respondent determined the following deficiencies in income tax of petitioner:Taxable yearAmountApr. 22 1949 to Feb. 28, 1950$ 7,719.94Fiscal year ended Feb. 28, 19519,666.70Fiscal year ended Feb. 29, 195235,634.39The petitioner contends that it overpaid its tax for each of the periods listed above and that it is entitled to a refund.The parties have entered into stipulations relating to issues involving the amount of depreciation allowable for each year, and also the amount of capital gain or loss on machinery and equipment sold during the year ended February 29, 164 1952. These issues will be disposed of under Rule 50.The remaining issues are (1) whether amounts accrued as interest on bonds in each of the taxable years are deductible, and (2) whether petitioner is entitled to annual deductions for amortized portions of fees and expenses incurred in connection with the issuance of the bonds. The amounts involved in these issues are as follows:Amortizationof feesandTaxable yearInterest on bondsexpensesApr. 22, 1949 to Feb. 28, 1950$ 16,168.00$ 4,147.63Year ended Feb. 28, 195118,833.198,463.96Year ended Feb. 29, 195217,599.924,381.32FINDINGS OF FACT.Some of the facts have been stipulated and they are incorporated herein by reference.The petitioner is a corporation organized under Delaware law on April 22, 1949; and is the surviving corporation incident to a statutory merger, to which petitioner and Leach Relay Co., a California corporation (hereinafter sometimes called Leach of California), were the parties.564 The original corporate name of petitioner was Leach Relay Co., but on February 26, 1954, its name was changed to Leach Corporation.Petitioner's principal business office is165 in Los Angeles, California. It filed its tax returns, on an accrual basis, for the taxable years (the period April 22, 1949, to February 28, 1950, and the fiscal years ended February 28, 1951, and February 29, 1952) with the then collector of internal revenue for the sixth district of California at Los Angeles, California.In February of 1946, Joseph F. Clark acquired control of Leach of California, a then dormant corporation, and this corporation acquired by purchase the inventory, fixed assets and unfilled orders of an operating electrical relay manufacturing business.An electrical relay may be described as an electro-magnetic contact-making or contact-breaking device, operated by a variation in the condition of one electric current to affect the operation of switches or devices operating in the same, or a different, electric current. A common use for electrical relays is to operate, by remote control, switches and devices in airplanes.Joseph F. Clark owned all of the issued and outstanding stock of Leach of California, which consisted of 2,000 shares of no-par stock with a stated value on the books of $ 20,000, or $ 10 per share.G. L. Ohrstrom & Co., a partnership, was an 166 investment banking firm, located in New York, which specialized in acquiring industrial companies, and the placing of the securities of such companies with its clients. It also had a staff experienced in industrial management to supervise the management of acquired companies. George L. Ohrstrom (who died in November of 1955) was the general partner in the firm, and there were several special partners.Robert Benson, Lonsdale & Co. Limited, and Robert Fleming & Co. Limited (hereinafter referred to as Benson Limited and Fleming Limited respectively), are English investment banking houses located in London, England, which specialize in placing investments in American securities. The two firms have operated in financing American investments for about 70 years.Benson Limited and Fleming Limited invest money on behalf of clients, both institutional and private, but chiefly institutional clients in the form of English and Scottish investment trusts. An investment trust is a trust company formed for investment purposes with a managing board of four or five directors. In some, but not all cases, the English and Scottish investment trusts of interest in this proceeding had a member of 167 Benson Limited or Fleming Limited on their boards of directors to render financial advice, but the function of Benson Limited and Fleming Limited in this regard was simply to advise and recommend investments to the trusts as specialists in American securities, and the boards of directors of the investment trusts independently established their own investment policies.565 Benson Limited and Fleming Limited had had business relations with George L. Ohrstrom and G. L. Ohrstrom & Co. for some 30 years, and they had bought a great number of securities through the Ohrstrom Co. The English firms had great confidence in G. L. Ohrstrom & Co. and its managerial abilities, and they were interested in any investment recommended by it, in cases where the management of the continuing operations of the subject company would be supervised by Ohrstrom & Co.G. L. Ohrstrom & Co., became interested in acquiring the relay business operated by Leach of California. It first sought to purchase the land, buildings, and operating assets of that corporation. Joseph F. Clark refused to negotiate on the basis of a sale of assets, but was agreeable to a sale of the capital stock of Leach of California168 for $ 620,000, of which $ 520,000 was to be paid in cash and the remainder by notes.Sometime prior to April 11, 1949, George L. Ohrstrom entered into negotiations with representatives of Benson Limited and Fleming Limited with the object of securing funds to finance the venture. He apprised them of what Leach of California had done and was doing, and showed them its balance sheet for the year ended February 28, 1949. The balance sheet disclosed that its assets, liabilities and net worth on that date were as follows:AssetsCurrent assets$ 381,673.06Fixed assets (net book value):Land$ 8,515.50 Buildings31,480.32 Other fixed assets31,542.58Total71,538.40Other assets (exclusive of good will)17,815.71Total assets471,027.17Liabilities and Net WorthCurrent liabilities (including reserve for Federal income taxes $ 116,464.85)$ 162,042.35Net worth: Capital stock -- Authorized 2,500 shares of no par value -- issued and outstanding 2,000 shares$ 20,000.00Earned surplus: Balance Mar. 1, 1948$ 99,540.83 Add -- Net profit year ending Feb. 28, 1949, after provision for Federal income taxes189,443.99 Balance Feb. 28, 1949288,984.82Total net worth308,984.82Total liabilities and net worth471,027.17169 566 Ohrstrom told the representatives of the two English banking houses that, with orders in hand, the prospect was that the future earnings of the business would be about $ 240,000 per year.At that time certain foreign exchange control policies of Great Britain were being administered by the Bank of England and permission had to be obtained from the Bank of England by British residents before investment in securities of a foreign corporation could be made. The general policy of the Bank of England was not to permit the English banking houses or their investment-trust clients to invest in stock, common or preferred, of an American corporation whose stock was not traded on a recognized stock exchange, and not to permit a loan to be made to such a corporation that was not secured by a mortgage. The Bank of England did not require that mortgaged assets have a value equivalent to the amount of a loan.Benson Limited and Fleming Limited were aware of the policy of the Bank of England and told Ohrstrom that neither they nor their investment-trust clients would be interested in the stock of a small California corporation which was not listed on any stock exchange, and that, in 170 any event, the Bank of England would not permit the purchase of such stock. A plan was finally formulated which met with the approval of the two English banking houses. Under this plan a new Delaware corporation was to be organized and used to effectuate the acquisition of the stock of Leach of California. Its initial capital stock was to be 1,000 shares of common stock having a par value of $ 1 per share. Within a short time its capital stock was to be increased to 105,000 shares of the same par value. It was to issue 5 per cent first mortgage bonds in the amount of $ 400,000, payable on or before December 1, 1956, which were to be secured by a first mortgage or deed of trust on its land and buildings and were to contain a provision for mandatory redemption, from time to time, through the operation of a sinking fund accumulated from 80 per cent of its net earnings. Benson Limited and Fleming Limited were to purchase these bonds for $ 400,000 and acquire 500 shares of its initial capital stock for $ 1 per share. Ohrstrom and his associates were to acquire a controlling interest of approximately 52 per cent of the stock (500 shares of the initial issue and 50 shares to be issued171 shortly thereafter) for $ 550. When the purchase of the stock of Leach of California was consummated, its business and assets were to be acquired by the new corporation. Joseph F. Clark was to be retained as its president and placed in charge of all of its operations, subject to George L. Ohrstrom's supervision as chairman of its board of directors.Benson Limited and Fleming Limited applied to the Bank of England for permission to make an investment of $ 400,000 in bonds of the new Delaware corporation and of $ 500 in its stock, and the bank gave its consent to these investments.567 One of the factors which induced the two English banking houses to obligate themselves to purchase the bonds was that they were to receive 500 shares of stock for a nominal amount. It was their intention to sell the bonds to their investment-trust clients, and they were satisfied that the bonds, with shares of stock as an added feature, would be a good investment for their clients. They would not have recommended that their clients invest in the bonds without the shares of stock. However, they were content to let the Ohrstrom group acquire majority stock control, because, among other reasons, 172 neither they nor their clients desired management control of foreign business investments, and they were not equipped to assume management control of industrial operations.On April 11, 1949, Joseph F. Clark as the "seller" and G. L. Ohrstrom & Co. as the "purchaser" entered into a written "Stock Purchase Agreement" for the sale and purchase of the 2,000 shares of the capital stock of Leach of California. The agreed consideration to be paid for the stock was $ 620,000, payable as follows:(a) $ 520,000 in cash at closing.(b) The balance, $ 100,000, to be represented by four notes as follows: (1) A non-interest bearing note for $ 25,000 due June 10, 1949.(2) Three notes of $ 25,000 each, dated as of date of closing, bearing 5 per cent per annum interest, and payable on or before six, twelve and eighteen months respectively from the date of the note.The stock purchase agreement stated as part of its terms that the purchaser represented he would assign the agreement rights to a corporation formed or to be formed and that such "assignee of purchaser shall have funds in cash of at least $ 400,000.00 which may be represented by secured debt of such assignee and may at the option173 of such assignee become an encumbrance upon the stock being sold hereunder, the company or its assets which may be evidenced by a trust deed (mortgage) of or on the land and buildings." The agreement also provided that the $ 400,000 cash funds be paid to the seller as part of the purchase price.The agreement further provided that the purchaser "may at any time assign this agreement and all its rights and obligations hereunder to a corporation (organized or to be organized) which shall assume all the purchaser's rights and obligations hereunder; and upon such assignment the purchaser shall thereupon be relieved and released of all obligations and liability hereunder to the seller under any of the covenants, terms or conditions of this agreement."G. L. Ohrstrom & Co. caused the petitioner to be incorporated under the laws of Delaware on April 22, 1949; and on April 26, 1949, G. L. Ohrstrom & Co. assigned to the petitioner all of its rights and obligations under the Stock Purchase Agreement.568 The initial authorized capital stock of petitioner consisted of 1,000 shares with a par value of $ 1 per share, and on April 25, 1949, petitioner issued to Albert Boustead all of its 174 capital stock (1,000 shares) for $ 1,000 in cash. The shares were issued in the name of Boustead as nominee for the persons, other than himself, who were, or were to become, the beneficial owners of the shares. Albert Boustead was an associate of G. L. Ohrstrom & Co.In order to pay Joseph F. Clark the $ 520,000 in cash required by the terms of the Stock Purchase Agreement it was necessary to obtain some interim financing from the Bank of America. On May 2 or 3, 1949, Vernon R. Y. Lynn, president of the petitioner, applied to this bank for a loan of not to exceed $ 225,000. The bank requested assurance that the $ 400,000 of bonded indebtedness would at all times be subordinate to the claim of the bank in connection with the proposed loan. On May 3, 1949, the board of directors of petitioner adopted a resolution that no bonds or pledge of security of any of the assets of the corporation would be issued or granted in connection with the bond issue of $ 400,000 until the indebtedness to the Bank of America in connection with the interim financing had been paid, and the bank received the requested assurance. On May 6, 1949, petitioner borrowed $ 170,000 from the Bank of America for175 a 10- or 12-day period as an interim "closing loan" for use in purchasing the stock of Leach of California. This money was repaid to the bank on May 12, 1949.On May 5 and 6, 1949, the petitioner received $ 400,000 from Benson Limited and Fleming Limited.On May 5, 1949, 1 the petitioner acquired all of the capital stock of Leach of California pursuant to the terms of the Stock Purchase Agreement, for a cash payment of $ 520,000, plus the issuance to Joseph F. Clark of four promissory notes, each dated May 5, 1949, and each in the amount of $ 25,000. The due date of the first note was June 10, 1949, and the other three notes were dated May 5, 1949, and were due on or before 6, 12, and 18 months, respectively, from May 5, 1949. Leach of California was merged into petitioner as of the close of business on May 6, 1949.176 The balance sheet of Leach of California at May 6, 1949, prior to merger, was as follows:AssetsCurrent assets: Cash$ 227,755.87 Accounts receivable less reserve118,381.42 Inventories131,288.29Total current assets$ 477,425.58Fixed assets (net book value): Land$ 8,515.50 Buildings31,261.91 Furniture and fixtures6,311.59 Machinery and equipment12,477.10 Dies and jigs14,520.89 Automobiles and trucks2,141.93 Patents0 Total fixed assets$ 75,228.92 Other assets6,365.98Total assets559,020.48Liabilities and Net WorthCurrent liabilities: Accounts payable -- trade$ 34,334.74 Salaries, wages, commissions16,603.31 Christmas bonus2,932.25 Payroll taxes and insurance6,189.84 State franchise tax10,619.84 Other taxes6,241.56 Reserve Federal income tax138,019.86Total current liabilities$ 214,941.40Net worth: Capital stock (authorized 2,500 shares no par) issued and outstanding, 2,000 shares20,000.00 Earned surplus324,079.08Total liabilities and net worth559,020.48569 The amount paid and payable 177 by petitioner in acquiring the stock of Leach of California ($ 620,000), plus capitalized expenditures incurred in the purchase transaction, was $ 278,420.92 in excess of the book value of the net assets of Leach of California.The cost bases to the petitioner at May 7, 1949, of the assets listed below which it had acquired from Leach of California were as follows:Land$ 16,000.00Buildings64,000.00Office equipment and furniture20,798.00Shop machinery and equipment46,301.00Shop fixtures14,483.00Dies and jigs63,000.00Automobiles and trucks2,880.00Subtotal227,462.00Goodwill126,187.84Total353,649.84570 On May 9, 1949, George L. Ohrstrom was elected chairman of the board of directors of petitioner, and Joseph F. Clark was elected president. They served in these capacities during the taxable years involved in this proceeding.On July 19, 1949, the petitioner increased its authorized capital stock to 105,000 shares with a par value of $ 1 per share.On July 28, 1949, Elizabeth J. Ohrstrom, Margaret H. Cavanaugh, H. T. Cavanaugh, Gretchen Stubbs, and Merrill Stubbs became the holders of record of 500 of the 1,000 shares of common178 stock originally issued on April 25, 1949, in the name of Albert Boustead. On the same date, July 28, 1949, the petitioner issued to Albert Boustead 50 shares of its common stock for $ 50 in cash, and he was the beneficial owner, as well as the record owner of these shares. These individuals, hereinafter referred to as the Ohrstrom Group, were partners and associates, and the wives of partners and associates, of the New York partnership of G. L. Ohrstrom & Co. This group, on July 28, 1949, owned 52.38 per cent of the issued and outstanding stock of petitioner, but was not at any time material herein the owner of record or the beneficial owner of any of its bonds. The remaining 47.62 per cent of the capital stock of petitioner (500 shares of its initial issue) was acquired for $ 500 by the British Group (composed of Benson Limited and Fleming Limited and their clients), and it acquired all of petitioner's bonds.The stock and bonds of petitioner held by the British Group were registered in "street names," and were beneficially owned by persons resident in Great Britain. "Street names" are names used by banks, brokerage houses, and the like, to hold of record securities in their179 custody which are beneficially owned by their clients.The following companies became the holders of record of 500 of the 1,000 shares of common stock originally issued on April 25, 1949, in the name of Albert Boustead, on the dates and in the amounts listed below:DateNumber of sharesMay 10, 1949Cudd & Co38 3/4May 10, 1949Grace Church Co18 3/4May 10, 1949Clark, Dodge & Co30 May 10, 1949C. A. England & Co20 May 10, 1949Egger & Co12 1/2July 28, 1949Shaw & Co380 On December 6, 1949, the petitioner paid a stock dividend of 103,950 shares to its stockholders of record.On February 21, 1950, Shaw & Co. made the following transfers of stock:SharesTo Wonham, Albert & Co23,750To Suydam & Co750To Egger & Co3,750571 Prior to February 21, 1950, the percentage of ownership of record of shares of stock and bonds of petitioner, by the eight companies, was not in direct proportion. On February 21, 1950, their respective holdings of record among themselves were in direct proportion, and were as follows:StockBondsRecord holderTotalPercentageAmountPercentagesharesCudd & Co3,8757 3/4$ 31,0007 3/4Grace Church Co1,8753 3/415,0003 3/4Clark, Dodge & Co3,0006 24,0006 C. A. England & Co2,0004 16,0004 Egger & Co5,00010 40,00010 Shaw & Co9,75019 1/278,00019 1/2Suydam & Co7501 1/26,0001 1/2Wonham, Albert & Co23,75047 1/2190,00047 1/2Totals50,000100 400,000100 180 While there was no requirement that the stock and bonds be passed on to the clients of Benson Limited and Fleming Limited in exact proportions, it is the usual practice to do so in ventures of this kind. After the stock dividend was declared each beneficial owner of bonds owned 125 shares of stock for each $ 1,000 bond.There was no impediment or restriction on the resale, by clients of Benson Limited and Fleming Limited, of the securities of petitioner acquired by them.The $ 400,000 received by petitioner for the issue of its "5% 1st Mortgage Bonds" was paid by Benson Limited and Fleming Limited from their own funds. They took the original risk, and, with the exception of amounts retained by these two firms and by their members, sold the remainder to their English and Scottish investment-trust clients. Neither the petitioner, nor its controlling stockholders, the Ohrstrom Group, had any control over the resale of petitioner's securities by Benson Limited and Fleming Limited.The bonds of petitioner were issued as of May 10, 1949, and were in the conventional form of a mortgage bond indebtedness, with a sinking fund provision. They had a fixed due date, and were payable on December181 1, 1956. They provided for the payment of interest semiannually, at the rate of 5 per cent per annum, on the unpaid balance of principal on the first day of June and December of each year, with the first payment due December 1, 1949; for acceleration of the maturity date in the event that the payment of interest was in default for a specified period, or if the petitioner became bankrupt, or insolvent, or went into voluntary or involuntary liquidation; and for the setting up of a sinking fund reserve, semiannually on or before June 1 and December 1 of each year, commencing June 1, 1950, for the purchase, redemption or partial payment of the bonds, in an amount equal 572 to 80 per cent of its net earnings for the prior 6 months' fiscal period ending February 28 and August 31, respectively. The sinking fund reserve was to be applied as soon as practical on or after June 1, 1950, and on or after each June 1 and December 1 thereafter, to the purchase, redemption or partial payment of the bonds. No other use could be made of the sinking fund reserve.The bonds were in registered form. They were redeemable from time to time, at the option of petitioner, upon notice. They required182 that payment of the principal and interest be secured by a first mortgage or deed of trust on all of the real property, and the buildings and improvements thereon, then owned by the company, or which the company thereafter acquired, subject to any existing mortgage or deed of trust on property then owned, and subject to any purchase money mortgage or deed of trust on after-acquired property. In the event of voluntary or involuntary dissolution or liquidation, or in the event of insolvency, neither the principal of the bonds, nor unpaid interest, could be paid "from the general assets of the Company" until all obligations of the company representing money borrowed from banks or trust companies on short-term maturities not exceeding 18 months, in an amount not exceeding $ 150,000 in the aggregate, were paid; however, rights under the mortgage were to remain unaffected by the foregoing priority with respect to the general assets.The deed of trust securing the petitioner's 5 per cent first mortgage bonds was executed on October 24, 1949, and was filed of record on November 3, 1949, in the office of the county recorder of Los Angeles County, California. The delay in executing the document183 was attributable principally to difficulties encountered in selecting trustees.The deed was executed by the petitioner as trustor, naming as trustees three individuals and their respective successors, for the benefit of the registered holders of each and every bond as beneficiaries. It authorized the trustor, together with beneficiaries holding not less than a majority in face amount of the bonds then outstanding, to substitute, from time to time, a successor to any trustee. It granted to the trustees, in trust and "with power of sale," the real estate of petitioner, together with all buildings and improvements thereon, for the purpose of securing all of the petitioner's obligations under its bonds. It provided that, in the event of any default by the trustor, the trustees may, on their own volition, and shall, on the written request of the beneficiaries holding not less than a majority in face amount of the bonds then outstanding, declare all sums secured by it to be immediately due and payable, by delivering written notice to trustor, together with demand for sale or notice of election to cause the property to be sold. It specified the procedure for sale at public auction under184 the trustees' power of sale, with the application of the proceeds to the payment, with interest, of sums expended by 573 the trustees, the payment of all other sums secured by the deed, and the payment of the remainder, if any, to the person or persons legally entitled thereto.One of the three trustees was Vernon Lynn, who was president and a director of petitioner from April 25, 1949, to May 9, 1949, and held a power of attorney from G. L. Ohrstrom & Co. He and the other two trustees were members of a New York law firm which had been counsel for Ohrstrom in many matters, including the setting up of companies.If the petitioner had defaulted on its bonds, the investment trusts and the Bank of England would have insisted upon the enforcement of the security obligations; and Benson Limited and Fleming Limited considered they had a fiduciary responsibility to protect the interests of the investment trusts.Except as modified with the written consent of the bondholders, the requirements of the sinking fund provisions of the bonds were observed by the petitioner. Bonds in the principal amount of $ 40,000 were redeemed on July 31, 1950, and $ 8,000 in bonds were redeemed on December185 19, 1950, leaving bonds outstanding in the principal amount of $ 352,000. The sinking fund reserve as of February 28, 1951, was $ 112,637.23. Prior to June 1, 1951, the petitioner obtained the written consents of the bondholders to defer the application of the mandatory redemption features of the sinking fund for a period not beyond June of 1952, and to use the reserve, to the extent required, as additional working capital then needed to handle increased business incident to the National Defense program. On its accounting records the petitioner showed, as "Restricted" surplus reserved for the retirement of its bonds, the following amounts of sinking fund reserves:Year ended Feb. 28, 1951$ 112,637.23Year ended Feb. 29, 1952352,000.00In March of 1951, the petitioner sought to establish a line of credit with the Bank of America; but negotiations were terminated because the bank insisted on a condition that the sinking fund provisions be subordinated to the proposed line of credit, and petitioner felt the bondholders would not consent to this.On January 7, 1952, petitioner increased its authorized capital stock to 109,200 shares, of which 105,000 shares, with a par 186 value of $ 2 a share, was common stock, and 4,200 shares without par value, was $ 5 cumulative preferred stock.In February of 1952, the directors of petitioner discussed the matter of refinancing the 5 per cent first mortgage bonds outstanding, in view of the fact that under the sinking fund provisions the $ 352,000 balance of the bonds was due for redemption in June of 1952. The officers of petitioner were authorized by the directors to negotiate and enter into a loan agreement with Atlantic Life Insurance Company to 574 borrow $ 300,000 to apply in redemption of the outstanding bonds at the earliest practicable date.The Atlantic Life Insurance Company refused to make the $ 300,000 loan unless it was given the right to purchase 16,800 shares of petitioner's common stock at 10 cents a share.On March 4, 1952, the petitioner purchased as treasury stock all of the stock held by the British investment trusts. Benson Limited and Fleming Limited did not sell their own shares. The shares purchased (42,250 shares of common stock) were bought at a price of $ 8 a share, payable in terms of $ 4 a share in cash and $ 4 a share in promissory notes (due on or before August 31, 1955) 187 which were to be convertible later into any preferred stock petitioner might issue.Out of the 42,250 shares of common stock purchased by petitioner on March 4, 1952, it distributed 25,450 shares on March 7, 1952, as a stock dividend on its then outstanding common stock. On the same date petitioner distributed as a stock dividend to its common stockholders 2,510 shares of its $ 5 cumulative preferred stock. The preferred stock was assigned a stated value of $ 100 a share, and $ 251,000 was transferred from surplus to capital account upon the issuance of the preferred shares.On March 10, 1952, petitioner granted the Atlantic Life Insurance Company the right to purchase up to 16,800 shares of petitioner's common stock, then held in its treasury, at 10 cents per share at any time on or before April 30, 1952.On March 10, 1952, petitioner borrowed $ 300,000 from Atlantic Life Insurance Company of Richmond, Virginia, on its unsecured promissory note, due on or before August 31, 1959, bearing interest on the amount of unpaid principal at the rate of 5 per cent per year, payable semiannually on the last days of February and August in each year, commencing August 31, 1952. Under a concurrent188 loan agreement, the petitioner was obligated to use the borrowed funds together with other funds to retire all of its 5 per cent first mortgage bonds.On March 10, 1952, the petitioner redeemed the remaining balance, $ 352,000, of its 5 per cent first mortgage bonds with the $ 300,000 borrowed from Atlantic Life Insurance Company, and $ 52,000 of its own funds.On March 24, 1952, the Atlantic Life Insurance Company exercised its option to purchase 16,800 shares of petitioner's common stock for 10 cents per share.On April 1, 1952, petitioner issued 1,690 shares of its $ 5 cumulative preferred stock, at an assigned value of $ 100 a share, in exchange for the promissory notes (in the total amount of $ 169,000) then held by the British investment trusts.575 The decision to issue preferred stock to the British investment trusts arose out of events incident to the borrowing of funds from Atlantic Life Insurance Company in 1952, and there was no plan, at the inception of the corporate life of petitioner, to issue preferred stock to the British interests.During the years here involved:(a) Residents of the United Kingdom not engaged in trade or business in the United States were 189 exempt from United States tax on gains from the sale or exchange of capital assets;(b) Interest on bonds, securities, notes, debentures, etc., derived from sources within the United States by a resident of the United Kingdom, who is subject to United Kingdom tax on such interest and not engaged in trade or business in the United States, was exempt from United States tax;(c) None of the above kinds of income received by a resident of the United Kingdom was subject to withholding at the source in the United States.On June 17, 1949, the board of directors of petitioner authorized the payment to George L. Ohrstrom of compensation in the amount of $ 38,000 (9 1/2 per cent of $ 400,000) for his services in negotiating and securing financing of $ 400,000 represented by the first mortgage bonds. Fees of $ 169.45 were also paid to the Corporation Trust Company in connection with the issuance of the bonds.On its returns for the taxable years the petitioner claimed the following deductions:Amortization offinancing feesYear(Total $ 38,169.45)InterestPeriod Apr. 22, 1949 to Feb. 28, 1950$ 4,147.65$ 16,168.00Year ended Feb. 28, 19518,463.9618,833.19Year ended Feb. 29, 19524,381.3217,599.92190 In determining the deficiencies, the respondent disallowed the deduction of all of the amounts claimed for interest, and all of the amounts claimed for amortization of financing fees, with the exception of $ 169.45.The issuance of petitioner's 5 per cent first mortgage bonds in the face amount of $ 400,000 resulted in the creation of a bona fide indebtedness between petitioner and the bondholders.OPINION.1. Benson Limited and Fleming Limited, two English banking houses, joined in 1949 with G. L. Ohrstrom & Co., an American firm which specialized in acquiring industrial companies, in a venture which contemplated the purchase of the stock of a California corporation by a new Delaware corporation, the petitioner, and the acquisition by the latter of the business and assets of the California576 corporation. In order to get the venture under way, petitioner was incorporated under the laws of Delaware with a capital stock of 1,000 shares having a par value of $ 1 per share (the minimum permitted by the laws of Delaware (8 Del. C., sec. 102 (4)); the English banking houses advanced as loans the amount of $ 400,000, and acquired 500 shares of its stock for $ 1 per share; and the191 Ohrstrom group purchased 550 shares of its stock (500 of the initial issue and 50 of a subsequent issue) for $ 1 per share. Thereafter a stock dividend increased the outstanding stock to 105,000 shares, but the Ohrstrom group and the English shareholders continued to own the stock in the same proportions, namely, 52.38 per cent and 47.62 per cent, respectively. The $ 400,000 advance was evidenced by 5 per cent first mortgage bonds bearing a 1956 maturity date. The two banking houses, in turn, sold most of the bonds and shares of stock to institutional investors in Great Britain. The principal issue is whether petitioner may deduct interest upon the bonds, and the answer depends upon whether the bonds represented a bona fide indebtedness, as contended by petitioner, or whether they were in truth and in substance merely equity capital.The problem is a familiar one, and there is no magic formula that provides the solution. The facts of each case must be studied, and the comparative emphasis or weight that is to be accorded to the various factors usually examined in this connection depends upon the facts as a whole. After a complete review of all of the facts we have reached the192 conclusion that the bonds, in substance as well as in form, constituted a bona fide indebtedness.The bonds bore an early maturity date, December 31, 1956, and were subject to redemption even prior thereto through the operation of a mandatory sinking fund. Indeed, the entire issue was in fact redeemed within 2 years and 10 months, after two intermediate redemptions totaling $ 48,000 in face value of bonds. The bondholders had no rights under the bonds or deed of trust to participate in or to control the management of petitioner. While it is true that the mortgage security was not fully adequate, the bondholders had further protection through the medium of the sinking fund. We do not deem this aspect of the case fatal to petitioner's position. Taking into account the entire history of the transaction we are satisfied that the bonds were not a sham and that they represented a true indebtedness.The respondent points to certain facts in support of his contention that the bonds were really equity capital and not bona fide loans. Thus, he stresses the delay in the formal execution of the deed of trust, the priority accorded the temporary closing loan from the Bank of America, and193 the waiving of the sinking fund requirement. However, 577 when these are examined carefully, it will be seen that they are not inconsistent with the existence of a bona fide debt.The delay in execution of the deed of trust was satisfactorily explained as having been occasioned by difficulties in the selection of trustees. It was originally intended that a corporate trustee, the Bank of America, would serve as a cotrustee, but the bank desired limitations on the responsibilities of the trustees which were not acceptable to the parties, and time-consuming steps were then taken to obtain the approval of the bondholders to the appointment of three individual cotrustees recommended by G. L. Ohrstrom & Co. We fail to see how this delay in executing the deed constituted a significant failure to observe the security provisions of the bonds. Moreover, the bonds, issued on May 10, 1949, provided that they "shall be secured by a first mortgage or deed of trust on all the real property, and all buildings and improvements thereon, now owned or which may be acquired by the Company at any time hereafter." And it seems probable that under California law this agreement itself was sufficient194 to create an equitable lien which would be enforceable by judicial foreclosure. Cf. Higgins v. Manson, 126 Cal. 467">126 Cal. 467, 58 P. 907">58 P. 907; Beckwith v. Sheldon, 168 Cal. 742">168 Cal. 742, 145 P. 97">145 P. 97. See also Haas v. Rendleman, 62 F.2d 701">62 F.2d 701, 702 (C. A. 4).On May 6, 1949, petitioner borrowed $ 170,000 from the Bank of America as a "temporary closing loan" for a 10-to 12-day period. Petitioner gave the bank assurance that no pledge or security of any of its assets would be issued or granted in connection with the bond issue of $ 400,000 until the $ 170,000 loan had been paid. The bonds were issued on May 10, 1949, and the bank loan was paid on May 12, 1949. There was, therefore, a temporary overlapping of these loans for a 2-day period. The evidence convinces us that it was not contemplated that the $ 400,000 loan would be subordinated to the bank loan for any appreciable time, and that the limited priority accorded this temporary closing loan did not constitute a material failure to observe the security provisions of the bonds.As of February 28, 1951, the sinking fund 195 reserve was $ 112,637.23, and unredeemed bonds in the amount of $ 352,000 were outstanding. Prior to June 1, 1951, petitioner obtained the written consents of its bondholders to defer the application of the mandatory redemption features of the sinking fund for a period not beyond June of 1952, and to use the reserve, to the extent required, as additional working capital then needed to handle increased business incident to the national defense program. We are unable to see how this constituted a failure on the part of petitioner to observe the provision of the bonds relating to the reserve. On the contrary, it indicates that the petitioner recognized the binding character of the sinking fund provisions 578 and sought and received the consent of the bondholders when it wished to be released from applying them for a short period. The receipt of this consent did not in any way affect the obligation of petitioner to retire the bonds on or before December 1, 1956, and on March 10, 1952, it retired all of the bonds then outstanding.The respondent further contends that the proportionate holdings of bonds and stock strongly indicate that the $ 400,000 advanced by the English banking196 houses was, and was intended to be, in the nature of capital investment. We do not agree. The stockholders of petitioner did not hold its bonds in uniform proportion to stock. The Ohrstrom Group, which held 52.38 per cent of its stock, owned no bonds, and the British Group, which owned all of the bonds, held 47.62 per cent of its stock. Moreover, prior to February 21, 1950, the respective stock and bond holdings within the British Group were not in direct proportion. Approximately 9 months after the bonds and stock were issued, after one "street name" in the British Group had made stock transfers to three other "street names" in the group and after a stock dividend had been declared by petitioner, the holdings within the British Group fell into direct proportions. This appears to have resulted from negotiations between Benson Limited and Fleming Limited and their clients in connection with the resale of the bonds, and not from any requirement by petitioner or the Ohrstrom Group that the stock and bond holdings be proportionate within the British Group. The opportunity to purchase stock for a nominal amount was one of the important factors which induced the two English banking197 houses to purchase the bonds. The issuance of stock to subscribers to corporate bonds as an inducement to purchase bonds is not without precedent, 2 and we are satisfied from the evidence that when the English banking houses agreed to purchase the bonds, they intended to offer a proportionate amount of this stock to their investment-trust clients as an inducement to them to purchase bonds. The execution of this intention resulted in the apparent proportionate holdings of bonds and stock on and after February 21, 1950, within the British Group.The Government's most insistent contention revolves around the high debt-to-equity ratio, sometimes referred to as "thin incorporation." There is no doubt that a disproportionately high debt structure is a suspicious circumstance, and calls for inquiry into whether the indebtedness is really what it appears to be. Cf. Isidor Dobkin, 15 T. C. 31, 33, affirmed 192 F. 2d 392198 (C. A. 2). But there is no rule of thumb that automatically classifies a debt as a sham merely because of a high debt-to-equity ratio. One must still look to see whether the so-called creditors placed their investment at the risk of the business, or whether there was an intention that the alleged loans be repaid in any 579 event regardless of the fortunes of the enterprise. Cf. Root v. Commissioner, 220 F. 2d 240, 241 (C. A. 9). And although this may be a close case in view of the high debt-to-equity ratio, we are satisfied that the intention here was to create a debt. The bonds had a comparatively early maturity date and were in fact paid off even prior thereto. The history of the venture, particularly the requirements of the Bank of England, point to an intention to establish a debtor-creditor relationship. The sharply disproportionate ratio between ownership of stock and bonds goes far to overcome the high debt-to-equity ratio here. The bondholders owned only some 48 per cent of the stock. The situation would have been quite different had all the stock and bonds been owned by the same interests in substantially the same proportion. 199 This is not to say that such proportionate ownership is indispensable to the Government's position, for it is not (cf. Colony, Inc., 26 T. C. 30, 43, affirmed on another issue 244 F. 2d 74 (C. A. 6)); but where the disproportion is so substantial and where the parties are so completely unrelated as the Ohrstrom Group and the clients of the English banking houses, such disproportion tends strongly to neutralize the inferences that might otherwise be drawn from the high debt-to-equity ratio.The Government has made a variety of other contentions, some of them based upon alleged attempts at tax avoidance, both under American and British law. We have considered them all, but we are still of the opinion that the bonds herein were nevertheless a bona fide indebtedness and that the interest thereon is properly deductible.2. The remaining question relates to deductions taken by petitioner for amortization of financing fees. The respondent contends that since the bonds were in substance shares of equity capital, the entire amount of the fees and expenses incident to obtaining the bonds represents part of peitioner's invested capital, *200 and, as such, is not deductible. In the alternative, he contends that the payment to Ohrstrom of $ 38,000 was in return for his services in organizing petitioner, and, therefore, constituted a nondeductible capital expenditure.Inasmuch as we have held that the bonds constituted a genuine indebtedness, the respondent's principal contention must fail. Nor can his alternative contention stand. There is no evidence that the financing fees incurred by petitioner represented an organizational expense. The parties have stipulated that they were incurred for "services in negotiating the bond financing." Expenses of this character may be amortized over the life of the bonds and deducted as amortized from gross income. Cf. Helvering v. Union Pacific Co., 293 U.S. 282">293 U.S. 282, 284; G. C. M. 14349, XIV-1 C. B. 47. The respondent erred in disallowing the amortization deductions claimed by petitioner for each of the taxable years.Decision will be entered under Rule 50. Footnotes1. The stipulation of the parties fixes May 5, 1949, as the date of acquisition of the stock. However, since the bank loan and the transfer of funds from Benson Limited and Fleming Limited were not completed until May 6, 1949, it may be that the stipulated date is based on a typographical error, or that the parties treated May 5, 1949, as the date of acquisition, notwithstanding that the event may have occurred in fact shortly thereafter.↩2. See Fletcher, Cyc. Corp., permanent ed., Vol. 6A, sec. 2680.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623159/	GARDNER ABBOTT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Abbott v. CommissionerDocket No. 59969.United States Board of Tax Appeals30 B.T.A. 227; 1934 BTA LEXIS 1355; March 29, 1934, Promulgated 1355 Fees received by this petitioner for services rendered by him as a receiver, under appointment by the Common Pleas Court for Cuyahoga County, Ohio, are not exempt from taxation, Edward H. Wright,29 B.T.A. 1267">29 B.T.A. 1267, followed, nor may such fees, when surrendered by him to the law firm, a copartnership, of which he was a member, be deducted from his gross income as an ordinary and necessary business expense in the computation of his net taxable income. Gardner Abbott, Esq., pro se. C. A. Ray, Esq., for the respondent. MORRIS228 OPINION. MORRIS: This proceeding is for the redetermination of a deficiency in income tax of $2,542.59 for the calendar year 1929, the proposed imposition of which the petitioner contests on the ground that the respondent erred (a) by including in his taxable income for that year compensation paid to him as a receiver of the Thistledown Co., duly appointed as such by the Common Pleas Court for Cuyahoga County, Ohio, and (b) in finding that payment by him of the amount of such compensation to the partnership of Tolles, Hogsett & Ginn, of which he was a member, was not a deductible business expense for1356 that year. The petitioner, an individual, resident of Cleveland, Ohio, is a member of the law firm of Tolles, Hogsett & Ginn, engaged in the practice of law in that city. At some time prior to 1929 the petitioner was appointed receiver of the Thistledown Co. by the Common Pleas Court for Cuyahoga County, Ohio, and as such receiver he received compensation of $8,475 during the taxable year 1929, which sum was allowed by the Common Pleas Court. He turned over to the aforesaid law firm, under his partnership contract, the $8,475 so received by him. The firm of Tolles, hogsett & Ginn, filed a partnership return of income for the calendar year 1929 showing each partner's distributive share of the income of the firm, including the petitioner's, and, presumably, though the record does not so show, the amount of such compensation turned over to it by the petitioner was included in gross income in such return. The petitioner filed an individual income tax return for the calendar year 1929 and in that return he deducted the amount of $8,475, as a business expense, in the computation of his net taxable income, on the theory that such sum having been surrendered to the partnership1357 under his partnership contract, the surrender thereof constituted a business expense to him. Unon the foregoing facts the petitioner contends that the compensation received by him as receiver was exempt from income tax imposed by the United States, it representing compensation to a state officer or employee for his services in connection with the exercise of an essential governmental function. Even assuming that the petitioner's premise is sound, that is, that a receiver appointed by a state court under certain circumstances may be regarded as an officer or an employee of a political subdivision, entitled to the exemption here claimed, we are, nevertheless, 229 compelled to say that the facts adduced are wholly insufficient to permit us to so classify him. As far as the evidence goes, however, the facts are practically identical with those found in , wherein we held that fees received by that petitioner, representing compensation for services rendered as a receiver under appointment of the Court of Chancery of the State of New Jersey, were not exempt. So that, in any event, the respondent's determination must be approved1358 in this particular. There seems to be no dispute between the parties as to whom the amount in controversy should ultimately be taxed, if found not to be exempt under the statute, that is, whether it may be taxed in its entirety to the petitioner or whether it should be included in the gross income of the partnership, which appears to have been done, and taxed to the individual partners upon their distributive shares thereof. In fact, as we understand it, this income as such was never included in the petitioner's return at all. Nor has it been included therein by the respondent. In other words this is not a case where the income was included in the gross income of this petitioner, on the one hand, which is sought to be eliminated therefrom through the medium of a deduction, on the other, resulting in a dispute between the parties as to whether the income as such was properly so eliminated from the determination of net taxable income. The petitioner's claim is simply that he has suffered a business expense by the payment to the partnership of the amount which he received as a receiver, which should be deducted from his gross income. A statement of the issue would seem sufficient*1359 to demonstrate the fallacy of the petitioner's claim. The act of surrendering fees which he had earned, as a lawyer, to the partnership of which he was a member and for which he was accountable under his partnership agreement involves not a semblance of expense. It constitutes merely the pooling of the fruits of his individual efforts preparatory to a division thereof together with the fruits of the efforts of his coworkers in some agreed ratio. What transpired here is not infrequently the practice where a lawyer is employed by a client to perform a particular service, personally, and where, upon the completion of his task, the client compensates him, personally, either in cash or otherwise. Naturally, if he is a member of a copartnership, it is his duty, in the absence of an agreement to the contrary, to surrender such fees to the partnership fund. The partnership should include them in its gross income, and the partners are taxable on their distributable shares of the partnership net income without any deduction for amounts individually earned which become a part of the partnership income. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623161/	JONATHAN E. STROMME AND MARYLOU STROMME, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentStromme v. Comm'rDocket No. 14706-09United States Tax Court138 T.C. 213; 2012 U.S. Tax Ct. LEXIS 10; 138 T.C. No. 9; March 13, 2012, Filed10 Decision will be entered under Rule 155.Ps owned two houses during the years at issue. They lived in one of those houses (on LaCasse Drive) and worked (but did not live) in the other house (on Emil Avenue). In the house on Emil Avenue they provided lodging for individuals with developmental disabilities. The county paid sums for the care of these individuals. Ps reported the amounts on their tax returns but then excluded them from income.Held: Ps cannot exclude the payments received to provide foster care under I.R.C. sec. 131 because they did not live in the house in which they provided lodging for the developmentally disabled adults.Jay B. Kelly, for petitioners.Christina L. Cook, for respondent.COHEN, HALPERN, FOLEY, VASQUEZ, GALE, THORNTON, MARVEL, GOEKE, WHERRY, KROUPA, HOLMES, GUSTAFSON, PARIS, and MORRISON, JJ., agree with this opinion of the Court. GUSTAFSON, J., concurring. COLVIN, GOEKE, and KROUPA, JJ., agree with this concurring opinion.COLVIN214 COLVIN, Chief Judge: In 2005 and 2006 three (and then four) developmentally disabled adults lived in a house on Emil Avenue in Shoreview, Minnesota. The Emil Avenue house was owned by Marylou and Jonathan Stromme, who cared for their 11 clients and managed the property. The local government paid them more than $250,000 in 2005 and more than $300,000 in 2006 for providing this foster care service. The Code makes these payments tax free if the clients were cared for in the Strommes' "home". But as discussed below the Strommes owned and resided in another home, and worked in, but did not live in, the house on Emil Avenue in Shoreview. Thus we hold that they may not exclude the foster care payments from income for the years at issue.1FINDINGS OF FACTJudge Holmes, who was the trial Judge in this case, fully agrees with the findings of fact herein. The Strommes were Minnesota residents when they filed their petitions.Marylou Stromme grew up as one of ten siblings in a small home, and it was her relationship with one of her brothers, Danny, that inspired her vocation. Danny was developmentally disabled and, following the custom of the time, had been sent to live in an institution called the Lake Owasso Children's Home (which was later 12 renamed the Lake Owasso Residence). Ms. Stromme stayed close to her brother, and from about the age of twelve began making regular weekend visits to the institution. Danny eventually was able to move in with the Strommes, and Ms. Stromme cared for him until his death in 2001.The course of her brother's life left Ms. Stromme with a strong desire to help those with developmental disabilities. Before Danny died, she had become a board member of the Lake Owasso Residence. She had long been acquainted with the case managers there, and after Danny's death one of them suggested that she think about operating a group home--a smaller residence usually in a family-friendly community that contemporary thinking has concluded provides a better life for developmentally disabled adults than 215 large congregate care. But where? At the time, Ms. Stromme and her husband Jonathan Stromme owned two houses in Shoreview: one on Mound Avenue and another on Emil Avenue. They lived at the Mound Avenue house with their children and had purchased the Emil Avenue house as an investment in April 2001.213 Petitioners chose to develop the Emil Avenue house as a group home. Jonathan Stromme oversaw the extensive renovation of the Emil Avenue house. He added a fourth bedroom, a bathroom, and a living area in the basement and added a deck with a wheelchair ramp on the outside. He also sought the advice of a certified public accountant (C.P.A.), and then he and his wife started doing business as SISTER Group Home.3 After the Strommes finished these preparations, the Ramsey County Human Services Department licensed them in 2003 as foster care service providers. The Emil Avenue house, with four bedrooms and an office area where the Strommes kept detailed records of client activities, was ready for business.Ms. Stromme took charge of caring for the clients. Doctor's appointments were a constant, but the clients also went around town to "do everything like you would do as a normal person". She organized events for them such as making Easter baskets, painting, and mowing lawns--including the lawn at the Strommes' other house.4 According 14 to Ms. Stromme, she always had a client with her and the constant interaction was a "24/7 job".To handle these client demands, the Strommes also had help. They hired six employees--most, including Jon and Molly, were family members, but at least one was not. These employees helped out both day and night. The sleeping arrangements, however, were tight; for part of 2005 there was an open bedroom, but for the rest of that year and 2006 the employees and the Strommes had to sleep on either the futon or the convertible sofa while they were on duty.216 Several neighbors saw the Strommes or their cars during the day. They saw them collecting mail there. And for all these neighbors knew, the Strommes lived there.What the Emil Avenue neighbors did not seem to know was that the Strommes owned another house. The Strommes sold their Mound Avenue house in April 2003 and moved into the one they bought on LaCasse Drive in nearby Anoka County. It was at the LaCasse Drive house that the Strommes held family gettogethers and 15 celebrated the safe return of another son from service in Iraq. The LaCasse Drive house was also where they celebrated Thanksgiving and Christmas. Ms. Stromme found it a more restful place to recover from foot surgery. This was in part because the LaCasse Drive house was much larger than the one on Emil Avenue. Excluding the basement, the LaCasse Drive house had 2,808 square feet, in contrast to the 1,168 square feet of the Emil Avenue house--and it was large enough to accommodate the Strommes' extended family and everyday life. Its six bedrooms often housed not only the Strommes and their two children, but also two other children from Ms. Stromme's first marriage, plus Ms. Stromme's brother, a niece, and two grandchildren. It also was large enough for the Strommes to bring their clients over for outings.Four of respondent's witnesses--the Strommes' neighbors on LaCasse Drive--had a good grasp of where the Strommes spent their time during 2005 and 2006, better than the Emil Avenue neighbors. The LaCasse Drive neighbors also knew the Strommes owned two houses, and those neighbors understood that the Strommes worked at the Emil Avenue house. They frequently saw Ms. Stromme leave in the 16 morning to go to work at the Emil Avenue house and then return in the evening. They often saw Mr. Stromme working in the yard or on his cars; they saw both Strommes bringing in groceries and noted Ms. Stromme's car was reliably in the driveway around dinnertime. They also credibly recounted scenes of the Strommes having ordinary suburban American fun, like returning from a Minnesota Wild hockey game or throwing a lively pool party--the Strommes had installed a pool in 2005. The pool was one of the LaCasse Drive house's great features, giving the Strommes, and sometimes their visiting clients, a place to relax.217 The Strommes and their neighbors had some disagreements. We will not memorialize these in any great detail but only note that the resulting police reports show that the Strommes were present at the LaCasse Drive house and reported it as their residence.In 2006 the Strommes separated. By November of that year they had sold the LaCasse Drive house--Mr. Stromme moved to a home in Forest Lake, Minnesota, and Ms. Stromme found her own place. The Strommes considered making the LaCasse Drive house a group home in lieu of selling it, though they were not licensed by Anoka County.The State 17 of Minnesota paid SISTER about $256,662 in 2005 and $305,561 in 2006. This enabled the Strommes, even after they took care of the Emil Avenue house and its clients, to pay the mortgage, the utilities, and the cost of improvements at the LaCasse Drive house.5Respondent determined that the payments from the State of Minnesota were taxable.618 After allowing the Strommes some business expense deductions, i.e., depreciation, employment and real estate taxes, interest, and wages, respondent determined deficiencies and penalties that totaled more than $140,000.OPINIONI. Section 131The Strommes claim eligibility under the section 131 exclusion from income of qualified foster care payments. Under that section, petitioners may exclude the 2005 and 2006 payments if they were:• made pursuant to a foster care program of a State;• paid by a State or political subdivision thereof, or a qualified agency; and218 • paid to a foster care provider for the care of "a qualified foster individual in the foster care provider's home."7Seesec. 131(b)(1). The parties disagree about the third requirement. Does the phrase "foster care provider's home" merely require ownership, as petitioners contend; or does it mean the foster care must be provided in a taxpayer's residence, as respondent contends? We conclude that it means the foster care must be provided in a taxpayer's residence.819 A. OwnershipThere are no regulations under section 131, and there is not much caselaw on the issue before us.920 We explicate the meaning of "home" in section 131 by looking first to the text of the Code. If the meaning is plain, we generally enforce it according to its terms. See, e.g., United States v. Ron Pair Enters., Inc., 489 U.S. 235">489 U.S. 235, 241-243, 109 S. Ct. 1026">109 S. Ct. 1026, 103 L. Ed. 2d 290">103 L. Ed. 2d 290 (1989). If the language is ambiguous, we can consider the legislative history. See, e.g., Cato v. Commissioner, 99 T.C. 633">99 T.C. 633, 640-641 (1992).The only case on the meaning of "home" in section 131 is Dobra v. Commissioner, 111 T.C. 339 (1998). In Dobra, the taxpayers owned four houses where they cared for developmentally disabled people, but conceded that only one house was their "'personal family residence.'" Id. at 340. The Dobras nevertheless argued that because they owned each house, they could exclude payments tied to the individuals in all four. Id. at 342. We held, however, that under section 131 a person's "home" is where he resides.10 "Put more plainly, in order for a 'house' to constitute * * * [a home], petitioners must live in that house." Id. at 345. Precedent fences us in: 219 The Strommes' mere ownership of the Emil Avenue house is insufficient to make it their home.B. Did the Strommes Live at the Emil Avenue House?It was easy enough to decide that the Dobras did 21 not live in more than one of their houses--hired help provided the care--but the Strommes spent a lot of time at the Emil Avenue house in 2005 and 2006. Ms. Stromme had an office there, and that is where she kept records of the clients' daily activities. Their neighbors regularly saw the Strommes at the house and saw the Strommes' cars in the driveway. And respondent stipulated that the Strommes worked shifts at the Emil Avenue house.These facts show the Strommes were frequently present at and worked at the Emil Avenue house, but is that enough? We conclude that using a house for business11 does not make it a residence. We interpret the Code's use of the word "home" to mean the house where a person regularly performs the routines of his private life--for example, shared meals and holidays with his family, or family time with children or grandchildren.The Strommes did argue that the Emil Avenue house was a home in this sense. They pointed to the bedroom available to them there early in 2005, and then to the living room couch and basement sofa once the fourth client moved in. But they did not dispute that the other six employees 22 also slept in the same locations when their turn for night shifts came. The Strommes focused as well on the location of their clothes, claiming that they had two dressers in the basement, with additional clothes stored in the laundry room.12 Mr. Stromme also said that when he needed to stay at the LaCasse Drive house to make improvements, he would carry over personal items in a duffel bag.1323 220 The Emil Avenue neighbors either do not recall or never actually saw the living arrangements inside the Strommes' Emil Avenue house. And one of the Strommes' employees, Daniel Hess, testified that Ms. Stromme did not always sleep at the Emil Avenue house during the shifts he worked.We have only the Strommes' word, but their unwillingness to admit that the LaCasse Drive house was even one of their "homes" casts serious doubt on their claim about living at the Emil Avenue house. The Strommes said they had a plan to make the LaCasse Drive house a group home, which limited their use of that house during the years at issue to visits with their children, repair work, and outings with their clients. They want us to believe that they did not eat lunch or 24 dinner at the LaCasse Drive house and that Mr. Stromme slept there only when he needed to do repairs.Their actions do not match their words. The Strommes received a license from Ramsey County for the Emil Avenue house in a mere six months, even though they had to remodel the entire basement. In contrast, they never applied for a similar license from Anoka County during their more than three years at the LaCasse Drive house. And while their neighbors did see the Strommes working at the LaCasse Drive house, they also saw them doing everyday chores, from bringing in groceries and eating meals with the family to hosting late-night pool parties. Their neighbors on LaCasse Drive credibly testified that the Strommes said that they "worked" at Emil Avenue. We believe that admission and find that the Strommes lived at the LaCasse Drive house. It was a big house, with plenty of amenities. It was where they spent time with their children and grandchildren. It was the house where they lived their private life, while they worked at the Emil Avenue house. We therefore find that the LaCasse Drive house was their only home.14 The 221 payments that they received from the State of Minnesota in 2005 and 25 2006 are therefore taxable income.II. Accuracy-Related PenaltyRespondent also determined that the Strommes are liable for the penalty under section 6662(a) for each year in issue, claiming that the Strommes' exclusions of the foster care payments were negligent or in disregard of rules or regulations or led to substantial understatements of income tax. Seesec. 6662(b)(1) and (2). Negligence, as the regulations define it, is the failure to make a reasonable attempt to prepare one's tax returns, keep adequate books and records, substantiate items properly, or otherwise comply with the Code. Sec. 1.6662-3(b)(1), Income Tax Regs. Disregard of rules includes careless, reckless, or intentional 26 disregard of Code provisions or regulations. Sec. 1.6662-3(b)(2), Income Tax Regs. And an understatement of income tax is substantial if it is more than $5,000 or 10% of the tax required to be shown on the return, whichever is greater. Sec. 6662(d)(1)(A).Respondent has met his burden of production for at least the substantial-understatement ground by producing the income tax returns reflecting the error. Seesec. 7491(c); Campbell v. Commissioner, 134 T.C. 20">134 T.C. 20, 29 (2010), aff'd, 658 F.3d 1255">658 F.3d 1255 (11th Cir. 2011). The amounts excluded resulted in substantial understatements of income tax--since the Strommes did not report any taxable income for 2005 and 2006.But there is a reasonable cause and good faith defense to the penalty irrespective of whether it is based on negligence, intentional disregard, or a substantial understatement of income tax. Seesec. 6664(c)(1). We find, taking into account all the relevant facts and circumstances, that the Strommes had reasonable cause for the positions taken on their returns and acted in good faith. Seesec. 6664(c)(1); sec. 1.6664-4(b)(1), Income Tax Regs. The Strommes reported the amounts of the receipts on their returns, albeit not as taxable income. 27 They met all the other requirements of section 131. And while Dobra defines "home" as a "residence", the Strommes' situation was arguably different--the Dobras never litigated the question of whether they lived in more than one home. IRS 222 publications do not even try to define what a "home" is in describing the foster care exclusion. Given the ambiguity in this area of the law, we find the Strommes' confusion reasonable and honest. See Higbee v. Commissioner, 116 T.C. 438">116 T.C. 438, 449 (2001) (noting that an honest and reasonable misunderstanding of fact or law weighs against imposing an accuracy-related penalty) (citing section 1.6664-1(b)(1), Income Tax Regs.). On the basis of these facts, particularly the Strommes' honest attempts to calculate their tax liabilities, we therefore find that the Strommes had reasonable cause to take the reporting position that they did.Respondent counters that there are clear indicators the Strommes did not act in good faith. Respondent notes they failed to produce records to substantiate their foster care expenses and failed to substantiate when the fourth client came to the Emil Avenue house. Respondent also suggests that the Strommes relied on their C.P.A. 28 to create a section 131 "facade". The Strommes, however, did keep records. And the date that the fourth client entered the group home would not have changed the character of payments.We therefore reject respondent's determination that the Strommes owe accuracy-related penalties.To reflect the foregoing,Decision will be entered under Rule 155.Reviewed by the Court.COHEN, HALPERN, FOLEY, VASQUEZ, GALE, THORNTON, MARVEL, GOEKE, WHERRY, KROUPA, HOLMES, GUSTAFSON, PARIS, and MORRISON, JJ., agree with this opinion of the Court.HOLMES; GUSTAFSONHOLMES, J., concurring: I agree with nearly everything in the opinion of the Court, except where it states that the Commissioner argues that the phrase "foster care provider's home" means that "foster care must be provided in a taxpayer's residence." Op. Ct. p. 9. That's not exactly what the Commissioner was arguing -- in his brief and at trial, he argued that the phrase "foster care provider's home" means that foster care must be provided in a taxpayer's principal223 residence. See, e.g., Answering Brief for Respondent 24; Pretrial Memorandum for Respondent 8.It is our failure to engage that argument that compels me to write separately.I.The Commissioner 29 argued throughout this case that the Emil Avenue house needs to be the Strommes' principal residence for section 131 to apply. He points to section 121's home-sale exclusion,1 and reads Dobra as excluding foster care payments from income only if the taxpayers provide care in their principal home.2 The Strommes even went along with this and argued that the Emil Avenue house was their primary residence.I do not think that the Strommes had to argue quite so vociferously (and unconvincingly) because 30 I disagree with the argument that "home" under section 131 means only a taxpayer's principal residence. We held in Dobra that "in ordinary, everyday speech, the phrase * * [foster care provider's home] means the place (or places) where petitioners reside." Dobra v. Commissioner, 111 T.C. 339">111 T.C. 339, 345 (1998) (emphasis added). As support for our reading, we looked elsewhere in the Code. See id. at 348. Section 2(b)(1), for example, says that a head of household has to "maintain[] as his home a household which constitutes for more than one-half of such taxable year the principal place of abode * * * of * * * a qualifying child * * * [or] a dependent." The Ninth Circuit has held that this language does not limit a taxpayer to having only one home. See Dobra, 111 T.C. at 347 (discussing Smith v. Commissioner, 332 F.2d 671">332 F.2d 671 (9th Cir. 1964), rev'g40 T.C. 591">40 T.C. 591 (1963)); see also Muse v. United States, 434 F.2d 349">434 F.2d 349, 353 (4th Cir. 1970). Acknowledging the Ninth Circuit's decision, we clarified in Dobra that the relevant 224 inquiry for a "home" is whether the taxpayer resided in the house at issue. See Dobra, 111 T.C. at 348.We recently had another chance to construe a Code section where Congress used 31 the word "home" without nailing "principal" to it. See Driscoll v. Commissioner, 135 T.C. 557">135 T.C. 557 (2010), rev'd and remanded, 669 F.3d 1309">669 F.3d 1309, 2012 U.S. App. LEXIS 2403">2012 U.S. App. LEXIS 2403, 2012 WL 384834">2012 WL 384834 (11th Cir. 2012). According to the Code, a minister of the Gospel doesn't include in income the "rental value of a home furnished to him as part of his compensation." Sec. 107(1). Driscoll's congregation provided him with two houses. Driscoll excluded payments associated with both from his income, but the Commissioner allowed the exclusion only for his principal residence. See Driscoll, 135 T.C. at 558-559. We disagreed: We read section 107 as applying to compensation in the form of a dwelling house; and since the parties had stipulated that the Driscolls' second house was also Driscoll's "residence", we found that it too was covered by the plain meaning of the statute. See id. at 566.In my view, Driscoll supports Dobra: A home is where one resides. And because a taxpayer may reside in more than one house, section 131 does not limit him to only one "home". But Driscoll was also controversial: It carried only by a seven-to-six vote. See id. at 567, 573. It was reversed by the Court of Appeals for the Eleventh Circuit, which is 32 not where this case would be headed.II.Therein is the explanation for why this case, like McLaine v. Commissioner, 138 T.C. 228">138 T.C. 228, 2012 U.S. Tax Ct. LEXIS 11">2012 U.S. Tax Ct. LEXIS 11 (2012), also filed today, ended up in conference: a reluctance to include in the opinion supporting our decision a fuller explanation of why we're doing what we do.The audience for our opinions should note a decided lack of majority support, especially after Driscoll, in actually defending the Commissioner's position that a taxpayer who provides foster care in his home may exclude payments only if (or maybe to the extent that) he provides that care in his principal home. Not only did we implicitly reject that point in Dobra, but as mentioned above, Dobra itself built on cases like Smith v. Commissioner, 332 F.2d at 673, holding that 225 "[a] person can have but one domicile, but we see no reason why a person cannot have two homes."Once we decided Driscoll, which would seem to have been a harder case--the Code section there does use the singular "a home"--it seems odd not to mention it in Stromme. And if a minister can own more than one "a home," surely a foster-care provider can provide care in more than one "taxpayer's home." Unless, of course, we want to go 33 back on Dobra's holding that "home" means "residence" and challenge the Ninth Circuit's similar construction of section 2(b) by adopting a different rule of construction to require us to insert "principal" or "at most one" before "home" where the Code uses that word, or maybe to interpret "home" to mean "domicile".In one way, of course, Driscoll is directly on point: The opinion of the Court there held that the rule of construction in current section 7701(p)(1) (cross-referencing title 1 of the U.S. Code) applies, and tells us to treat singular nouns as including plural. See Driscoll, 135 T.C. at 565 (citing prior version at section 7701(m)(1)). Judge Gustafson nevertheless argues, as he did in his Driscoll dissent, that "home" has a connotation of singularity, that one can only use one house at a time. See Gustafson op. pp. 26-27.In Driscoll he had further argued that allowing the parsonage allowance for more than one home served no legislative purpose. See Driscoll, 135 T.C. at 569-571. Noting the phrase "to the extent used by him to * * provide a home," in section 107(2), he suggested a reading that would require a minister to allocate his rental allowance among his homes with 34 only a part excluded. See id. at 571.One can be sure that this part of Judge Gustafson's dissent in Driscoll does not apply to section 131. Not only does the phrase "to the extent" not occur in section 131, but the legislative history runs directly opposite:The recordkeeping necessitated by present law requires prorating such expenses as housing and utility costs as well as expenditures for food. The committee believes that the requirement of such detailed and complex recordkeeping may deter families from accepting foster children or from claiming the full exclusion from income to which they are entitled.H.R. Rept. No. 99-426, at 863 (1985), 1986-3 C.B. (Vol. 2) 1, 863.226 The aim of the amendment was to help taxpayers afford the advantages of a home life to children or the disabled in need. And it seems obvious that a family can have more than one home. If not, how would we possibly analyze in any reasonable way, situations like:! a down-on-its-luck family that moves with its foster children among several homes during the course of the year; or! a family where one spouse moves with a small child to the family's summer home, while the other stays with the school-age children at their principal 35 residence; or! a minister's family that shuttles between the various homes whose expenses we've already decided are all subject to exclusion in DriscollAs it turns out, there is no majority to take this reasoning on, only a simple reluctance to rule against the Commissioner on one point when he wins on another. A similar reluctance is at work in McLaine, but it's not one I think it wise for us to indulge in as a general matter. Judge Halpern, in his concurrence in McLaine, lists the advantages of alternative holdings where there's a reason for reaching alternative arguments. As trial Judge here, I faced the related problem of a bad argument in support of the winning side. The Commissioner raised the argument, and the presence of the still-outstanding Technical Advice Memorandum 9429004 (July 22, 1994), see supra note 2, suggests that the Commissioner will continue to do so until there's authority to the contrary. Proposing to address it was not gratuitous, but a reasonable progression from Dobra (home means residence, not ownership) to Driscoll (home includes two houses that the parties stipulated were residences) to Stromme--where one party relied on the legal argument that only principal 36 residences are homes, but presented lots of evidence on the factual issue that the house in question wasn't a residence at all.The answer to the legal question seemed pretty obvious, and would clear up this tiny, murky corner of the Code a bit. See, e.g., Ashcroft v. al-Kidd, 563 U.S. , , 131 S. Ct. 2074">131 S. Ct. 2074, 2080, 179 L. Ed. 2d 1149">179 L. Ed. 2d 1149 (2011) (court has discretion to correct errors at each step of two-step analysis). We did the same thing in Dobra itself, where we held for the Commissioner, but also rejected his definition of "foster care provider's home" as meaning "the family residence of a licensed foster care provider 227 in which the licensee is the primary provider of foster care." Dobra, 111 T.C. at 342-343.It seems odd to have the Court sit in conference on cases where there's no disagreement on the result, and the only articulated dispute on the underlying legal questions reiterates a dissent from an earlier case decided differently. It is clearly prudent and justified for any Judge not to reach out and analyze tangential issues, or even especially controversial issues, but as in Mitchell v. Commissioner, 131 T.C. 215">131 T.C. 215 (2008), discussed in Koprowski v. Commissioner, 138 T.C. 54">138 T.C. 54, 66 (2012)37 (Holmes, J., concurring), so today in McLaine and Stromme, we take this counsel of prudence imprudently far: A home-plate umpire shouldn't be opining on the theoretical applicability of the infield-fly rule, but surely he can tell the catcher that, though the pitch was outside, at least it was above the knees.GUSTAFSON, J., concurring: I agree with the opinion of the Court. I write separately here to address the concurring opinion of Judge Holmes, who proposes we should hold that a foster parent may have two "homes" under section 131. I disagree for two reasons:First, we manifestly did not need to reach this issue in order to decide this case. Section 131 excludes from income payments made "to the foster care provider for caring for a qualified foster individual in the foster care provider's home." A trial was conducted, and the evidence yielded a finding of fact (with which Judge Holmes fully agrees) that the Emil Avenue house was not the petitioners' "home". The opinion of the Court reaches this conclusion without having to consider whether section 131 contemplates that a foster parent may have two "homes" or instead permits only one. Judge Holmes suggests that one 38 should note "a decided lack of majority support" for a one-"home"-only interpretation of section 131, see Holmes op. p. 21; but in fact one should note instead simply that the majority found it unnecessary even to reach this interpretive question, which is not really implicated here.Second, if we were required to reach that question, I would conclude that the statutory phrase "in the foster care provider's 228 home" does not mean "in one of the foster care provider's homes". Rather, as I observed before in another context,In common usage, a person has one "home", <2> and the word therefore has a connotation of singularity.<2> The leading (non-obsolete) definition of "home" in the Oxford English Dictionary (1933) is "A dwelling-place, house, abode; the fixed residence of a family or household; the seat of domestic life and interests; one's own house; the dwelling in which one habitually lives, or which one regards as one's proper abode"; and the first definition for "home" in Webster's Third New International Dictionary (1966) is "the house and grounds with their appurtenances habitually occupied by a family: one's principal place of residence: DOMICILE".Driscoll v. Commissioner, 135 T.C. 557">135 T.C. 557, 569-570 (2010)*39 (Gustafson, J., dissenting), rev'd and remanded,669 F.3d 1309">669 F.3d 1309, 2012 U.S. App. LEXIS 2403">2012 U.S. App. LEXIS 2403, 2012 WL 384834">2012 WL 384834 (11th Cir. Feb. 8, 2012). The most that can be said for the multiple-"homes" position is that the statute might be ambiguous--i.e., that the apparently singular "home" might actually mean the plural "homes". But if the statute is ambiguous, then we must interpret it in light of the elementary principle "'that exclusions from income must be narrowly construed.'" Commissioner v. Schleier, 515 U.S. 323">515 U.S. 323, 328, 115 S. Ct. 2159">115 S. Ct. 2159, 132 L. Ed. 2d 294">132 L. Ed. 2d 294 (1995) (quoting United States v. Burke, 504 U.S. 229">504 U.S. 229, 248, 112 S. Ct. 1867">112 S. Ct. 1867, 119 L. Ed. 2d 34">119 L. Ed. 2d 34 (1992) (Souter, J., concurring)). The narrower construction here--and the one I would adopt--is that "home" means one home.COLVIN, GOEKE, and KROUPA, JJ., agree with this concurring opinion.Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code (Code) in effect for the years at issue; all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. For the years in issue, the Strommes had claimed the Emil Avenue house as their "homestead", affording them some real property tax relief. See, e.g., Minn. Stat. Ann. sec. 273.1384, subdiv. 1↩ (West 2007).3. SISTER stands for Success in Special Needs Together Encouraging Residents.↩4. The reason for the last activity, according to the Strommes, was that a client "was 'compulsive' about mowing grass", and in fact had to be monitored or else would mow all the time.↩5. The record is, for the most part, ambiguous about the exact cost of running SISTER Group Home. The Strommes drew less than bright lines between their personal expenses and the expenses of their clients. It is difficult for us to understand how certain expenses relating to trips to Mazatlan, Mexico, and to Treasure Island Resort and Casino in Welch, Minnesota, paid with SISTER's American Express card, aided the four developmentally disabled adults living at the Emil Avenue house.↩6. The Strommes did report some taxable business income on their 2005-06 returns: $10,632 from Ms. Stromme's windshield repair business and a separate payment to Ms. Stromme of $2,400 for adult foster care, which she did not explain at trial.7. The sec. 131↩ requirements we list are those relevant to the Strommes' situation for the years at issue.8. We need not consider whether the foster care may be provided in a taxpayer's second home because in this case the care was not provided in petitioners' second home; the place the care was provided was not petitioners' primary or second home. For now, the better course is "to observe the wise limitations on our function and to confine ourselves to deciding only what is necessary to the disposition of the immediate case." Whitehouse v. Ill. Cent. R.R., 349 U.S. 366">349 U.S. 366, 372-373, 75 S. Ct. 845">75 S. Ct. 845, 99 L. Ed. 1155">99 L. Ed. 1155 (1955); Ashwander v. TVA, 297 U.S. 288">297 U.S. 288, 345-346, 56 S. Ct. 466">56 S. Ct. 466, 80 L. Ed. 688">80 L. Ed. 688 (1936) (Brandeis, J., concurring); accord Liverpool, N.Y. & Phila. S.S. Co. v. Emigration Commissioners, 113 U.S. 33">113 U.S. 33, 39, 5 S. Ct. 352">5 S. Ct. 352, 28 L. Ed. 899">28 L. Ed. 899↩ (1885). Our silence on the issue should not be construed as our agreement with either party's argument.9. There is caselaw construing the phrases "paid by a State or political subdivision thereof or by a placement agency", see Cato v. Commissioner, 99 T.C. 633">99 T.C. 633, 640-646 (1992), and "qualified foster individual", see Micorescu v. Commissioner, T.C. Memo. 1998-398↩.10. We also found that the legislative history of sec. 131 "provides little if any guidance to the meaning of 'home', for purposes of adult foster care, that cannot also be gleaned from the plain language of the statute." Dobra v. Commissioner, 111 T.C. 339">111 T.C. 339, 344↩ (1998).11. We do not read sec. 131↩ as prohibiting a profit motive.12. They also claimed that they received both personal mail (such as Christmas cards) and business mail at the Emil Avenue house; but the record contained specific examples of only the latter, some using the Emil Avenue address and others (e.g., tax documents and bank statements) the LaCasse Drive address.↩13. The fact that the Strommes homesteaded the Emil Avenue house, but not the LaCasse Drive house, also fails to convince us. The Strommes claimed that they could not homestead the LaCasse Drive house because it was not their home. We disagree. The Strommes listed the LaCasse Drive house as their principal residence on their 2003 Certificate of Real Estate Value filed with the State--rebutting their assertion. In fact, declaring the LaCasse Drive house their homestead was not in their financial interest. The Emil Avenue house was eligible for the homestead tax credit, but the LaCasse Drive house was not. The Strommes bought the LaCasse Drive house for $415,000, and the Emil Avenue house for $123,000. The homestead tax credit is phased out completely for property valued over $413,000. See Minn. Stat. Ann. sec. 273.1384, subdiv. 1↩ (homestead credit equal to 0.4% of the first $76,000 of the property value minus 0.09% of the excess of $76,000).14. Although the Strommes sold the LaCasse Drive house in November 2006, it is unclear exactly when, and for where, Marylou Stromme left. Jonathan Stromme claimed she went to the Emil Avenue house. A LaCasse Drive neighbor remembered Ms. Stromme's moving to the Floral Bay Drive house. We do not know where the Strommes' children moved. Without support for the position that Ms. Stromme in fact moved to the Emil Avenue house in 2006, seeRule 142(a)↩, we cannot allow her an exclusion for even part of the year.1. Section 121 excludes gain from the sale of a principal residence. If a taxpayer owns two residences, he can apply section 121 to only one--the one, in light of the time he spends there during the year and other relevant factors, that is his principal residence. Seesec. 1.121-1(b)(2), Income Tax Regs.↩2. The Commissioner took the one-home approach in a 1994 Technical Advice Memorandum. SeeTech. Adv. Mem. 9429004 (July 22, 1994). We don't give Technical Advice Memoranda any more deference than we would a litigating position taken by the Commissioner. Seesec. 6110(b)(1)(A), (k)(3); CSI Hydrostatic Testers, Inc. v. Commissioner, 103 T.C. 398">103 T.C. 398, 409 n.10 (1994), aff'd, 62 F.3d 136↩ (5th Cir. 1995).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623162/	Boston Elevated Railway Company, Petitioner, v. Commissioner of Internal Revenue, RespondentBoston E. R. Co. v. CommissionerDocket No. 12893United States Tax Court16 T.C. 1084; 1951 U.S. Tax Ct. LEXIS 192; May 16, 1951, Promulgated 192 Decision will be entered under Rule 50. 1. Under Massachusetts law petitioner was in effect guaranteed a level of income sufficient to meet its operating costs and to pay dividends to its stockholders at a specified rate. Although petitioner's books disclosed deficits for periods ending in 1941, amounts payable by the Commonwealth of Massachusetts pursuant to the guarantee held not accruable as income in 1941 by reason of the fact that the commonwealth was challenging the legality of the accounting procedures whereby such deficits were computed, and it was not possible to make any reasonable estimate in 1941 as to what amounts, if any, petitioner would eventually receive upon the termination of the dispute. Similarly, no such amounts could be accrued in 1942 or 1943, when the dispute had already been taken to the Massachusetts courts and the issues were being actively litigated.2. Loss with respect to the Atlantic Avenue section of petitioner's elevated structure held to have been sustained in 1942, when it was demolished pursuant to decision of Massachusetts court rendered in that year, rather than in 1938, when petitioner ceased to use the structure for passenger 193 traffic, but thereafter treated it as a standby facility on which it continued to maintain power and compressed air lines serving other parts of its system. Held further, petitioner is entitled to depreciation on the structure for taxable periods prior to the time of the loss.3. Petitioner, having paid $ 1,409,253.35, and given other consideration, for a 28-year extension of the period of public control with its attendant benefits, including a guaranteed income, held entitled to amortize such payment over the life of the extension. Charles W. Mulcahy, Esq., Numa L. Smith, Jr., Esq., and J. Joseph Maloney, Jr., Esq., for the petitioner.Melvin L. Sears, Esq., and Wm. C. W. Haines, Esq., for the respondent. Raum, Judge. RAUM1085 The respondent determined deficiencies in income taxes and declared value excess-profits taxes, as follows:Declared valueYear:Income taxexcess-profits tax1940$ 15,440.871941805,165.72$ 42,265.1019421,100,226.3853,037.851943734,142.19Petitioner claims an overpayment of income tax for the year 1940 in the amount of $ 269,923.81.The questions raised by the pleadings are:(1) Should the petitioner, on the 196 accrual system of accounting, have accrued as income for the calendar year 1941 so-called cost-of-service deficits for which it sought reimbursement from the Commonwealth of Massachusetts, in the amount of $ 2,341,167.29 for the 12-month period ending March 31, 1941, and $ 1,311,406.44 for the 9-month period ending December 31, 1941? In the alternative, should the petitioner have accrued either or both of these amounts as income for the calendar year 1942 or 1943?(2) Was the petitioner's loss with respect to the Atlantic Avenue section of its elevated railway structure sustained either in 1941 or in 1942?(3) Is the petitioner entitled to deductions of $ 27,833.08, $ 27,833.08 and $ 13,916.53 in the taxable years 1940, 1941, and 1942, respectively, for depreciation on the Atlantic Avenue section of its elevated structure?(4) Is the petitioner entitled to a pro rata deduction in each of the taxable years 1940 to 1943, inclusive, of an amount ($ 50,330.47) representing one twenty-eighth of the sum ($ 1,409,253.35) it paid to the Commonwealth of Massachusetts in 1931, pursuant to Chapter 333 of the Massachusetts Special Acts of 1931?1086 FINDINGS OF FACT.The stipulated facts197 are found accordingly.Petitioner is a Massachusetts corporation organized in 1894 and having its principal office in Boston, Massachusetts. Its returns for all of the years here involved have been filed in the collection district of Massachusetts upon the calendar year basis and upon the accrual method of accounting. At all times material to this proceeding, petitioner was engaged in the business of a common carrier of passengers in the City of Boston and nearby cities and towns by means of street (surface) railway, elevated railways, subways, and bus lines.Since July 1, 1918, and until August 29, 1947, petitioner and all of the properties owned, leased, or operated by it were managed and operated by a Board of Trustees (referred to as the Trustees) created by Section 1 of Chapter 159 of the Special Acts of Massachusetts for the year 1918 (referred to as the Public Control Act) in accordance with the provisions of the Public Control Act and amendatory legislation.Section 2 of the Public Control Act provided that the Trustees "shall take and have possession of said properties in behalf of the commonwealth during the period of public operation, and, for the purposes of this act, 198 shall, except as is otherwise provided in this act have and may exercise all the rights and powers of said company and its directors, * ."Section 4 provided that the stockholders should, as theretofore, elect a board of directors which should, however, during the period of public operation have no control over the management and operation of the street railway system; its duties were confined to maintaining the corporate organization, protecting the interests of the company so far as necessary, and taking such action from time to time as might be deemed expedient in cases where the Trustees could not act in its place.Section 5 required the company to raise 3 million dollars by the issue of preferred stock, 1 million of which was to be set aside as a reserve fund, hereinafter described.Section 6 required the Trustees to fix such rates of fare as would reasonably insure sufficient income to meet the "cost of the service" [also referred to herein as "cost of service"], which was made to include operating expenses, taxes, rentals, interest on indebtedness, such allowance as they should deem necessary or advisable for depreciation of property and for obsolescence and losses in respect199 to property sold, destroyed or abandoned, all other expenditures and charges properly chargeable against income or surplus, fixed dividends on the preferred stocks of the company from time to time outstanding, and dividends on the common stock of the company from time to time outstanding 1087 at the rate of 5 per cent during the first two years, 5 1/2 per cent for the next two years, and 6 per cent for the balance of the period of public operation.Section 8 provided that the reserve fund should be used only for the purpose of making good any deficiency in income, as provided in section 9, or for reimbursing the commonwealth, as provided in sections 11 and 13.Section 9 provided that, whenever the income of the company was insufficient to meet the cost of service, the reserve fund should be used as far as necessary to make up such deficiency, and whenever, on the other hand, such income was more than sufficient to meet the cost of service, the excess should be transferred to and become a part of the reserve fund.Section 10 provided for periodical changes in the rates of fare to provide revenue to meet the cost of service.Section 11, as amended, 1 provided that as of a given200 day each year [the last day of March for years after 1934, to and including 1941, and thereafter the last day of December, beginning with December 31, 1941] if the amount remaining in the reserve fund should be insufficient to meet any deficiency in the cost of service, the Trustees were required "to notify the treasurer and receiver general of the commonwealth of the amount of such deficiency, less the amount, if any, in the reserve fund applicable thereto, and the commonwealth shall thereupon pay over to the company the amount so ascertained." Provision was also made to reimburse the commonwealth for amounts thus paid over if the reserve fund should rise above the level at which it was originally established.The original period of public control was fixed by section 2 of the Act at 10 years from July 1, 1918. Section 12 provided that the public management and operation of the railway should continue after the expiration of the original 10-year period upon the terms and conditions specified201 in the Act until such time as the commonwealth should elect to discontinue the same by appropriate legislation passed not less than two years before the date fixed for such termination.Section 13 required the Trustees to maintain the property in good operating condition and to make such provision for depreciation, obsolescence and rehabilitation, that, upon the expiration of the period of public management and operation, the property be in good operating condition. It provided that, upon the expiration of the period of public management and operation, control of the property should revert to the company, and, if at that time the reserve fund was less than the amount originally established, the commonwealth should 1088 restore it to its original amount, and, if the amount in the reserve fund exceeded the amount originally established and any amount required to meet the cost of service to the expiration of such period, such excess should be paid over to the commonwealth.Section 14 provided that the amount of any deficiency payments which might be made by the commonwealth to the company under the provisions of sections 11 and 13 should be assessed upon the cities and towns in202 which the company operated by an addition to the state tax next thereafter assessed.In 1931 the period of public control was extended until July 1, 1959, by section 1 of chapter 333 of the Acts of 1931. Section 2 of that act reduced from 6 to 5 per cent the dividends payable upon the common stock of the company. Section 3 provided that in case of a deficit of which notice was given to the Treasurer and Receiver General, the Trustees should also notify the trustees of the Metropolitan Transit District 2 and the Department of Public Utilities; that the fares should be increased if the council of the Metropolitan Transit District should so determine, and that the Department of Public Utilities should investigate and report its recommendations as to the avoidance of future deficits. Section 3A provided the means by which the leases of existing subways and tunnels might be extended by the City of Boston, and that, in the determination of any question as to constitutionality, this section should be deemed to be separable from the remaining provisions of the Act. Section 4 authorized the issuance of bonds of the company, the proceeds of which were to be used for the retirement of the203 then existing preferred stocks of the company. Section 5 provided for the purchase of these bonds by the Metropolitan Transit District. Section 6 provided that petitioner was to pay a special compensation tax to the Metropolitan Transit District. Section 8 provided that acceptance of the Act was to be by vote of petitioner's stockholders and evidenced by the filing of a Certificate of Acceptance and certain other qualifying documents.Section 17 provided, among other things, that the acceptance was to:* * * constitute an agreement by the company to sell to the commonwealth or any political subdivision thereof * * , at any time during the period of public management and operation, its whole assets, property and franchise as a going concern upon the assumption by the commonwealth or such political subdivision of all its outstanding indebtedness204 and liabilities, and the payment of an amount in cash [determined in accordance with a specified formula] * * .Section 22 temporarily suspended the operation of sections 10 and 11 of the Public Control Act, which authorized an increase in fares and payment of deficits by the commonwealth, and provided that no such payment should be required in the year 1931.1089 Facts Relating to "Cost of Service" Deficits.On March 12, 1941, the Finance Commission of the City of Boston made public a report to the mayor of the city wherein it was charged that in past years the Trustees had made excessive charges to the cost of service of approximately $ 20,000,000, and that the methods and practices used by the Trustees in determining the amount of deficits under the Public Control Act were improper and illegal, and recommended that a suit be brought against petitioner for an accounting.On April 16, 1941, the Trustees notified the Treasurer and Receiver General of the Commonwealth that, as of March 31, 1941, the income of the company for the period since March 31, 1940, had been insufficient to meet the cost of service, as defined in the Public Control Act, by the sum of $ 2,341,167.29, 205 and that there was no amount in the reserve fund applicable thereto.Again, on January 28, 1942, the Trustees notified the Treasurer and Receiver General that, as of December 31, 1941, the income of the company during the period since March 31, 1941, had been insufficient to meet the cost of service, as defined in said Act, by the sum of $ 1,311,406.44, and that there was no amount in the reserve fund applicable thereto.No payment was made to petitioner of either of the deficits above referred to, and petitioner did not accrue these amounts as income upon its books. However, payment of both deficits was made in 1947 to the Metropolitan Transit Authority after it acquired the petitioner's assets and franchises in 1947, as hereinafter set forth.Pursuant to section 11 of the Public Control Act, deficits were certified by the Trustees to the Treasurer and Receiver General and paid to the petitioner, as follows:Date of certificationDate of paymentAmountJuly 1, 1919July 24, 1919$ 3,980,151.67July 1, 1932July 15, 19321,775,338.80July 1, 1933July 14, 19332,753,124.14July 2, 1934July 20, 19341,551,631.97Apr. 15, 1935Apr. 26, 19351,396,388.83Apr. 17, 1936Apr. 24, 19362,086,202.37Apr. 15, 1937Apr. 23, 19371,799,357.27Apr. 13, 1938Apr. 29, 19381,674,823.31Apr. 17, 1939Apr. 28, 19392,842,831.73Apr. 17, 1940May 2, 19402,724,679.87206 On April 30, 1941, the Governor of the commonwealth and the Executive Council requested an advisory opinion from the Justices of the Supreme Court of Massachusetts upon the following questions:(1) Whether the provision of part second, c. II, § 1, art. XI, of the state constitution required that a warrant providing for the payment of the deficiency for the period ended March 31, 1941, of which the 1090 Treasurer and Receiver General was notified by the trustees of the Boston Elevated Railway Company in accordance with Section 11 of the Public Control Act, be signed by the Governor with the advice and consent of the Council as a condition precedent to the payment by the Treasurer and Receiver General of the amount of such deficiency. The constitutional provision referred to is as follows:No moneys shall be issued out of the treasury of this commonwealth * * but by warrant under the hand of the governor for the time being, with the advice and consent of the council * * (2) Whether doubt on the part of the Governor and Council as to the correctness of the deficiency would, as a matter of law, give to the Governor the right to withhold his signature to the warrant and give207 to the Council the right to withhold the advice and consent with relation to said warrant.(3) Whether the Governor and Council had the right to withhold payment of the alleged deficiency for the year ended March 31, 1941, pending a determination of its correctness.(4) Whether the Governor had the right to withhold his signature from the warrant providing for the payment of said deficiency and whether the Council had the right to withhold from the Governor its advice and consent with respect to the approval of said warrant "doubts having been raised as to the correctness thereof as notified to the Treasurer and Receiver General by the Trustees of the Boston Elevated Railway Company"; and(5) Whether the Governor was required to sign the warrant and the Council required to give its advice and consent to the Governor with relation to said warrant, "notwithstanding the matter of doubts raised and presented to the Governor and Council as to the correctness of the amount of the deficiency." Opinion of the Justices, 309 Mass. 609">309 Mass. 609, 610-612, 35 N.E.2d 5">35 N. E. 2d 5.On May 28, 1941, the Justices rendered their opinion to the Governor and Council in which208 they advised:(1) That a warrant signed by the Governor with the advice and consent of the Council was "a condition precedent to the payment by the Treasurer and Receiver General of the amount of such deficiency." Opinion of the Justices, 309 Mass. 609">309 Mass. 609, 624.In response to the remaining questions, the Justices advised as follows (309 Mass. 609">309 Mass. 609, 626, 627, 629-631): * * In conformity with the principle here stated, the Governor has the "right to withhold his signature to said warrant," and the Council has "the right to withhold its advice and consent with relation to said warrant," pending reasonable opportunity for them to inform themselves whether the proposed payment is in accordance with the law.However, the reference in the question submitted to the "correctness of the deficiency as notified by the Trustees of the Boston Elevated Railway Company 1091 to the Treasurer and Receiver General" raises a subsidiary question whether, in inquiring whether the proposed payment is in accordance with the law, the Governor and the Council are concluded by this notification as to the amount to 209 be paid, or, on the other hand, may go behind such notification to inform themselves whether it is correct with respect to the amount to be paid.* * * We find nothing in the provisions of the statute requiring the trustees to notify the Treasurer and Receiver General of the amount to be paid by the Commonwealth that makes such notification conclusive upon the Commonwealth that the elements included in the computation by them of the amount to be so paid are, in all particulars, in accordance with the law. In our opinion the provision of § 11, as amended, that the Commonwealth shall "pay over to the company the amount so ascertained," refers to the amount so ascertained in accordance with statutory authority, and not to an amount ascertained by the trustees as stated in the notification regardless of their statutory authority with respect to the elements upon which such amount is based. In other words, the obligation or liability of the Commonwealth to pay the "deficiency" is limited to an obligation or liability to pay the amount thereof legally incurred, and the notification by the trustees to the Treasurer and Receiver General is not in the nature of an adjudication that the 210 amount stated by them constitutes such an obligation or liability. * * * We conclude, therefore, that in determining whether there is an obligation or liability upon the Commonwealth for the amount of the "deficiency", discharge of which by payment is authorized by law, the Governor and the Council have the right to consider whether the elements entering into the computation of such "deficiency" are in accordance with the law.While it is not the purpose of Part II, c. 2, § 1, art. 11, of the Constitution to give the Governor and the Council power to refuse to pay obligations and liabilities lawfully incurred ( Willar v. Commonwealth, 297 Mass. 527">297 Mass. 527, 529; compare Rice v. Governor, 207 Mass. 577">207 Mass. 577), it is a matter for the exercise by them of sound executive judgment and discretion to determine whether there is sufficient reason for delay by them in issuing a warrant for the payment of money in discharge of such an obligation or liability, in order to give reasonable opportunity for a determination whether the elements entering into the computation are in accordance with the law. It is a matter for the exercise of such211 executive judgment and discretion for them to determine what constitutes such reasonable opportunity. In the exercise of such executive judgment and discretion, reasonable doubt on the part of the Governor and the Council as to the existence or amount, according to law, of an obligation or liability could be found by them to be a sufficient reason for delay in issuing a warrant * ** * * Subject to the explanations and limitations stated we answer the second question submitted "Yes".The three remaining questions present in substance the same question as that presented by the second question, though they are stated in somewhat different terms. Subject to the explanations and limitations herein stated, we answer the third question submitted "Yes", the fourth question submitted "Yes", and the fifth question submitted "No".On June 20, 1941, the attorney general of the commonwealth, to whom the Governor had referred the report of the Finance Commission of the City of Boston, recommended that legal proceedings be instituted seeking a declaratory judgment with respect to the authority of the Trustees in making charges to the cost of service, and requested 1092 that an appropriation212 of funds be made for the purpose of meeting the expenses of such proceedings.On June 23, 1941, the Governor sent to the legislature a special message recommending an appropriation to cover the cost of the proceeding recommended by the attorney general. In his message the Governor stated:The Justices of the Supreme Court recently advised the Governor and Council with relation to the deficit of 1941. This opinion stated that the Governor and Council were not bound to accept the deficit as it was certified to them by the Public Trustees but could, in their discretion, determine for themselves its accuracy. In view of this decision the difficulty of the Governor and Council in properly approving a warrant for this deficit becomes great. It means in substance that each year the Governor, before submitting a warrant for the deficit in operation of the Elevated Railway to the Council, must be sure in his own mind that this deficit has been accurately computed. * * No approval of a warrant for the deficit of 1941 has as yet been given and, under the present circumstances for the reasons cited above, it will be impossible for the Governor to submit any recommendations to the Council213 on this subject. * Therefore, it becomes clear that such a suit to obtain a declaratory judgment on the proper method for assessing the depreciation and cost of service as has been suggested by the Attorney General be brought and a sufficient appropriation be made to carry on such a suit * .The Governor's message renewed a previously made recommendation for public ownership of the petitioner as an alternative to the appropriation to permit suit for a declaratory judgment to be brought by the attorney general.By chapter 89 of the Resolves of 1941, approved October 27, 1941, the State Department of Public Utilities, under the direction of the attorney general, was authorized to expend a sum not exceeding $ 75,000 --for the purpose of bringing a proceeding at law or in equity seeking a declaratory judgment, order or decree interpreting the provisions of chapter one hundred and fifty-nine of the Special Acts of nineteen hundred and eighteen, as amended, pertinent to the authority of the board of trustees of the Boston Elevated Railway Company to make certain charges to the cost of service and their accounting duties incidental to such charges, or such other proceeding at214 law or in equity as said department and the attorney general deem advisable for the purpose of having a judicial determination of the powers and duties of said trustees under said chapter or otherwise * * .Preparation of the proceeding thus authorized was actively commenced by the attorney general's office in the fall of 1941, and conferences were held in that year between officials and counsel for petitioner and the attorney general and his staff in an unsuccessful effort on the part of the company to obtain payment of this deficit from the commonwealth, either outright, or as a qualified payment without prejudice to the right of the commonwealth to recover the amount of the payment in case of a later court decision favorable to the commonwealth.1093 On January 26, 1942, the attorney general filed an information in equity, which was later amended, against petitioner and the Trustees, alleging that the Trustees had improperly included for prior years in the cost of service large amounts on account of items and charges not authorized by law to be included therein. The information alleged that the Trustees had continued, and intended to continue, these improper and unauthorized215 methods and practices, and sought a declaratory decree defining the authority of the Trustees to include such charges as a part of the cost of service, and an injunction to restrain the Trustees from charging in the future against the cost of service such items as might be determined to be improper or unauthorized by law.A demurrer filed by the company to the information was overruled in the Superior Court and the case was reported to the Supreme Judicial Court of Massachusetts. On June 3, 1946, the Supreme Judicial Court affirmed the order of the lower court overruling the demurrer and the case was remanded to the Superior Court for amendment in certain formal respects and for trial on the merits.On February 2, 1942, a bill in equity, later amended, was filed by a group of 29 taxpayers of Massachusettssub nom. Richards v. Treasurer & Receiver General, in which the commonwealth, the Treasurer and Receiver General of the Commonwealth, the Boston Elevated Railway Company, and the Trustees were made respondents. This bill, after reciting in substance that the Trustees had reported that the income of the company was insufficient to meet the cost of service in the amounts 216 of $ 2,341,167.29 and $ 1,311,406.44 for the periods ending March 31, 1941, and December 31, 1941, respectively, contained the following allegations:The petitioners believe, and therefore aver, that these last two named alleged deficits aggregating $ 3,652,573.73 do not legally exist; that the trustees in ascertaining the amount of these deficits included elements unauthorized by law and outside the discretionary powers conferred upon the trustees by said statute and that these deficits should not be paid by the Commonwealth.22. The petitioners are informed, believe and therefore aver that the trustees are pressing the Treasurer and Receiver General and other officials of the Commonwealth for the immediate payment of said deficits alleged by the trustees in their notification to the Treasurer and Receiver General of the Commonwealth on April 16, 1941, and on or about January 27, 1942; and the petitioners aver that there is immediate danger that such payments will be made either directly or indirectly at the expense of the Commonwealth. The petitioners further aver that the payment by the Treasurer and Receiver General of any part or the whole of either or both of said alleged deficits217 will be an illegal expenditure of public moneys for the reason set forth in the foregoing paragraphs.The bill prayed for an injunction restraining the Treasurer and Receiver General of the Commonwealth from paying to the Trustees of the company the whole, or any part, of either, or both, of these deficits.1094 The answer of the Treasurer and Receiver General to the amended bill of complaint contained the following:* * * This respondent has not paid and does not intend to pay the amount of either of said alleged deficiencies unless and until a warrant or warrants therefor shall have issued under the hand of the Governor with the advice and consent of the Council, comformably to the provisions of the Constitution Part II, chapter 2, section 1, article xi; that no such warrant or warrants has yet issued and this respondent is not about to make payment of the amount of said deficiencies.Appeal was taken to the Supreme Judicial Court from interlocutory orders of the Superior Court entered November 22, 1944, sustaining demurrers to the bill of complaint, and from a final decree entered in the Superior Court on January 9, 1945, dismissing the bill. The Supreme Judicial Court218 of Massachusetts, in a decision handed down June 3, 1946, affirmed both the interlocutory decree and the final decree of the Superior Court. Richards v. Treasurer & Receiver General, 319 Mass. 672">319 Mass. 672.By Mass. Stat. 1943, c. 566, approved June 12, 1943, the time within which petitions founded on claims against the commonwealth could be prosecuted under chapter 258 of the General Laws (Ter. Ed.) was limited to a period of 3 years next after the cause of action accrued.On February 1, 1944, petitioner filed a petition against the commonwealth under General Laws (Ter. Ed.), c. 258, setting forth the two deficits previously referred to for the 12-month period ended March 31, 1941, and the 9-month period ended December 31, 1941, respectively, and alleging that the commonwealth owed to it the sum of said deficiencies, namely, $ 3,652,573.73. The commonwealth filed an answer in abatement and a demurrer, which were overruled on May 19 and May 17, 1944, respectively. The commonwealth, on May 20, 1944, appealed from the order overruling its demurrer, and on the same day filed a claim of exception to the order overruling the commonwealth's plea in abatement. 219 On May 29, 1944, the commonwealth filed an answer denying "each and every material allegation contained in the petition."On June 6, 1944, the attorney general filed in the equity proceedings then pending in the Superior Court a motion seeking an injunction restraining the petitioner from further prosecuting its suit against the commonwealth to recover the alleged deficiencies for the 12 months ended March 31, 1941, and the 9 months ended December 31, 1941, alleging in substance that the issues would be more expeditiously determined in the equity proceedings.On June 7, 1946, the Governor sent a special message to the legislature recommending a further appropriation of funds to meet the expenses incident to a trial on the merits in the equity proceedings instituted by the attorney general for a declaratory decree as to the 1095 authority of the Trustees in making charges to the cost of service; and an appropriation of $ 68,000, in addition to amounts theretofore appropriated, was made for that purpose.By stipulation filed by leave of court and approved August 7, 1946, the suit of the petitioner against the commonwealth and the information of the attorney general seeking a 220 declaratory judgment were ordered to be tried together before a single justice, auditor or master, as the court might determine, beginning not later than January 13, 1947. By subsequent stipulations in these cases the trial date was postponed, the last postponement being to June 23, 1947.No certifiable deficits existed for any period after 1941 until 1946. The Trustees notified the Treasurer and Receiver General of the Commonwealth of Massachusetts of the amount of the 1946 deficit and it was included in the payment made to the Metropolitan Transit Authority, on October 28, 1947, as hereinafter set forth.Chapter 544 of the Massachusetts Acts for the year 1947, effective June 19, 1947, created the Metropolitan Transit Authority as a body politic and corporate and a political subdivision of the commonwealth. Section 5 of the Act directed the Authority to exercise the option set forth in section 17 of chapter 333 of the Acts of 1931. This option was exercised by the Authority, and on August 29, 1947, it acquired all of the assets, property and franchises of petitioner as a going concern in the manner and for the consideration specified in chapter 544.Sections 24 and 25 of said 221 chapter 544 provided in part as follows:Section 24. Upon acquisition of the property and franchises of the company by the authority, all actions pending between the commonwealth and the company shall be discontinued.Section 25. When the authority has acquired the property and franchises of the company and when the pending suits between the commonwealth and the company shall have been discontinued, as provided in this act, the state treasurer shall pay over to the authority the deficiencies of which the board of public trustees of the company notified the state treasurer in accordance with section eleven of chapter one hundred and fifty-nine of the Special Acts of nineteen hundred and eighteen, as amended, for the year ended March thirty-one, nineteen hundred and forty-one in the amount of two million three hundred and forty-one thousand one hundred and sixty-seven dollars and twenty-nine cents, for the nine months ended December thirty-one, nineteen hundred and forty-one in the amount of one million three hundred and eleven thousand four hundred and six dollars and forty-four cents, and for the year ended December thirty-one, nineteen hundred and forty-six in the amount of seven222 hundred and eighty-seven thousand five hundred and twenty-seven dollars and eighty-nine cents * * .On September 15, 1947, the case of Boston Elevated Railway Co. v. Commonwealth and the information in equity seeking a declaratory judgment were discontinued, and, on October 28, 1947, the state treasurer paid over to the Metropolitan Transit Authority the deficits specified in section 25 of chapter 544.1096 The petitioner did not include either the amount of $ 2,341,167.29 or $ 1,311,406.44 in its income tax return for the year 1941. The respondent in his notice of deficiency included both of these amounts in petitioner's income for the year 1941. 3At the end of each of the years 1941, 1942, and 1943, the petitioner did not have a fixed or unconditional right to receive payment of either of the amounts referred to in the preceding paragraph223 and did not have a reasonable expectation that such amounts would be collected by it, except in the event of favorable termination of its controversy with the Commonwealth of Massachusetts.Facts Relating to Atlantic Avenue Loss.Petitioner's elevated railway system was constructed under authority of Mass. Stat. 1894, c. 548, as amended by Stat. 1897, c. 500. It consisted of the so-called main line and the Atlantic Avenue line. The main line extended from Forest Hills on the south to the southerly end of the Washington Street Tunnel, which passes through the central part of Boston, and from the northerly end of the Washington Street Tunnel to Everett, the northern terminus of the elevated system. The Washington Street Tunnel, through which the main line is operated, is owned by the City of Boston and was used by petitioner under contract with the city, which was executed September 25, 1902, and later extended pursuant to Mass. Stat. 1911, c. 741, sections 29 and 34, and Stat. 1931, c. 333, section 3A. The Atlantic Avenue line was roughly in the form of a loop, beginning at the main line somewhat south of the tunnel, and joining the main line again north of the tunnel. The224 elevated structure on the main line and on the Atlantic Avenue line together thus formed a continuous line of elevated railway owned by petitioner from Forest Hills to Everett, and the Atlantic Avenue line was the only connection owned by the petitioner between the northerly and the southerly portions of its main line. The contract with the city for the use of the tunnel is terminable by the city on July 1, 1962, or on the first day of any July thereafter. Mass. Stat. 1931, c. 333, section 3A.The Atlantic Avenue line was put in operation in 1901. It was a section of petitioner's elevated railway consisting of a double-track elevated railway structure and the stations, tracks, signals, telephones, etc., incident thereto. Also carried on the structure was part of the distribution system for the transmission of electric power and compressed air.Petitioner's total investment in the Atlantic Avenue line was approximately $ 5,600,000, of which $ 2,793,548,51 was paid for damages to abutting estates pursuant to section 8, Mass. Stat. 1894, c. 548.1097 Operation of the main line service through the Washington Street Tunnel was commenced in 1908, and thereafter a considerable 225 falling off was experienced in the traffic over the Atlantic Avenue line. The company made reductions in train service during the years 1919 to 1938. Operation of trains over the Atlantic Avenue line resulted in interference with operation through the tunnel at grade crossings.During the period from 1923 to 1938 (the fare being the same during the entire period) the revenue collected at the four stations on the Atlantic elevated structure decreased steadily from $ 522,961.28 for the year ended December 31, 1923, to $ 180,854.18 for the year ended December 31, 1937.In 1924, and on several occasions in subsequent years, suggestions were made by various public officials looking to a possible sale by petitioner to the state or city of its Atlantic Avenue elevated structure for use as an elevated vehicular highway.It was the opinion of the Trustees and of their general counsel that, while they had full power to discontinue service over the Atlantic Avenue line, they had no authority to sell or remove the structure without the consent of the board of directors.The Trustees were of the opinion that substantial operating savings could be effected by discontinuing the operation of trains226 over the Atlantic Avenue line, and from an operating standpoint, the Trustees had no objection to the sale or other disposition of the Atlantic Avenue line, provided the sale was for cash and for a sum which would substantially aid in the financing of the road.In 1937, a bill was introduced in the Massachusetts legislature providing for the purchase of the Atlantic Avenue elevated structure.By chapter 22 of the Resolves of 1937, approved May 12, 1937, a special commission was appointed to investigate the removal of the Atlantic Avenue structure. The Trustees wrote to this commission on November 4, 1937, and, among other things, said that there were valid arguments for either the abandonment or retention of the Atlantic Avenue loop; that it formed a connecting link between the south and north sides of the city, and in an emergency might be useful to maintain through service without interruption; that a powerful argument for its sale was that it would reduce the deficit by about $ 81,000 per year; and that it was the opinion of their general counsel that they could abandon service on the loop, but that they had no authority to sell or remove the structure without the approval of 227 the board of directors. The letter expressed the conclusions that (1) if the structure could "be acquired by the District at a reasonable figure," the Trustees would favor such action, and (2) reasonably adequate bus service could be substituted if the posts were removed from Atlantic Avenue or if the structure were converted to an elevated highway over which the busses could operate.1098 The majority of the commission reported in favor of the purchase of the Atlantic Avenue structure and the conversion of it into an elevated highway.On May 6, 1938, the Trustees authorized Edward Dana, President and General Manager, to request petitioner's board of directors "to consent to the abandonment of the Atlantic Avenue Section, so-called, of the elevated structure."By letter dated June 6, 1938, the chairman of petitioner's board of directors notified Dana that the board had taken no action on the request of the Trustees, in view of the opinion of the board's counsel, a copy of which was enclosed. That opinion stated that the board did not have the power to give up the company's right to maintain the elevated structure or any part of it; that it was the duty of the Trustees under228 section 2 of the Public Control Act to operate the properties of the company; that their authority to determine the extent of the service and facilities to be furnished did not give them authority to abandon and tear down or sell a part of the elevated structure; that under section 13 of the Act it was their duty to maintain the property of the company in good operating condition and to preserve the company's rights to maintain the structure. Moreover, the opinion advised the directors not to consent to the abandonment of service since such action might result in the loss of the company's rights by reason of non-user; but stated that, if the Trustees themselves should abandon the use of the structure, it would not seem that such abandonment would work a forfeiture.On August 24, 1938, the Public Works Department of the City of Boston notified the company of the city's intention to resurface a portion of Atlantic Avenue under the elevated structure with concrete pavement. On August 30, 1938, petitioner replied, stating that it wished to increase the number of ducts in its conduit under Atlantic Avenue from four to twelve before the paving work was begun. It was the regular practice229 of the company to put its wires underground whenever the city undertook to resurface a street.On September 7, 1938, the superintendent of power of petitioner wrote to Edward Dana, President and General Manager of petitioner, in reference to the proposed paving construction of the City of Boston in which he stated:Considering the possibility of the removal of the Atlantic Avenue structure, it would appear desirable to construct an underground conduit prior to the reconstruction of the street so that provision will exist for installing the overhead feeders underground.Authorization to perform the construction was granted by the Trustees on September 12, 1938.At a meeting of the Trustees on September 21, 1938, the president and general manager outlined plans for discontinuance of passenger 1099 service on the Atlantic Avenue elevated structure commencing October 1, 1938, and it was voted that he be authorized to discontinue such service on that date. On October 1, 1938, all passenger service was discontinued on the Atlantic Avenue line and no trains were thereafter operated over it.The plans outlined by the president and general manager at the meeting of September 21, 1938, 230 were that the service over the Atlantic Avenue line would be discontinued on October 1, 1938; that the service through the Washington Street Tunnel would be increased to take care of the additional traffic; that bus service would be instituted to certain points being served by the Atlantic Avenue line; and that the Atlantic Avenue line would be kept ready for use at all times, in case the need arose.The petitioner obtained "locations" from the City of Boston to operate busses on Atlantic Avenue about the time service was discontinued on the Atlantic Avenue section.On October 4, 1938, the chairman of the board of directors wrote to the chairman of the board of trustees objecting to discontinuance of service on the Atlantic Avenue line and suggesting that such discontinuance was contrary to Massachusetts law. The answering letter, of October 17, 1938, undertook, among other things, to refute the suggestion that the discontinuance by the Trustees would work a forfeiture of petitioner's rights, in violation of law, calling attention to the opinion expressed by counsel for petitioner, previously referred to, that abandonment of use by the Trustees would not result in the forfeiture 231 of the petitioner's rights.The cost of track walking for the Atlantic Avenue structure prior to the middle of December 1938 was $ 63.50 a week. After that a weekly inspection was made until the middle of February 1942 at a cost of $ 3.46 a week. The only maintenance expense shown on the books and records of the company between 1938 and 1942 was the repair of a pipe line on the structure in July 1941 at an expense of $ 254. However, the books contained no record of items regarded as expense as distinguished from capital items.A bill was filed with the 1939 Massachusetts Legislature (Senate No. 221) providing for the taking by eminent domain or the acquisition by purchase by the commonwealth of the Atlantic Avenue structure.Another bill (House Bill No. 116) was introduced in the 1939 Massachusetts Legislature upon petition of the mayor of Boston, to authorize the Transit Department of the City of Boston, with the approval of the mayor, to enter into a contract with petitioner for the purchase of the Atlantic Avenue elevated structure for an amount subsequently to be determined.1100 In 1939 the Massachusetts Legislature enacted a statute (Stat. 1939, c. 482, approved August232 12, 1939) which had been substituted in the House for House Bill No. 116. Section 1 of the statute provided that the right of the petitioner to construct, maintain and operate its elevated railway structure on Atlantic Avenue was thereby declared forfeited as the structure was no longer being operated in the public service for the purpose for which the franchise of the company to operate an elevated structure on that location was granted and that the structure constituted a nuisance in the public highway and unreasonably interfered with the enjoyment and use of the highway to the detriment of the public health and safety, and that the location and right of the company to construct, maintain, and operate an elevated railway structure thereon was thereby revoked. Section 2 provided in part as follows:The company, acting by its board of directors, may, within thirty days of the effective date of this act, file a petition in equity in the supreme judicial court to determine whether there is just cause for the revocation and declaration of forfeiture provided for in section one. The supreme judicial court shall have jurisdiction in equity to determine the issues raised in such petition233 and to affirm, modify, or annul the said revocation and declaration of forfeiture, and service of an order of notice upon the state secretary shall be sufficient.Following the enactment of this statute, the petitioner, on September 8, 1939, filed a petition in the Supreme Judicial Court of Massachusetts contesting the validity of the statute and seeking a determination that there was no just cause for the revocation and declaration of forfeiture provided for in section 1 of that Act. The case was argued on May 14, 1940. The opinion of the court was rendered January 8, 1942, and final decree was entered on January 21, 1942. Boston Elevated Ry. Co. v. Commonwealth, 310 Mass. 528">310 Mass. 528, 39 N. E. 2d 87. Petitioner paid $ 7,500 to its counsel, Gaston, Snow, Rice & Boyd, for legal services in the preparation and prosecution of the case.On January 21, 1942, the Board of Trustees passed the following vote:Voted:Whereas a Final Decree has this day been entered in the Supreme Judicial Court of the Commonwealth of Massachusetts in case of Boston Elevated Railway Company vs. Commonwealth of Massachusetts et als that the right of the Boston Elevated234 Railway Company to construct, maintain and operate its elevated railway structure located in and upon Commercial Street, Atlantic Avenue, Beach Street and Harrison Avenue and public or private lands or ways in the City of Boston between cross girder 164 over 201 east of Keany Square and cross girders numbers 1E and 1W near Washington Street, described in section one of Chapter 482 of the Acts of 1939, is forfeited as declared by said section, because the Company's elevated structure therein referred to is no longer being operated in the public service for the purpose for which the franchise of the Company to operate an elevated structure on the location described in said section one was granted;1101 That Edward Dana, President and General Manager, be and he hereby is authorized and directed in the name and behalf of the Boston Elevated Railway Company to arrange forthwith for the removal of said structure under and in accordance with the provisions of said Chapter 482 of the Acts of 1939 by making the necessary changes in and providing necessary substitute facilities for the compressed air pipe and electric cables now carried on the structure so that the air compressors and235 electric facilities at Lincoln Power Station may be connected with those parts of the elevated structure and railway system not to be removed, by removing from said structure such materials, equipment and parts of said structure as the Railway Company desires to retain and by requesting bids for removal of those parts of said structure not to be retained by the Railway Company under form of contract to be approved by General Counsel providing that the materials removed shall, when removed, become the property of the Contractor.The work referred to in the preceding vote was commenced on March 17, 1942, and was completed July 13, 1942. Later in that year the book value of the Atlantic Avenue line was written off on the books of the petitioner.Subsequent to October 1, 1938, and until the decision of the Supreme Judicial Court in 1942, the Atlantic Avenue elevated structure constituted a facility which could be used in case of interruption for any cause of service through the Washington Street Tunnel, in case of shift in traffic load, or to lessen congestion at the Washington Street station in case of traffic overload in the tunnel. Also during this period it continued to carry electric236 cables and air pipe lines which were used for the transmission of electricity and compressed air for use in connection with the operation of other parts of petitioner's system.When the operation of trains over the Atlantic Avenue line was discontinued, instructions were given to the various departments that the Atlantic Avenue structure should be kept in such condition that service could be resumed on reasonably short notice.During the years 1939 to 1942 the petitioner removed from the Atlantic Avenue line some passimeters, fare boxes, and other miscellaneous equipment. The removal of this equipment would not have interfered with the resumption of operation of trains over this line during the period October 1, 1938, to January 1942.In 1941, certain frogs and switch points at the junction of the mainline elevated and the Atlantic Avenue line near Tower D at Castle and Washington Streets became worn out and plain rail was substituted therefor. At the time of this substitution instructions were issued to the engineer in charge of the matter to retain spare parts at that junction "until the question relative to the Atlantic Avenue section is settled," and that "should it become necessary237 to make use of the switch at Tower D connecting with the Atlantic Avenue section the spare parts would enable you to restore this connection in a short period."1102 Subject to this qualification, there was no severance of the tracks on the Atlantic Avenue line from the main-line elevated and there was no rearrangement of the rail system which would have prevented the running of trains from the main line over the Atlantic Avenue line, or vice versa.A special order was issued on December 15, 1941, pursuant to authorization of the Trustees on December 8, 1941, for the installation of new cable in conduits to take the place of the copper then on the elevated structure. The 1939 statute provided that work of demolition of the elevated structure should begin within 30 days from the date of the decision of the court. In view of the shortage of materials and the fact that it was estimated it would take in excess of 30 days to install this cable, it was deemed advisable to anticipate a decision unfavorable to the company and take steps to install the cable in the conduit so that the 30-day requirement could be satisfied.Service over the Atlantic Avenue line could have been resumed238 upon a few hours' notice at any time from October 1, 1938, up to the time of the decision in 1942.There was no abandonment of or intention to abandon the Atlantic Avenue structure at the time operation of trains was discontinued in 1938, or at any other time prior to the decision of the Supreme Judicial Court of Massachusetts in 1942.The loss with respect to its Atlantic Avenue line was claimed as a deduction by petitioner in its income tax return for 1942. It was disallowed by respondent in his notice of deficiency upon the ground "that the property was abandoned during the year 1938 and the loss occurred in that year." Petitioner did not claim depreciation on the Atlantic Avenue line in its income tax returns for any period after the calendar year 1938 and none has been allowed by the respondent.Petitioner sustained a loss with respect to its Atlantic Avenue line in the year 1942 in the amount of $ 3,570,047.07, less the amount of depreciation allowable on the Atlantic Avenue structure for the years 1939 to 1942, inclusive.Facts Relating to Pro Rata Deduction on Account of 1931 Extension Payment.Chapter 740 of the (Mass.) Acts of 1911 provided for the consolidation of 239 the properties and franchises of the West End Street Railway Company (referred to herein as "West End") and the petitioner to take effect on June 10, 1922, the date of the termination of the then existing lease from West End to petitioner. The consolidation was to take the form of a sale of all the property, privileges, and franchises of West End to petitioner (sec. 1). For this purpose the petitioner 1103 was authorized to increase its capital stock by an amount equal in par value to the par value of the stock of West End; the new stock was to be divided into first preferred stock and second preferred stock, the aggregate par value of the first preferred to be equal to the aggregate par value of West End's outstanding preferred, and the aggregate par value of the second preferred to be equal to the aggregate par value of West End's outstanding common stock (sec. 2). The new stock was to be issued to West End in full payment for all of its properties, privileges, and franchises, subject to its existing indebtedness and liabilities, and thereupon distributed to the West End stockholders (sec. 4).Section 9 provided that West End should forthwith sell to petitioner all of the240 real estate of West End not required in the conduct of the business of the companies, that the proceeds of the sale to an amount not exceeding $ 1,500,000 should be held as a special trust fund by petitioner to be invested and accumulated until June 10, 1922, when the consolidation was to take effect, and that the petitioner should thereafter continue to invest the fund and accumulations to that date and apply the annual income thereof to the purchase and retirement of the second preferred stock referred to above. Section 9 further provided that no part of the fund or its income should be used for any other purpose until all of the second preferred stock had been retired, at which time the fund with its accumulations was to be applied by petitioner to any purpose for which its stock and bonds could legally be issued.Section 10 provided that, upon the consolidation (June 10, 1922), the petitioner should assume and be responsible for all of the indebtedness and liabilities of West End and should, in general, succeed to all its powers, privileges, rights, and franchises and be subject to all of its duties, obligations and restrictions, and that all claims of one against the other should241 be deemed satisfied and extinguished.Pursuant to section 9, petitioner acquired in 1913 the real estate of West End not required for railway purposes and established a special trust fund amounting to $ 1,500,000.Chapter 333 of the Acts of 1931 providing for the extension of the period of public control until 1959 contained the following provisions:Section 23. When all the second preferred stock of the company has been retired, the special trust fund established under the provisions of section nine of chapter seven hundred and forty of the acts of nineteen hundred and eleven shall, to the extent necessary therefor, be converted by the trustees of the company into cash and the same shall thereupon be applied to repay to the commonwealth all amounts which, prior to the effective date of this act, have been assessed under the provisions of chapter one hundred and fifty-nine of the Special Acts of nineteen hundred and eighteen upon the cities and towns served 1104 by the company and which have not been previously repaid to the commonwealth, and the treasurer and receiver general of the commonwealth shall thereupon distribute the same to such cities and towns as provided in said242 chapter. Any balance remaining in said fund shall be applied as provided in said chapter seven hundred and forty.Pursuant to said section 23 of the 1931 act, petitioner paid, on August 19, 1931, from the special trust fund established under section 9 of the 1911 Act to the Commonwealth of Massachusetts the sum of $ 1,409,253.35. This was the amount which, prior to the effective date of the 1931 act, had been assessed under the provisions of the Public Control Act upon the cities and towns referred to in the Public Control Act and for which the Commonwealth had not theretofore been reimbursed by petitioner.In determining the deficiencies set forth in his notice of deficiency, respondent allowed as a deduction the amount of $ 50,330.47 in each of the years 1940, 1941, 1942, and 1943, which amount represents one twenty-eighth of the sum of $ 1,409,253.35 paid by petitioner to the Commonwealth of Massachusetts on August 19, 1931. Respondent now asserts in his amended answer that such deductions are not allowable.OPINION.1. Petitioner employed the accrual method of accounting, and there is no dispute here that payments due from the State of Massachusetts on account of the so-called243 cost of service deficits would constitute taxable income in the year or years that they were properly accruable. Boston Elevated Railway Co., 45 B. T. A. 906, affd. (C. A. 1), 131 F.2d 161">131 F. 2d 161, certiorari denied, 318 U.S. 760">318 U.S. 760. The cost of service deficits herein for which petitioner sought reimbursement from the state were claimed to be $ 2,341,167.29 for the 12-month period ending March 31, 1941, and $ 1,311,406.44 for the 9-month period ending December 31, 1941. Respondent's principal contention is that these amounts must be accrued in 1941. However, during 1941 and for some years thereafter, the state was challenging the legality of certain accounting procedures used in arriving at these amounts, and was therefore refusing to make any payments to petitioner. Accordingly, petitioner contends that these amounts were not properly accruable while thus in dispute. This issue turns, therefore, upon the application of the principles of accrual accounting to the facts of this case.These principles have long been understood and applied in a wide variety of cases. Thus, it has been held that liability244 for a tax accrues and is deductible from gross income, when "all the events" have occurred "which fix the amount of the tax and determine the liability of the taxpayer to pay it." United States v. Anderson, 1105 269 U.S. 422">269 U.S. 422, 441. Moreover, an item may be accrued, "if there is legal liability, even though the amount is not definitely fixed, if all the events have occurred by which the amount may be determined with reasonable exactitude. Continental Tie & Lumber Co. v. United States, [286 U.S. 290">286 U.S. 290]." Lehigh Valley Railroad Co., 12 T. C. 977, 995. But where the item, whether of income or deduction, depends upon a contingency or future events, it may not be accrued until the contingency or events have occurred and fixed with reasonable certainty the fact and amount of the liability involved. United States v. Safety Car Heating Co., 297 U.S. 88">297 U.S. 88, 93-94; Lucas v. American Code Co., 280 U.S. 445">280 U.S. 445, 451, 452. And where liability is substantially in controversy, accrual must await the resolution of the controversy. 245 Security Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281, 284; Dixie Pine Co. v. Commissioner, 320 U.S. 516">320 U.S. 516, 519; William Justin Petit, 8 T. C. 228; cf. North American Oil v. Burnet, 286 U.S. 417">286 U.S. 417, 423-424.Respondent contends that "petitioner's right to receive the deficit payments as defined in the Public Control Act as amended (certified by the Trustees to be the sums of $ 2,341,167.79 and $ 1,311,406.44) was fixed and definite at the end of its taxable year December 31, 1941"; that "at the end of December 1941 the Commonwealth was under a definite and fixed liability to pay whatever deficiency existed at that time"; that "the Commonwealth nowhere denied its liability to pay such amounts as deficiencies as were properly computed"; and that the amounts involved must therefore be accrued as of the end of 1941. Respondent further contends that, in any event, since the litigation contesting the payments was not instituted until 1942, it could not preclude the accrual of income as of the end of 1941 (cf. Edward J. Hudson, 11 T. C. 1042, 1050,246 affd. (C. A. 5), 183 F. 2d 180; Automobile Ins. Co. v. Commissioner (C. A. 2), 72 F.2d 265">72 F. 2d 265, 267). We do not agree.Although the litigation had not yet been formally instituted in 1941, the controversy had ripened to the point where the state in 1941 was openly contesting its liability with respect to the amounts certified by the Trustees, and had taken significant steps to challenge the legality of the processes by which these amounts were computed.On March 12, 1941, the Finance Commission of the City of Boston made public its report in which it charged that in past years the Trustees had made excessive charges to cost of service of approximately $ 20,000,000, and that the methods and practices used by the Trustees in determining the amount of the deficits were improper and illegal. That report, which was made approximately one month prior to the notification given by the Trustees to the commonwealth of the March 31 cost-of-service deficit, apparently raised doubts in the mind of the Governor as to the validity and existence of this 1106 alleged deficit, and caused him to request an advisory opinion by the Justices247 of the Supreme Judicial Court of Massachusetts. Their opinion, dated May 28, 1941, declared that the liability of the commonwealth to pay the alleged March 31 "deficiency" was limited to an obligation to pay the amount thereof legally incurred; that the notification by the Trustees was not in the nature of an adjudication that the amounts stated by them constituted such an obligation; that in determining whether there was a liability upon the commonwealth for the amount of the "deficiency," the Governor and the Council had the right to consider whether the elements entering into the computation of such "deficiency" were in accordance with law; and that reasonable doubt on the part of the Governor and the Council as to the existence or amount, according to law, of an obligation or liability could be found by them to be a sufficient reason for delay in issuing a warrant for payment.Thereafter, in June 1941, the attorney general of the commonwealth recommended that legal proceedings be instituted to ascertain whether the Trustees had improperly included in cost of service large amounts on account of items and charges not authorized by law to be included therein, and, upon recommendation248 of the Governor, an appropriation of $ 75,000 was made by the legislature for this purpose in October 1941. In the fall of 1941, the attorney general's office started work on the preparation of such proceedings. In the latter part of that year, the petitioner made an unsuccessful attempt to induce the commonwealth to make either an outright or a qualified payment of the amount of the March 31 deficit.To be sure, suit was not actually filed until January 26, 1942. But the fact that a $ 75,000 appropriation had already been approved by the legislature in 1941 to finance the litigation made it virtually a foregone conclusion that suit would be filed. The controversy had reached a high pitch as of December 31, 1941. Surely, petitioner had no reasonable grounds for believing that it would be reimbursed for the deficits shown on its books, other than in the event of a successful termination of the pending dispute. The filing of the suit and other events in 1942 merely confirmed the existence of the controversy in 1941.It is misleading to suggest, as does respondent, that the commonwealth nowhere denied its liability to pay such amounts as deficiencies as were properly computed. 249 Of course, the commonwealth did not deny such liability as the statute imposed upon it; but the heart of the controversy was the challenge to the legality of the underlying procedures that were employed to measure that liability. This was more than a mere difference as to computations. It was a substantial legal controversy of a high order of magnitude; and until it was resolved, 1107 petitioner could not be required to accrue as income any payments which depended upon the outcome of that controversy.Respondent presses upon us a number of decisions growing out of the Federal control of railroads around the time of World War I. 4 In particular, he places special reliance upon Continental Tie & Lumber Co. v. United States, 286 U.S. 290">286 U.S. 290. In the Continental Tie & Lumber Co. case a payment was received by a taxpayer in 1923 pursuant to an award in that year by the Interstate Commerce Commission under section 204 of the Transportation Act of 1920. That section provided for such an award to a railroad which during any part of the period of Federal control competed for traffic, or connected, with one under Federal control, and sustained a250 deficit in operating income for that portion of the period during which it operated its own railroad. The Act directed the Commission to compare the results of such operation with those of the test period (the 3 years ended June 30, 1917); and, if less favorable during the period of Federal control than during the test period, to award an amount calculated as prescribed by the section. The Supreme Court held that the award to the taxpayer had accrued in 1920, when the Act providing for the award was enacted, and was taxable income in that year rather than in 1923, the year in which the award was made. The underlying basis for this holding was that the right to the award was fixed by the passage of the Transportation Act in 1920; that all that remained was mere ascertainment of the amount to be paid; and that the taxpayer had in its own books and accounts in 1920 data to which it could apply the calculations required by the statute and ascertain the quantum of the award within reasonable limits.251 It is true that there is a certain superficial similarity between the present case and the Continental Tie & Lumber Co. case. As the Court pointed out (pp. 296-297), the 1920 Act merely formulated general principles for the computation of the award, leaving a number of problems, many of them difficult, to be worked out by the Interstate Commerce Commission, and indeed the applicable principles dealing with those problems were not settled by the Commission until 1921, 1922, and 1923. Nevertheless, the Court declared that (pp. 297-298) "in spite of these inherent difficulties we think it was possible for a carrier to ascertain with reasonable accuracy the amount of the award to be paid by the Government. * * * It does not appear 1108 that a proper effort would not have obtained a result approximately in accord with what the Commission ultimately found." 5252 Regardless of the conclusion thus reached upon the record in that case, it is our view that upon the record now before us the petitioner herein could not in 1941 make any reasonably accurate forecast of the ultimate outcome of the pending controversy and that it could not at that time make any reasonable estimate as to how much, if anything, it would ever receive upon its claims for reimbursement with respect to its alleged deficits. In these circumstances, petitioner was not required to accrue the amounts in question in 1941.Respondent has made certain alternative contentions that the amount of the deficit for the 9-month period ending December 31, 1941, should be accrued in 1942, or that, in any event, both deficits should be accrued in 1943. However, the controversy was no closer to a solution in 1942 and 1943 than it was in 1941, and, for the reasons stated above, these alternative contentions must similarly be rejected.2. Petitioner claims a deduction from its 1942 gross income for a loss with respect to the Atlantic Avenue section of its elevated railway structure. By amendment to its petition, the petitioner makes the alternative claim that the loss was sustained in 1941. 253 Respondent, on the other hand, contends that the loss was sustained in 1938 by reason of abandonment in that year.Section 23 (f) of the Internal Revenue Code permits a corporation to deduct losses sustained during the taxable year and not compensated by insurance or otherwise. The Commissioner's regulations provide that the difference between the adjusted basis and the salvage value of a capital asset may be deducted as a loss under section 23 (f) when the usefulness of the asset in the taxpayer's business is suddenly terminated and it discards the asset permanently from use in its business. Section 19.23 (e)-3, Regulations 103; section 29.23 (e)-3, Regulations 111.In order to have an abandonment it is necessary that there be an intention of the owner to abandon the property, coupled with an act of abandonment, both of which must be ascertained from all of the surrounding facts and circumstances. Belridge Oil Co., 11 B. T. A. 127, 137; Reuben H. Donnelley Corp., 26 B. T. A. 107, 115; Ewald Iron Co., 37 B. T. A. 798, 799; W. B. Davis & Son, Inc., 5 T.C. 1195">5 T. C. 1195, 1219.254 1109 Non-use, alone, is not enough. W. B. Davis & Son, Inc., supra;I. G. Zumwalt, 25 B. T. A. 566, 574; Ewald Iron Co., supra.The respondent contends that the petitioner did not sustain any loss in 1941 or 1942, and that the loss, if any, was sustained prior to 1941. He urges that the evidence indicates that the Trustees became dissatisfied with the Atlantic Avenue line prior to 1938 and intended to abandon its use and substitute bus service; that they carried out this intention in 1938 "knowing well that it would result in a forfeiture of the location"; and that the intent to discontinue service when combined with the knowledge that such action constituted grounds for the declaration of a forfeiture of the location on Atlantic Avenue is sufficient to establish an intent on the part of the Trustees to abandon the Atlantic Avenue line. He also urges that intention to abandon in 1938 is indicated by acts with reference to the structure subsequent to that year, such as, the reduction in expenditures for track walking from $ 63.50 a week to $ 3.46 a week, the placing of some of the cable255 on the structure in an underground conduit, the removal of passimeters, fare boxes, etc., from stations on the structure, and the substitution in 1941 of plain rail for certain frogs and switch points where the structure joined the main line at Tower D.That the Trustees became dissatisfied with the Atlantic Avenue line prior to 1938 is undoubtedly true. The principal causes of this dissatisfaction were the decline in revenue from that line after the opening of the Washington Street Tunnel, the interference of Atlantic Avenue trains with main line trains on the elevated structure where they separated to travel their respective routes, and the potential saving in cost of service, estimated in 1937 to be approximately $ 81,000 per year, which they felt would result from the substitution of bus and other service for the train service on the Atlantic Avenue line. It is not surprising, therefore, that the Trustees let it be known in 1924 and in 1937, that from an operating standpoint they would not object to the sale of the Atlantic Avenue structure for an elevated roadway, provided the sale was for cash and for a sum which would substantially aid in the financing of the road. They 256 realized, however, that they had no authority to effect a sale or otherwise dispose of the structure without the consent of the board of directors. Before taking action to discontinue service in 1938, they sought the consent of petitioner's board of directors, and although they failed to get it, their letter to the board dated October 17, 1938, indicates that their decision to discontinue service as of October 1, 1938, was made in the light of the opinion of counsel for the board that, while consent of the board to such discontinuance would result in forfeiture of the structure, an independent decision by the Trustees themselves to discontinue service would not. In these circumstances, we think that the respondent is not justified in saying that when the Trustees decided to discontinue 1110 service on the Atlantic Avenue structure they knew that such action constituted grounds for forfeiture.In a letter dated November 4, 1937, to the Special Commission appointed by the State legislature to investigate the removal of the Atlantic Avenue structure, the Trustees said: "It is a fact that the Atlantic Avenue Elevated forms a connecting link between the south and north sides of 257 the city, and in an emergency might be useful to maintain through service without interruption." This thought also appears in the statement of the president and general manager to the Trustees at the time of discontinuance of service in 1938, that he planned to keep the Atlantic Avenue line ready for use at all times, in case the need arose, and in his memorandum to the Superintendent of Power dated November 23, 1938, that he approved cutting off the power from the third rail on the Atlantic Avenue structure, "on the understanding that it can be made alive, if necessary, upon reasonable notice." Moreover, he instructed the various departments of the company that the structure should be kept so that if it were needed for any reason, it could "be opened reasonably quickly," and he testified that to the best of his knowledge it was kept in a condition so that service ice could have been resumed on reasonably prompt notice. The superintendent in charge of the operation of the rapid transit lines testified that his understanding at the time service was discontinued was that the Atlantic Avenue structure was to be inspected frequently so that it would be ready for use within, possibly, 258 an hour's time, and that the only thing done between October 1938, and January 1942, that would have delayed resumption of operations for a longer period was the removal of frogs and switches at Tower D and the substitution of plain rail in 1941. The reinstallation of these frogs and switches, which were kept on location, would, according to the witness, have taken about three or four hours.The president and general manager testified that he considered the Atlantic Avenue structure to be a valuable facility not only for use in case of interruption for any cause of service through the Washington Street Tunnel, but also in case anything transpired that shifted the traffic load to such an extent that they might want to use it again. A director of the company since 1930 testified that it had considerable value during the period from October 1, 1938, to the time of its demolition in 1942, as an alternative route, in the event the tunnel became overcrowded or there was any breakdown in the service, and because it was the only connection owned by petitioner between the northerly and the southerly portions of its main line elevated railway. He also testified that it had a potential value259 in case of a sale for use as an elevated highway, or in the event of possible acquisition by the state or other public authority of the properties of petitioner by eminent domain.1111 Further evidence that the petitioner did not intend to abandon the Atlantic Avenue structure and that it considered it to have a value in excess of what might be realized upon demolition, is the action it took to protect its rights to the structure and location, after the Massachusetts legislature in 1939 enacted a statute purporting to declare the right of the petitioner to maintain and operate the Atlantic Avenue structure had been forfeited and to require its removal. Petitioner immediately filed a petition in equity in the Supreme Judicial Court of Massachusetts to determine whether there was just cause for the declaration of forfeiture, pursuant to a provision in the statute permitting it to do so. Petitioner expended $ 7,500 for legal services in the preparation and prosecution of this case. It was not until 1942 that the court rendered its opinion holding that the petitioner had forfeited its right to maintain the Atlantic Avenue structure by reason of its breach of the implied condition260 upon which the location and the right to maintain and operate an elevated structure had been granted, i. e., that it be used to "equip, maintain and operate engines, meters and cars thereon." Boston Elevated Railway v. Commonwealth, 310 Mass. 528">310 Mass. 528, 39 N. E. 2d 87, 116. 6261 Petitioner has proved to our satisfaction that there was no abandonment of or intention to abandon the Atlantic Avenue structure at the time operation of trains was discontinued in 1938, or at any other time prior to the decision of the Massachusetts Supreme Judicial Court in 1942, and we have made a finding to this effect. The parties have stipulated that in such circumstances, the amount of the loss sustained in 1942 is $ 3,570,047.07, less the amount of depreciation allowable with respect to the Atlantic Avenue line for the intervening period from the end of 1938 to and including 1942.The respondent contends, however, that even if petitioner sustained a loss at the time of the removal of the Atlantic Avenue structure in 1942, it is not deductible under the provisions of section 23 (f), as a loss sustained during the taxable year "and not compensated for by insurance or otherwise." The respondent argues that under the provisions of the Public Control Act of 1918, as amended, the petitioner had a right to charge the Atlantic Avenue loss to cost of service, and thus to recover the amount of the loss from the commonwealth by way of deficit payment. We disagree.Passing the question262 whether the amount of this loss could be included 1112 in the cost of service in 1942 under the Massachusetts legislation, we think that respondent's position misconceives the nature of payments under the Public Control Act. The statute did not undertake to compensate petitioner for any particular loss; rather, it undertook to assure petitioner a given level of income, after providing for various charges (including losses) representing the cost of operation, that would enable petitioner to pay dividends at a specified rate. Thus, regardless of the amounts of any possible losses sustained by petitioner, no payments would be forthcoming to it if its income were sufficiently high, after absorbing the losses and other charges, to pay the required dividends. And to the extent that the commonwealth was obligated to make payments to petitioner, such payments constituted taxable income to petitioner. Boston Elevated Railway Co., 45 B. T. A. 906, affd. (C. A. 1), 131 F. 2d 161. certiorari denied, 318 U.S. 760">318 U.S. 760. They were not in the nature of payments restoring a loss of capital that would normally263 be received tax-free (apart from excess over basis). We think that the arrangement between petitioner and the commonwealth does not require the disallowance of the loss under section 23 (f).We conclude that petitioner's loss with respect to its Atlantic Avenue line is deductible in 1942. In the circumstances, it is entitled to depreciation deductions with respect thereto for the period prior to the loss. Cf. Carter-Colton Cigar Co., 9 T. C. 219, 221. The parties have stipulated the amounts which constitute a reasonable allowance for depreciation for the years included in that period, and deductions will be allowed herein for the years in controversy.3. The final issue relates to the right of the petitioner to a deduction in the amount of $ 50,530.47 in each of the years 1940, 1941, 1942, and 1943. These deductions, claimed by the petitioner, were allowed by the respondent in his notice of deficiency, but in his amended answer he alleges that no part thereof is properly deductible from petitioner's income for the taxable years.Since this issue was raised by respondent for the first time in his amended answer, the burden is upon him to prove that264 his allowance of the deductions was erroneous. His argument in support of disallowance is that there is nothing to show that the payment of $ 1,409,253.35 was the consideration for a 28-year extension of the period of public control, as petitioner urges, and that the evidence indicates that this payment was only one of the many conditions which petitioner had to meet to accept the provisions of chapter 333 of the Special Acts of 1931.Section 11 of the Public Control Act provided that whenever during the period of public operation the petitioner's reserve fund exceeded the amount originally established, the Trustees should apply the excess to reimburse the commonwealth for the amount of any "deficiency" 1113 which it had paid the company. At the time of the enactment of chapter 333 of the Massachusetts Acts of 1931, the commonwealth had received reimbursement of the amount of any deficiency theretofore paid by it to the company, with the exception of $ 1,409,253.35.The 1931 act was accepted by the stockholders of the petitioner on June 30, 1931, and section 22 was accepted by its board of directors on May 21, 1931. By such acceptance the company agreed to an extension of265 public management and operation of its properties to July 1, 1959 (sec. 1); to a reduction in dividends payable upon its common stock from 6 to 5 per cent (sec. 2); to certain changes in the procedure to be followed upon occurrence of a deficit (sec. 3); to the extension to July 1, 1962, of the term of all subway and tunnel leases (sec. 3A); to the issuance of its bonds in an amount not exceeding $ 30,000,000 for the purpose of retiring its preferred stocks, and for the purchase of such bonds by the Metropolitan Transit District (secs. 4, 5); to pay annually to the District, in addition to interest on its bonds, a sum sufficient when added to said interest to enable the District to net, after paying interest on its own bonds, an amount equal to 2 per cent per annum on the Company's bonds held by it (sec. 6) to declare and pay dividends not in excess of 6 per cent per annum on its common stock after termination of public management and operation (sec. 17); to give the commonwealth or any political subdivision thereof or any corporation specifically authorized by the commonwealth to purchase the same, the right to purchase, at any time during the period of public management and operation, 266 its assets and franchises as a going concern (sec. 17); to the taking of its property and franchises at any time through the exercise of the power of eminent domain (sec. 17); to be subject to and bound by such regulations as to fares and services as the General Court or the Department of Public Utilities might prescribe after the termination of public management and control (sec. 17); and to the suspension of the payment of deficits for the year ending June 30, 1931 (sec. 22).In addition to the foregoing, the 1931 act provided in section 23, as follows:When all the second preferred stock of the company has been retired, the special trust fund established under the provisions of section nine of chapter seven hundred and forty of the acts of nineteen hundred and eleven shall, to the extent necessary therefor, be converted by the trustees of the company into cash and the same shall thereupon be applied to repay to the commonwealth all amounts which, prior to the effective date of this act, have been assessed under the provisions of chapter one hundred and fifty-nine of the Special Acts of nineteen hundred and eighteen upon the cities and towns served by the company and which have 267 not been previously repaid to the commonwealth, and the treasurer and receiver general of the commonwealth shall thereupon distribute the same to such cities and towns as provided in said chapter. Any balance remaining in said fund shall be applied as provided in said chapter seven hundred and forty.1114 The $ 1,409,253.35 payment here involved was made pursuant to the provisions of section 23 on August 19, 1931.It is apparent from the foregoing that the petitioner indeed was required to consent to a number of conditions in addition to the payment provided for in section 23. The fact remains, however, that it did pay $ 1,409,253.35 in conjunction with other consideration flowing from it in order to obtain the 28-year extension of the period of public control with its attendant benefits to it, including a guaranteed income. And if the consideration for obtaining such a long term arrangement is amortizable over the period involved, it is apparent that the $ 1,409,253.35 payment must be so spread, even though it represented only part of the consideration. That an expenditure made in acquiring a capital asset or a contract which is expected to be income producing over a series268 of years is in the nature of a capital expenditure which must be amortized ratably over the life of the asset or the period of the contract is well established. Bonwit Teller & Co., 17 B. T. A. 1019, 1024, affirmed on this point (C. A. 2), 53 F.2d 381">53 F. 2d 381, certiorari denied, 284 U.S. 690">284 U.S. 690; Central Bank Block Assn. v. Commissioner (C. A. 5), 57 F. 2d 5; Young v. Commissioner (C. A. 9), 59 F.2d 691">59 F. 2d 691, certiorari denied, 287 U.S. 652">287 U.S. 652; Home Trust Co. v. Commissioner (C. A. 8), 65 F. 2d 532; Main & McKinney Bldg. Co. v. Commissioner (C. A. 5), 113 F. 2d 81, certiorari denied, 311 U.S. 688">311 U.S. 688; Blanche B. Burley, 26 B. T. A. 615; cf. Commissioner v. Boylston Market Assn. (C. A. 1), 131 F. 2d 966. The rule of these decisions requires that this issue be decided in favor of the petitioner.Decision will be entered under Rule 50. Footnotes1. Mass. Stat. 1941, c. 139.↩2. The Metropolitan Transit District is to be distinguished from the Metropolitan Transit Authority, hereinafter referred to, which was created by Mass. Stat. 1947, c. 544.↩3. By his amended answer respondent contends, in the alternative, for the inclusion of part of all of these amounts in petitioner's income for the year 1942 or 1943.↩4. Illinois Terminal Co., 5 B. T. A. 15; Great Northern Railway Co., 8 B. T. A. 225, affd. (C. A. 8), 40 F. 2d 372; Texas & Pacific Railway Co., 9 B. T. A. 365; Commissioner v. Old Dominion S. S. Co. (C. A. 2), 47 F. 2d 148; Commissioner v. Midland Val. R. Co., (C. A. 10), 57 F. 2d 1042; Helvering v. St. Louis Southwestern Ry. Co. (C. A. 8), 66 F.2d 633">66 F. 2d 633, certiorari denied, 292 U.S. 626">292 U.S. 626↩.5. The opinion of the Court of Claims, 52 F. 2d 1045, 1049, which was affirmed by the Supreme Court, contains the following statement: The plaintiff had previous knowledge and experience as to the test period whereby the railway operating income and deficit were to be measured and the transportation act was enacted in ample time for the necessary computations to have been made or reasonably estimated for the purpose of accrual in 1920. No contention is made as to any question of dispute or difference between the parties which might have made an estimate or accrual of the claim of the Cimarron & Northwestern Railway Company impossible. There appears to have been no substantial dispute between the plaintiff and the Interstate Commerce Commission as to its claim. * * ↩6. The court said (310 Mass. at p. 571, 39 N. E. 2d at pp. 116-117): The question involved is to be distinguished from the question of abandonment of an easement or other interest in land, where intention to abandon is an important factor. * * In such cases it has been said that abandonment is not to be inferred from mere nonuser. Here, however, the question arises between the Commonwealth, the grantor of this location, and the company, the grantee, and is whether the grantee has failed to perform a condition of the grant. Whether or not the grantee intended to abandon the location is not decisive if, in fact, such grantee has not performed the condition.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623163/	LESLIE G. KINDSCHI and SIGNE S. KINDSCHI, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Kindschi v. CommissionerDocket Nos. 3106-77, 3107-77, 3108-77, 3109-77, 3110-77, 3111-77, 3112-77, 3113-77, 3114-77, 3115-77, 3116-77, 3117-77, 3118-77, 3119-77, 3120-77, 6856-77.United States Tax CourtT.C. Memo 1979-489; 1979 Tax Ct. Memo LEXIS 33; 39 T.C.M. (CCH) 638; T.C.M. (RIA) 79489; December 6, 1979, Filed Thomas G. Ragatz,David F. Grams, and Stephen B. Braden, for the petitioners. Scott R. Cox, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in petitioners' Federal income taxes as follows: Dkt. No.(Petitioners)YearDeficiency3106-77Leslie G. & Signe1972$11,604.00S. Kindschi19734,144.003107-77Gary W. & Lorraine1972417.00I. Woroch1973195.003108-77Marcia L. Terman19724,617.381973837.003109-77Lealands Corporation19722,511.733110-77Duane A. & Phyllis19723,731.82Anderson19731,505.083111-77Raymond J. & Letty19722,001.90Morton3112-77Kenneth D. & Carol J.197216,186.57Opitz3113-77Robert A. & Elaine R.19728,125.49Sandahl1734,261.643114-77Michael E. & Marlyn A.19725,229.12Donogan19732,119.683115-77John A. & Mary H.19728,093.00Frantz19736,542.003116-77Perry J. & Sheila J.19727,252.36Armstrong19738,376.173117-77Douglas J. & Winifred1972314.41N. Baker3118-77Tad M. & Diane L.1972936.99Baker1973678.963119-77William E. Currier19723,976.886856-77William E. & Carol J.197313,906.00Currier3120-77Marcus & Sheila19723,775.21Cohen19731,502.7535 Concessions having been made, the remaining issues for decision are: (1) When did Chapel Hill partnership acquire an economic interest in the Chapel Hill apartment complex so as to be entitled to a deduction for depreciation under section 167(a). 2(2) Whether the Chapel Hill partnership was the "original user" of the Chapel Hill apartment complex within the meaning of section 167(j) (2) so as to qualify for accelerated depreciation under section 167(b) in 1972 and 1973. (3) Whether the payment of $90,000 by the Chapel Hill partnership to Arthur G. Grandlich in December 1972 was deductible by the partnership in 1972 as interest under section 163(a). (4) Whether the payment of $34,797.50 by the Chapel Hill partnership to the City of Madison, Wis., in December 1972 was deductible by the partnership in 1972 as real estate taxes under section 164(a). (5) Whether the $9,000 received by petitioner Perry J. Armstrong in March 1973 was a commission payment and therefore ordinary income, or a payment for the release of an option and therefore entitled36 to capital gain treatment under section 1234(a). FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. At the time of filing their petitions herein, the residences of the petitioners were as follows: Dkt. No.(Petitioners)Residence3106-77Leslie G. & SigneMonroe, Wis.S. Kindschi3107-77Gary W. & LorraineDenver, Colo.I. Woroch3108-77Marcia L. TermanChicago, Ill.3109-77Lealands CorporationMadison, Wis.3110-77Duane A. & PhyllisMadison, Wis.Anderson3111-77Raymond J. & LettyMadison, Wis.Morton3112-77Kenneth D. & CarolMadison, Wis.J. Opitz3113-77Robert A. & ElaineHilton Head Island,R. SandahlS.C.3114-77 Michael E. & MarlynMadison, Wis.A. Donogan3115-77John A. & Mary H.Monroe, Wis.Frantz3116-77Perry J. & SheilaMadison, Wis.J. Armstrong3117-77Douglas J. & WinifredOregon, Wis.N. Baker3118-77Tad M. & Diane L.Conyers, Ga.Baker3119-77William E. CurrierMadison, Wis.6856-77William E. & CarolJ. Currier3120-77Marcus & SheilaMadison, Wis.CohenDuring the years in issue, petitioners were partners37 in a Wisconsin limited partnership known as Chapel Hill. Where petitioners are husband and wife, only the husband was a partner and the wife was joined solely by reason of having filed a joint return. Petitioners Douglas J. Baker, Tad M. Baker, and Gary W. Woroch were members of an organization known as Baker Properties which held their interests in the Chapel Hill partnership. The partnership interest of petitioner Robert A. Sandahl was held by a trust bearing his name. In 1971, Arthur G. Grandlich (Grandlich) was the owner of real property located in Madison, Wis., on which he was constructing an apartment complex to be known as the Chapel Hill apartments.During the fall of 1971, Grandlich was attempting to sell the apartment complex. Grandlich had given an oral listing to National Mortgage Corporation (National Mortgage) and had agreed to pay National Mortgage a commission of $40,000 if an acceptable sale was arranged. In October of 1971, while National Mortgage was attempting to arrange a sale of the Chapel Hill apartments, petitioner Perry J. Armstrong (Armstrong) secured an oral option from Grandlich to purchase the apartments for $2,350,000. No payment was made by Armstrong38 to Grandlich for this option. Armstrong did not personally have the funds to purchase the apartments, but intended to bring in other investors to obtain the necessary capital. Since Armstrong was the owner of an abstract title insurance company in Madison and not a real estate broker, to help him find other investors, Armstrong contacted petitioner Kenneth D. Optiz (Optiz), who was president of Optiz Realty, Inc., a real estate brokerage firm in Madison. Opitz subsequently agreed to help Armstrong find investors with the capital to purchase the apartments. In exchange for Optiz' help, Armstrong orally assigned a one-half interest in his option to Optiz. Once enough investors were committed, Armstrong and Optiz intended to establish a limited partnership to purchase the Chapel Hill apartments from Grandlich. To obtain the financing to build the Chapel Hill apartments, Grandlich had obtained three mortgage notes, each in the amount of $615,000. The notes were secured by a single underlying mortgage on which Grandlich was personally liable. Before Grandlich could sell the apartments, it was necessary of the mortgage notes and from the company carrying his loan insurance. 39 At the same time Armstrong and Optiz were working with Grandlich to arrange a sale of the apartments, National Mortgage was attempting to arrange a sale with Roger Gaumnitz, an employee of Optiz' real estate brokerage firm. When National Mortgage learned that Armstrong and Optiz had an option to buy the apartments from Grandlich, an officer of National Mortgage contacted them and explained that National Mortgage was in a position to prevent the mortgage note holders and the insurance company from giving their consent unless National Mortgage's right to the $40,000 sales commission from Grandlich was preserved. To avoid problems in obtaining the consent agreements from the mortgage note holders and the insurance company, Armstrong and Optiz agreed with National Mortgage that the $40,000 commission should be split; National Mortgage would keep $22,000 and Armstrong and Opitz would each receive $9,000. On December 29, 1971, National Mortgage sent a letter to Armstrong confirming their agreement. The letter stated in part: Enclosed is a copy of the letter agreement regarding the commissions for the sale of Chapel Hill between [Grandlich] and National Mortgage Corporation. This40 is to confirm when National Mortgage Corporation receives the $40,000.00 at "Time T", National Mortgage Corporation will pay you $18,000.00 for the release of your options. In December 1971 Armstrong and Opitz orally assigned their option to themselves as co-trustees. On December 30, 1971, Armstrong and Opitz, as co-trustees, signed a written agreement with Grandlich whereby Grandlich agreed to sell the Chapel Hill apartments to Armstrong and Opitz. The agreement signed by the parties was labeled "Land Contract" and provided in part: WITNESSETH, FIRST, that the Purchasers hereby agree and bind their legal representatives, to pay or cause to be paid to the Vendor, his heirs, or assigns, the sum of Two Million Three Hundred Fifty Thousand ($2,350,000.00) dollars in the manner following: five thousand ($5,000.00) dollars at the ensealing and delivery hereof: the balance of $2,345,000.00 as follows: When the project achieves a gross monthly income of $24,000.00, and in addition, the improvements to be constructed thereon, * * * are completed (hereinafter called "Time T"), then:Purchasers shall execute a note to the Vendor in the amount of $150,000.00 for a term of one year41 (which may be extended for one additional year, at the option of the Vendor), at an interest rate of 8% per year. Purchasers shall pay $350,000.00 to the Vendor. * Beginning at "Time T", Purchasers agree to make payments to the Vendor pursuant to the terms and conditions of three notes which are secured by a Mortgage recorded in Volume 257 of Records, page 337, #1293649, copies of said notes are attached hereto * . * The said Purchasers further agree that they will pay, when due and payable, all taxes and assessments which have been assessed or levied on the above described premises since "Time T", and also all such as may be assessed or levied subsequent to "Time T" thereon or upon the interest of said Vendor in said premises; * . The Purchasers further agree that they shall insure and keep insured against loss or damage the buildings now on said premises and such as may hereafter be erected thereon during the life of this contract in the sum of at least two million ($2,000,000) dollars, against loss or damage by fire or other cause * * and the Purchasers shall pay the premium on such policy or policies when due * * . The Purchasers further42 agree to hold the said premises from the date hereof, as the tenants by sufferance of the Vendor, subject to be removed as tenants holding over, by process under the statute in such case made an provided, whenever default shall be made in the payment of any of the installments of purchase money, interest, taxes, assessments or insurance premiums as above specified; and also to keep the buildings and improvements on said premises in as good repair and condition as they now are, except ordinary wear and decay, and not to do any act whatsoever which tends to depreciate the value of said premises.Second, that the Vendor hereby agrees and binds his heirs, executors and administrators, that in case the aforesaid sum of two million three hundred fifty thousand ($2,350,000.00) dollars, with the interest and other moneys shall be fully paid and all the conditions herein provided shall be fully performed at the times and in the manner above specified, he will on demand, thereafter cause to be executed and delivered to the Purchasers, or their heirs or legal representatives, a good and sufficient Warranty Deed, in fee simple, of the premises above described, free and clear of all legal liens43 and incumbrances, except the taxes and assessments herein agreed to be paid by the Purchasers, and except any liens or incumbrances created by the act or default of the purchasers, their heirs, legal representatives or assigns and purchasers hereby state that they are satisfied with the title as shown by the abstract submitted to them for examination. * Fourth, the Vendor agrees to manage the project until "Time T" in consideration of an amount equal to the rents accrued thru "Time T". "Manage" as used above is to include the following: Advertising the project for rent and absorbing the cost thereof. Renting the apartments constructed thereon, in accordance with the Rent Schedule attached hereto * . Paying all other costs of maintainance and operation of the project thru "Time T", including, but not limited to all costs of utilities. Said management operations shall be subject to periodic review by the Purchasers. * * In accordance with the terms of this contract, on December 30, 1971, Armstrong and Opitz together made the initial payment to Grandlich of $5,000 toward the purchase of the Chapel Hill apartments. Although petitioners Armstrong and Opitz44 intended the December 30, 1971, contract to embody their agreement with Grandlich up to that point, since Grandlich had not yet obtained the consent agreements from the three mortgage note holders and the insurance company, and because they had not yet raised the necessary capital from investors, they did not intend this contract to be the final form of the sale; rather Armstrong and Opitz recognized that further negotiations might be necessary with respect to some of the contract terms. 3By March of 1972, Grandlich had obtained all of the necessary consent agreements and Armstrong and Opitz had received commitments from a sufficient number of investors to purchase the apartments. However, during the course of their negotiations with Grandlich, Armstrong and Optiz concluded that in order to make the proposed limited partnership more attractive to the investors, the following changes had to be made in the terms of the December 30, 1971, land contract: (1) the partnership's liability on the land contract should be nonrecourse in nature; (2) the purchasers should pay45 the vendor interest on the unpaid purchase price for the period between the date of the final contract and "Time T"; (3) the purchasers should pay a pro rata share of the 1972 real estate taxes due on the apartment property. These changes as well as others were reflected in two land contracts executed on April 1, 1972. In the first contract, Grandlich, as vendor, transferred the Chapel Hill apartments to Heather Hills, Inc. (Heather Hills) as purchaser. Heather Hills was a corporation owned by Opitz and his wife. In the second contract, Heather Hills, as vendor, transferred the Chapel Hill apartments to Armstrong and Opitz, as purchasers. Although Armstrong and Opitz were listed as the purchasers in the second contract, they intended to assign their interest in this second contract to a limited partnership which would then become the purchaser of the apartments. Heather Hills was used only as an intermediary in the sale to enable Armstrong's and Optiz' limited partnership to purchase the apartments from Grandlich with only nonrecourse liability. Since Grandlich was personally liable on the underlying mortgage on the apartments, by having him transfer the apartments to Heather46 Hills, Armstrong and Optiz could guarantee Grandlich's mortgage obligation, while at the same time allow the limited partnership to purchase the apartments from Heather Hills with only nonrecourse liability. Consequently, in the contract between Grandlich and Heather Hills, Grandlich, as vendor, not only had the right to foreclosure but he could also hold Heather Hills, as purchaser, liable for any balance due on the contract at the time of default. However, in the contract between Heather Hills and Armstrong and Opitz, Heather Hills' remedy, as vendor, against Armstrong and Opitz or their assignees, as purchasers, was limited to strict foreclosure. In all other respects the two land contracts executed on April 1, 1972, were identical. The pertinent provisions of the contract between Heather Hills, as vendor, and Armstrong and Opitz, as purchasers, were as follows: WITNESSETH: That the Vendor, in consideration of the payments to be made and the covenants and agreements by the Purchaser to be performed, as hereinafter set forth, hereby sells and agrees to convey unto the Purchaser, upon the prompt and full performance by the Purchaser of the covenants and agreements of this47 contract to be by the Purchaser performed, the following described real estate in Dane County, State of Wisconsin: * * * * * Vendor shall complete the improvements on the premises, * . If the said improvements are not completed by September 1, 1972, Vendor shall be assessed a penalty of $500.00 per day until said improvements are so completed. The Purchaser, in consideration of the covenants and agreements herein made by the Vendor, agrees to purchase the above described premises, and to pay therefor to the Vendor * * the sum of two million, two hundred twenty-five thousand and 00/100 Dollars, in manner following: $5,000.00 at the execution hereof, the receipt whereof is hereby acknowledged, and the balance as follows: On September 1, 1972, Purchaser shall pay: (1) $225,000.00 on principal; (2) Accrued interest on the unpaid balance hereunder ($2,220,000.00) at the rate of 9.72% per annum [from April 1, 1972 to September 1, 1972;] (3) $150,000.00 on principal, in the form of a note to the Vendor which shall have a term of one year and bear interest at the rate of 8% per annum [which may be extended, at the option of the Vendor, for one additional year provided48 that the Purchaser shall pay the accrued interest one year from the date of said note.] From September 1, 1972 the balance unpaid hereunder shall bear interest at the rate of 8 3/4% per annum. On October 1, 1972, November 1, 1972 and December 1, 1972, Vendees shall pay interest to the Vendor at the rate of 8 3/4% per annum on the unpaid balance hereunder [($1,845,000.00)]. Begining January 1, 1973, Purchaser shall pay monthly to the Vendor the sum of $15,184.35, provided the entire purchase money and interest shall be fully paid on or before December 1, 1998. * The purchaser hereby states that he is satisfied with the title as shown by the abstract submitted to him for examination; * * The Purchaser shall be entitled to take possession of said premises on April 1, 1972. The Purchaser shall be entitled to remain in possession as long as he performs all covenants and agreements herein mentioned on his part to be performed and no longer. The Purchaser covenants and agrees as follows: 1. To pay before they become delinquent all taxes and assessments now or hereafter assessed or levied against and on the real estate described in this contract. * * * 49 2. To keep said premises insured for fire and extended coverage for at least the sum of $2,000,000.00, to pay the premiums there when due, * . 3. To keep the premises in good condition and repair. 4. To keep the premises free from liens superior to the lien of this contract, or the rights of the Vendor in the premises. 5. Not to commit waste nor suffer waste to be committed. 6. Not to do any act which shall impair the value thereof. * The Vendor hereby agrees that in case the aforesaid purchase price with the interest and other moneys shall be fully paid and all the conditions herein provided shall be fully performed at the times and in the manner specified, he will on demand, thereafter cause to be executed and delivered to the Purchaser, a good and sufficient Warranty Deed, in fee simple, of the premises above described, free and clear of all legal liens and encumbrances, except any liens or encumbrances created by act or default of the Purchaser, and except easements and restrictions of record, zoning and other municipal ordinances. * The two land contracts executed on April 1, 1972, differed from the December 30, 1971, land contract50 in a number of respects. In addition to the provision for nonrecourse liability, the other changes made in the April contracts were as follows: (1) the purchase price was $2,225,000 rather than $2,350,000; (2) the purchasers were to begin payment on September 1, 1972, rather than at "Time T"; (3) the purchasers were liable for interest on the unpaid balance of $2,220,000 at the rate of 9.72% per year from April 1, 1972, until September 1, 1972; (4) the purchasers were liable for the 1972 real estate taxes on the apartment property after April 1, 1972, (5) the exception for "ordinary wear and decay" in the purchasers' maintenance obligation was removed; (6) the vendor was liable for liquidated damages in the amount of $500 per day if construction of the apartments was not completed by September 1, 1972; and (7) the provision for management of the apartments by Grandlich was removed. Shortly after the two contracts were executed on April 1, 1972, the parties made several amendments to the terms of both contracts. The amendments to the Heather Hills-Armstrong and Opitz contract were dated April 15, 1972, and the amendments to the Grandlich-Heather Hills contract were dated April 26, 1972. 51 All of the amendments to both contracts were substantially identical. The amendments, which clarified certain contract provisions and modified others, provided as follows: (1) the purchasers were to begin payment at "Time T" rather than on September 1, 1972. In the amendments, "Time T" was defined as the time at which the Chapel Hill apartments achieved a gross monthly income of $24,000. Petitioner Armstrong testified that $24,000 in monthly rental income represented approximately 75 percent of the apartments' potential monthly rental income; (2) the amount of interest purchasers owed to the vendor for 1972 was fixed at $90,000, which was the estimated amount of interest due on the unpaid balance of $2,220,000 at the rate of 9.725 percent per year from April 1, 1972, until September 1, 1972; (3) the amount of 1972 real estate taxes for which purchasers were liable was limited to $35,000, which was the estimated amount of real estate taxes on the property for the period April 1, 1972, through December 31, 1972; (4) Grandlich agreed to manage the apartments until "Time T" in consideration of an amount equal to the rents accrued through "Time T." As manager, Grandlich also agreed to52 pay all the costs of maintenance and operation of the apartments through "Time T." (5) The $500 per day liquidated damages clause was deleted. The parties decided that in lieu of the liquidated damages clause, the vendor would continue to bear the burden of the operating expenses without benefit of further payment of interest or real estate taxes by the purchasers if the vendor did not complete construction of the apartments and reach the "Time T" rental level by September 1, 1972. Although the purchasers were not to begin payment until "Time T" was reached, Armstrong and Opitz considered their obligation to purchase the apartments from Grandlich binding as of April 1, 1972. In addition, petitioners and respondent are in agreement that under the terms of the April 1, 1972, land contracts, as amended, Opitz and Armstrong as purchasers, had the following rights and obligations as of April 1, 1972: (1) the right to possession of the apartment complex; (2) the unconditional obligation to keep the apartment complex in good condition and repair; and (3) the unconditional obligation to maintain fire insurance on the apartment complex. Although Armstrong and Opitz had the obligation to53 provide fire insurance on the apartment complex, on April 1, 1972, when the contracts were executed, Grandlich agreed to have the purchasers named as additional insureds on his existing policy covering the apartment complex, with no additional charge to the purchasers. Pursuant to this agreement, Grandlich paid the 1972 insurance premiums on the policy covering the apartment complex. In May 1972, Armstrong and Opitz formed the Wisconsin limited partnership known as Chapel Hill to own and operate the Chapel Hill apartment complex. Armstrong and Opitz were the general partners and the other petitioners in this case were the limited partners. The certificate of limited partnership was filed on June 1, 1972. On this same date, Armstrong and Opitz assigned in writing their purchasers' interest including all rights and obligations in the Heather Hills-Armstrong and Opitz land contract to the Chapel Hill partnership. On June 12, 1972, Armstrong executed an affidavit which stated: Perry J. Armstrong II, being first duly sworn, on oath deposes and says that: 1. The interest held by he and Kenneth D. Opitz as co-trustees * * [in the Chapel Hill apartments] has been extinguished, 54 2. There now exists an interest in the [Chapel Hill apartments] in favor of CHAPEL HILL, a Limited Partnership. Petitioner Armstrong testified that this afidavit was intended to document the release to the partnership of the option to buy the apartments which he and Opitz held. The Chapel Hill apartment complex was first authorized for occupancy by the City of Madison on June 1, 1972, and was first occupied by tenants on that date. All leases were drawn in the name of the partnership and were signed and approved by either Armstrong or Opitz. All rents received were deposited in the partnership's bank account. At the end of each month, the amount of rents received would be computed and then such amount would be paid to Grandlich as a management fee pursuant to the terms of the management agreement contained in the amended April contracts. Although Grandlich, as manager, was responsible for the maintenance and operation of the apartments, Armstrong and Opitz retained the following functions in connection with the management of the apartments in addition to signing and approving leases: (1) review of the hiring and firing of maintenance personnel, (2) approval of any change55 in the rent structure, and (3) approval of purchases of maintenance items and supplies. Later in 1972, after it became apparent that "Time T" would not be reached on September 1, 1972, the partnership advanced Grandlich most of the cash it was obligated to pay him at "Time T." These advancements were in the form of unsecured loans and were made as follows: $88,000 on September 27, 1972; $162,000 on October 11, 1972; and $70,000 on November 7, 1972. These unsecured loans to Grandlich were made only because Armstrong and Opitz considered the obligation to purchase the apartments binding on the partnership even though "Time T" had not yet been reached. On October 11, 1972, the Grandlich-Heather Hills land contract was amended to permit payment of the $90,000 interest on or before December 31, 1972, even if "Time T" had not yet arrived. On December 20, 1972, the partnership paid $90,000 in interest to Heather Hills and on this same date Heather Hills paid $90,000 in interest to the First Wisconsin National Bank of Madison for the account of Grandlich. The 1972 real property tax bill on the Chapel Hill apartments was sent to the Chapel Hill partnership in care of Armstrong. On56 December 26, 1972, the partnership paid $35,000 to the City of Madison, of which $34,797.50 was for real estate taxes and $202.50 was for a special assessment. On February 28, 1973, Grandlich, Heather Hills, and Armstrong and Opitz, on behalf of the partnership, stipulated that "Time T" occurred on that date. On the following day, March 1, 1973, Grandlich repaid the cash advances made to him by the partnership and pursuant to the terms of the amended April contracts, the partnership paid Heather Hills $225,000 and Heather Hills in turn paid Grandlich $225,000.Also on March 1, 1973, the partnership gave Heather Hills a $150,000 mortgage note and Heather Hills in turn gave Grandlich a $150,000 mortgage note. Furthermore, Grandlich and Heather Hills stipulated that the remaining purchase payments could be made directly to the holders of Grandlich's underlying mortgage. However, since Grandlich remained personally liable on the underlying mortgage, the partnership was not given a deed to the property on March 1, 1973, because Grandlich preferred to retain the remedy of land contract foreclosure against the partnership. The management agreement between the partnership and Grandlich57 terminated as of March 1, 1973, and on this same date a new contract to manage the Chapel Hill apartments was entered into by the partnership and Opitz Realty, Inc. On March 2, 1973, Armstrong and Opitz purchased an insurance policy covering the Chapel Hill apartments. In March of 1973 National Mortgage received its $40,000 sales commision from Grandlich. Later in 1973, pursuant to the 1971 agreement between National Mortgage and Armstrong and Opitz, National Mortgage paid Armstrong and Opitz $9,000 each. Grandlich reported the sale of the Chapel Hill apartments on his 1971 Federal income tax return at a price of $2,225,000. On his 1972 Federal income tax return, Grandlich claimed no deduction for depreciation on the apartments, but he did claim a $39,645.68 loss on the operation of the apartments under the management contract he had with the partnership. On its 1972 Federal income tax return, the Chapel Hill partnership reported all of the rental income derived from the Chapel Hill apartments in 1972. The partnership also claimed deductions for: (1) management fees; (2) accelerated depreciation under the double declining balance method on the apartments for the period June 1, 1972, through58 December 31, 1972; (3) $90,000 in interest; and (4) $34,797.50 in real estate taxes. As a result of the deductions claimed by the partnership, it reported a loss for 1972. The petitioners reported their individual shares of this loss on their 1972 Federal income tax returns. On its 1973 Federal income tax return, the partnership reported all of the apartments' 1973 rental income and claimed deductions for: (1) accelerated depreciation under the double declining balance method on the apartments for the entire year; (2) management fees; and (3) numerous other expenses incurred in connection with the operation of the apartments. As in 1972, the partnership reported a loss for 1973 and the petitioners claimed their individual shares of this loss on their 1973 Federal income tax returns. On petitioner Armstrong's 1973 individual Federal tax return, he reported his receipt of the $9,000 from National Mortgage as capital gain from the release to the partnership of his option to buy the Chapel Hill apartments. However, Opitz considered the $9,000 to be income to his real estate brokerage firm and, consequently, this payment was reported by his firm on its 1973 return. Respondent59 in his statutory notice for 1972 determined that the partnership was not the owner of the Chapel Hill apartments until March 1, 1973, and therefore disallowed the depreciation deduction taken by the partnership in 1972. Respondent also determined that the $90,000 interest deduction and the $34,797.50 real estate tax deduction claimed by the partnership for 1972 were nondeductible capital expenditures. Respondent accordingly reduced the partnership's 1972 loss and each petitioner's share of that loss. Since respondent determined that the partnership did not become owner of the apartments until March 1, 1973, in his statutory notices for 1973, the respondent disallowed the partnership's depreciation deduction for January and February of 1973. Respondent also determined that for the period March 1, 1973, through December 31, 1973, the partnership was not entitled to accelerated depreciation under section 167(b) because the partnership was not the "original user" of the apartments within the meaning of section 167(j)(2). Respondent accordingly reduced the partnership's 1973 loss and each petitioner's share of that loss. In the statutory notice sent to petitioner Armstrong for60 1973, respondent determined that the $9,000 Armstrong received from National Mortgage was a commission payment and therefore ordinary income rather than capital gain. OPINION The first issue for decision is when did the Chapel Hill partnership acquire an economic interest in the Chapel Hill apartment complex so as to be entitled to a deduction for depreciation under section 167(a). As a general rule, section 167(a) provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business or held for the production of income by a taxpayer. However, a taxpayer is not entitled to a deduction for depreciation until he acquires an economic interest in property that will decrease in value as a result of depreciation. Helvering v. Lazarus & Co.,308 U.S. 252">308 U.S. 252, 254 (1939); Miller v. Commissioner,68 T.C. 767">68 T.C. 767, 775 (1977). Moreover, when a taxpayer enters a contract to purchase property, the taxpayer does not acquire a depreciable interest in the property until the sale is complete. Baird v. Commissioner,68 T.C. 115">68 T.C. 115, 124-125 (1977). The question61 of when a sale is complete is essentially a question of fact. No hard and fast rules of thumb exist and no single factor is controlling. The test to be applied is a practical one, taking into account all the facts and circumstances surrounding the transaction and the intent of the parties. Clodfelter v. Commissioner,426 F.2d 1391">426 F.2d 1391, 1393-1394 (9th Cir. 1970), affg. 48 T.C. 694">48 T.C. 694 (1967); Baird v. Commissioner,supra;Deyoe v. Commissioner,66 T.C. 904">66 T.C. 904, 910 (1976). Generally, a sale of real property will be complete on the transfer of legal title to the purchaser or upon the shift of the burdens and benefits of ownership to the purchaser if such shift occurs before the transfer of title. Baird v. Commissioner,supra;Deyoe v. Commissioner,supra. Thus, where passage of title is delayed to secure payment of the purchase price, the sale will be complete upon the acquisition of the burdens and benefits of ownership by the purchaser. Deyoe v. Commissioner,supra;Merrill v. Commissioner,40 T.C. 66">40 T.C. 66, 76 (1963), affd. per curiam 336 F.2d 771">336 F.2d 771 (9th Cir. 1964).62 In the present case, since Grandlich, as seller, was entitled to retain the deed and thus legal title to the Chapel Hill apartments until the partnership paid off the mortgage, to determine at what point the partnership acquired a depreciable interest in the apartments, we must first determine when the partnership acquired the burdens and benefits of ownership of the apartments. Petitioners argue that the Chapel Hill partnership acquired the burdens and benefits of ownership of the Chapel Hill apartments on June 1, 1972, when Armstrong and Optiz assigned their vendees' interest in the April 1, 1972, land contract to the partnership. In support of this argument, petitioners contend that the partnership had the following rights and obligations under the April contract: The unconditional obligation to purchase the apartments at a fixed price; the burden of wear and tear; the right to possession; the burden of insuring against losses; and the burden of interest and real estate taxes. Respondent, on the other hand, takes the position that until "Time T", February 28, 1973, Grandlich, the seller, had the right to all the rental income from the apartments and was responsible for the63 mortgage payments and numerous other expenses incurred in connection with his maintenance and operation of the apartments. Respondent, therefore, contends that the partnership did not acquire the burdens and benefits of ownership of the apartments until March 1, 1973. Taking into consideration all the facts and circumstances in this case, we conclude that the sale of the apartments to Armstrong and Opitz was complete on April 1, 1972, and the partnership acquired the burdens and benefits of ownership on June 1, 1972, when Armstrong and Opitz assigned their vendees' interest in the April 1, 1972, contract to the partnership. Our decision rests on a number of factors. First, we believe that the partnership as assignee under the amended April contract had the unconditional obligation to pay a fixed price for the apartments as of June 1, 1972. Respondent takes the position that the amended April contract was conditional because the partnership did not have to begin making purchase payments to the seller, Grandlich, until "Time T" was reached and, therefore, the partnership had no obligation to purchase the apartments until "Time T" was reached. 4 However, under Wisconsin law, 64 the fact that the time of payment under a contract to purchase land is controlled by the occurrence of a future event does not necessarily make the contract conditional. Locke v. Bort,10 Wis 2d 585, 103 N.W.2d 555">103 N.W.2d 555, 559 (1960). see also Boulevard Builders, Inc. v. Snyder,13 Wis. 2d 486">13 Wis. 2d 486, 108 N.W.2d 914">108 N.W.2d 914, 916 (1961). The controlling factor in determining whether a contract is conditional is the intent of the parties. Sprecher v. Weston's Bar, Inc.,78 Wis. 2d 26">78 Wis. 2d 26, 253 N.W.2d 493">253 N.W.2d 493, 497 (1977); Locke v. Bort,supra, at 558. The evidence in the record makes it clear that the parties to the65 April 1, 1972, contracts considered the vendees' obligation to purchase the apartments binding as of April 1, 1972. Nowhere in the language of the amended April contracts is the vendees' obligation to purchase the apartments described as conditional. In addition, both Armstrong and Opitz testified that they considered their obligation to purchase binding as of April 1, 1972, and the occurrence of "Time T" as merely controlling the time of payment. Armstrong further testified that the unsecured loans made by the partnership to Grandlich in the fall of 1972, prior to the occurrence of "Time T," would never have been made if the partnership's obligation to purchase the apartments was conditional. Since the partnership had the unconditional obligation to pay Grandlich $2,225,000 for the appartments as of June 1, 1972, if the value of the apartments fell below $2,225,000 after June 1, 1972, the partnership bore the risk of this form of economic depreciation and such a risk is clearly one of the burdens of ownership. Merrill v. Commissioner, 40 T.C. 66">40 T.C. 66, 76 (1963), affd. 336 F.2d 771">336 F.2d 771 (9th Cir. 1964); Wisconsin Electric Power Co. v. Commissioner, 18 T.C. 400">18 T.C. 400, 402 (1952).66 Second, petitioner and respondent agree that under the terms of the amended April contracts, the purchasers had the unconditional obligation to keep the apartments in good condition and repair. This obligation was contrary to a clause in the December 30, 1971, contract which provided that the purchasers had the obligation to keep the apartments in good condition and repair except for ordinary were and decay. This exception for ordinary wear and decay was deleted in the April contrscts. We believe this deletion indicates that the parties intended the purchasers, Armstrong and Opitz, to have the burden of wear and tear as of April 1, 1972, and when the April contract was assigned to the partnership on June 1, 1972, it assumed this burden of wear and tear. This burden is certainly a burden of ownership. Royal St. Louis, Inc. v. United States, 578 F.2d 1017">578 F.2d 1017, 1020 (5th Cir. 1978). Third, petitioner and respondent agree that under the terms of the amended April contracts, Armstrong and Opitz, as purchasers, were entitled to possession of the apartments on April 1, 1972. When Armstrong and Opitz assigned the April contract to the partnership on June 1, 1972, it67 acquired this right to possession. Although actual possession is not an essential element of a depreciable interest in property, it is one of the benefits of ownership. Commissioner v. Segall, 114 F.2d 706">114 F.2d 706, 709 (6th Cir. 1940); Fort Hamilton Manor, Inc. v. Commissioner, 51 T.C. 707">51 T.C. 707, 720 (1969), affd. 445 F.2d 879">445 F.2d 879 (2d Cir. 1971).Fourth, petitioner and respondent also agree that under the terms of the amended April contracts, the purchasers had the unconditional obligation to maintain fire insurance on the apartments. However, when the April contracts were executed, Grandlich agreed to have the purchasers named as additional insureds on his existing policy convering the apartments with no additional charge to the purchasers. Pursuant to this agreement, Grandlich paid the 1972 insurance premiums on the policy convering the apartments. Thus, even though the partnership assumed the contractual obligation to provide fire insurance on the apartments when it was assigned the contract on June 1, 1972, since Grandlich paid the insurance premium for 1972, the partnership did not actually have the burden of insuring the property. Nevertheless, 68 under the Wisconsin Uniform Vendor and Purchaser Risk Act, Wis. Stats. sec. 706.12, the partnership, as a purchaser in possession, had the risk of any uninsured loss. Section 706.12(1)(b) of the Uniform Act provides as follows: If, when either the legal title or the possession of the subject matter of the contract has been transferred, all or any part thereof is destroyed without fault of the vendor or is taken by eminent domain, the purchaser is not thereby relieved from a duty to pay the price, nor is he entitled to recover any portion thereof that he has paid. This risk of loss which the partnership bore is another burden of ownership. 2 Lexington Avenue Corp. v. Commissioner, 26 T.C. 816">26 T.C. 816, 824 (1956). Fifth, the partnership, as assigneee under the amended April contract, was liable for the real estate taxes on the apartment property from the date of the contract, April 1, 1972. On December 26, 1972, the partnership paid the City of Madison $34,797.50 in real estate taxes on the apartment property for 1972. The partnership was also obligated under the amended April contract to pay Grandlich $90,000 in interest, which was the estimated amount of69 interest due on the unpaid balance of $2,220,000 at the rate of 9.725 percent per year for the period April 1, 1972, to September 1, 1972. On December 20, 1972, the partnership paid Grandlich, through Heather Hills, $90,000 in interest. Both of these expenses incurred by the partnership during 1972 are burdens of ownership. Deyoe v. Commissioner, 66 T.C. at 910, 911; Estate of Johnston v. Commissioner, 51 T.C. 290">51 T.C. 290, 298 (1968), affd. sub nom. Dettmers v. Commissioner, 430 F.2d 1019">430 F.2d 1019 (6th Cir. 1970). Sixth, we are not persuaded by respondent's argument that since Grandlich, the seller, was entitled to all the rental income from the apartments and was responsible for the mortgage payments and numerous other apartment operation expenses until "Time T", February 28, 1973, the partnership did not acquire benefits and burdens of ownership of the apartments until March 1, 1973. In making this argument the respondent has overlooked the fact that Grandlich received the rent and paid the operating expenses under the terms of the management agreement set out in the amended April contracts. All of the rent received by the apartments between70 June 1, 1972, and March 1, 1973, was reported by the partnership on its 1972 and 1973 returns. When the partnership would receive the rent it would in turn pay such rent to Grandlich as a management fee and then deduct these fees on its 1972 and 1973 returns. Consequently, Grandlich's receipt of the rents and his payment of the apartment operation expenses cannot properly be viewed as a benefit and burden of ownership held by Grandlich. Finally, the fact that Grandlich was liable on the mortgage does not by itself lead us to the conclusion that Grandlich retained the burdens and benefits of ownership until "Time T." Having concluded that the sale of the apartments was complete on April 1, 1972, and that the partnership acquired the burdens and benefits of ownership on June 1, 1972, when it was assigned the contract, we hold that the partnership had an economic interest in the apartments as of June 1, 1972, and was therefore entitled to deduct depreciation for the period June 1, 1972, through December 31, 1972, and for the entire year 1973. The second issue we must decide is whether the Chapel Hill partnership was the "original user" of the Chapel Hill apartment complex within71 the meaning of section 167(j)(2) so as to qualify for accelerated depreciation under section 167(b) in 1972 and 1973. Under section 167(b) a taxpayer may deduct depreciation on property using one of several methods including the straight line method and such accelerated methods as the declining balance method and the sum of the years-digits method. Section 167(j)(2) provides that a taxpayer may deduct depreciation on residential rental property under an accelerated method if the "original use" of the property commenced with the taxpayer. On its 1972 return, the partnership, using the double declining balance method, claimed depreciation on the apartments for the period June 1, 1972, through December 31, 1972. On its 1973 return, the partnership again used the double declining balance method and claimed depreciation on the apartments for the entire year 1973. Respondent concedes on brief that if the partnership acquired the burdens and benefits of ownership of the apartments on June 1, 1972, then the partnership constituted the "original user" of the property and was therefore entitled to use an accelerated method of depreciation during 1972 and 1973. Since we have already72 found that the partnership acquired the burdens and benefits of ownership of the apartments on June 1, 1972, we hold that the partnership was entitled to accelerated depreciation on the apartments for the period June 1, 1972, through December 31, 1972, and for the entire year 1973. The third issue to be decided is whether the payment of $90,000 by the Chapel Hill partnership to Grandlich in December 1972 was deductible by the partnership in 1972 as interest under section 163(a). Section 163(a) permits a deduction for all interest paid or accrued within the taxable year on indebtedness. As assignee under the amended April contract, the partnership was obligated in 1972 to pay Grandlich $90,000 in interest on the balance of the unpaid purchase price. On December 20, 1972, the partnership paid Grandlich, through Heather Hills, $90,000 in interest and deducted this amount on its 1972 return. Respondent concedes on brief that if the partnership acquired the benefits and burdens of ownership of the apartments on June 1, 1972, then the partnership was entitled to deduct the $90,000 in 1972 as interest. Since we have found that the partnership acquired the benefits and burdens73 of ownership of the apartments on June 1, 1972, we therefore hold that the partnership properly deducted the $90,000 in 1972 interest. The fourth issue we must decide is whether the payment of $34,797.50 by the Chapel Hill partnership to the City of Madison in December 1972 was deductible by the partnership in 1972 as real estate taxes under section 164(a). Section 164(a) permits a deduction for state and local real property taxes paid or accrued within the taxable year. If real property is sold during the taxable year, section 164(d) provides that the portion of the real property tax allocable to the part of the year prior to sale shall be treated as a tax imposed on the seller, and the portion of the real property tax allocable to the part of the year after the sale shall be treated as a tax imposed on the purchaser. As assignee under the amended April contract, the partnership was liable for the real estate taxes on the apartment property from the date of the contract, April 1, 1972. On December 26, 1972, the partnership paid the City of Madison $34,797.50 in real estate taxes on the apartment property for 1972 and deducted this amount on its 1972 return. Respondent74 concedes on brief that if the sale of the apartments occurred on April 1, 1972, then the partnership was entitled to deduct the $34,797.50 in real estate taxes in 1972. Since we have already found that the sale of the apartments was complete on April 1, 1972, and that the partnership was obligated to pay the real estate taxes, we hold that the partnership properly deducted the $34,797.50 in real estate taxes in 1972.The fifth and final issue for decision is whether the $9,000 received by petitioner Armstrong in March 1973 was a commission payment and therefore ordinary income, or a payment for the release of an option and therefore entitled to capital gain treatment under section 1234(a). In 1971 when Grandlich was attempting to sell the Chapel Hill apartments, he gave National Mortgage an oral listing and agreed to pay National Mortgage a commission of $40,000 if an acceptable sale was arranged. In October of 1971, Armstrong secured an oral option from Grandlich to buy the apartments. No payment was made by Armstrong to Grandlich for this option.Armstrong did not personally have the funds to purchase the apartments, but intended to bring in other investors to obtain the necessary75 capital. Since Armstrong owned an abstract title insurance company in Madison and was not a real estate broker, to help him find other investors, Armstrong contacted Opitz, who was a real estate broker in Madison. Opitz subsequently agreed to help Armstrong find investors with the capital to purchase the apartments. In exchange for Opitz' help, Armstrong orally assigned a one-half interest in his option to Opitz. At the same time Armstrong and Opitz were working with Grandlich to arrange a sale of the apartments, National Mortgage was attempting to arrange a sale with Roger Gaumnitz, an employee of Opitz' real estate brokerage firm. When National Mortgage learned that Armstrong and Opitz had an option to buy the apartments from Grandlich, an officer of National Mortgage contacted them and explained that before Grandlich could sell the apartments he needed the consent of the holders of the mortgage notes on the apartment property. The officer also told Armstrong and Opitz that National Mortgage was in a position to proevent the mortgage note holders from giving their consent unless National Mortgage's right to the $40,000 sales commission was preserved. To avoid problems in76 obtaining the consent of the mortgage note holders, Armstrong and Opitz agreed with National Mortgage that the $40,000 commission should be split; National Mortgage would keep $22,000 and Armstrong and Opitz would each receive $9,000.On December 29, 1971, National Mortgage sent a letter to Armstrong confirming their agreement. The letter stated in part: Enclosed is a copy of the letter agreement regarding the commissions for the sale of Chapel Hill between [Grandlich] and National Mortgage Corporation. This is to confirm that when National Mortgage Corporation receives the $40,000.00 at "Time T", National Mortgage Corporation will pay you $18,000.00 for the release of your options. Thereafter, on June 12, 1972, Armstrong executed an affidavit in which he stated that the "interest" in the Chapel Hill apartments held by him and Opitz had been extinguished and this "interest" now existed in favor of the Chapel Hill partnership. Armstrong testified this document was intended to document the release to the partnership of the option to buy the apartments which he and Opitz held. In March 1973, National Mortgage received its $40,000 commission of the sale of the apartments from77 Grandlich. Later in 1973, pursuant to the 1971 agreement between National Mortgage and Armstrong and Opitz, National Mortgage paid Armstrong and Opitz $9,000 each. Armstrong and Opitz' reporting of this payment was inconsistent. Opitz considered the $9,000 to be income to his real estate brokerage firm and, consequently, this payment was reported by his firm on its 1973 return. Armstrong, however, treated the $9,000 as capital gain on his 1973 return. The respondent disallowed Armstrong's treatment and determined instead that the $9,000 was ordinary income to him in 1973.Petitioner Armstrong contends that the $9,000 payment was for the release to the partnership of his option to buy the apartments and therefore entitled to capital gain treatment as the sale of an option under section 1234(a). 5 Respondent, on the other hand, argues that this $9,000 payment Armstrong received was not for the release of his option but was, in reality, a commission payment as part of a co-brokerage fee on the sale of the apartments to the partnership. In support of this argument, respondent contends that when Armstrong and Opitz and National Mortgage discovered that they had been working independently78 of each other to arrange a sale of the apartments, an agreement was reached whereby National Mortgage would split the $40,000 commission with Armstrong and Opitz. Although petitioner Armstrong argues that the $9,000 was for the release of his option, the evidence he presented indicates nothing more than in form the transaction was a payment for the release of his option. However, the substance not the form of a transaction controls for tax purposes. Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331, 334 (1945); Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 470 (1935). Moreover, the burden of proving that the transaction was in substance a payment for the release of an option is on petitioner79 Armstrong. Rule 142, Tax Court Rules of Practice and Procedure.Based on the evidence presented, we conclude that petitioner Armstrong has failed to prove that the $9,000 he received in 1972 was in substance a payment for the release of his option to buy the apartments. We therefore sustain respondent's determination that the $9,000 Armstrong received in 1973 was ordinary income. To reflect concessions and the foregoing, Decisions will be entered under Rule 155. Footnotes1. The following cases have been consolidated for purposes of trial, briefing, and opinion: Gary W. Woroch and Lorraine I. Woroch, docket No. 3107-77; Marcia L. Terman, docket No. 3108-77; Lealands Corporation, docket No. 3109-77; Duane A. Anderson and Phyllis Anderson, docket No. 3110-77; Raymond J. Morton and Letty Morton, docket No. 3111-77; Kenneth D. Opitz and Carol J. Opitz, docket No. 3112-77; Robert A. Sandahl and Elaine R. Sandahl, docket No. 3113-77; Michael E. Donogan and Maryln A. Donogan, docket No. 3114-77; John A. Frantz and Mary H. Frantz, docket No. 3115-77; Perry J. Armstrong and Sheila J. Armstrong, docket No. 3116-77; Douglas J. Baker and Winifred N. Baker, docket No. 3117-77; Tad M. Baker and Diane L. Baker, docket No. 3118-77; William E. Currier, docket No. 3119-77; William E. Currier and Carol J. Currier, docket No. 6856-77; Marcus Cohen and Sheila Cohen, docket No. 3120-77.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, and in force during the years in issue.↩3. Arthur G. Grandlich, the seller, was not called as a witness at trial by either petitioner or respondent.↩4. Respondent made a preliminary argument on brief that the December 30, 1971, contract was the final agreement of the parties and under that contract the benefits and burdens of ownership were ot to shift until "Time T". However, it is clear that the December 30, 1971, contract was amended by the April 1, 1972, contracts and, therefore, under Wisconsin law the rights and obligations of the vendor and purchasers were controlled by the April contracts. See Estreen v. Bluhm,79 Wis. 2d 142">79 Wis. 2d 142, 255 N.W.2d 473">255 N.W.2d 473, 479↩ (1977).5. SEC. 1234. OPTIONS TO BUY OR SELL. (a) Treatment of Gain or Loss.--Gain or loss attributable to the sale or exchange of, or loss attributable to failure to exercise, a privilege or option to buy or sell property shall be considered gain or loss from the sale or exchange of property which has the same character as the property to which the option or privilege relates has in the hands of the taxpayer (or would have in the hands of the taxpayer if acquired by him).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623165/	Grover D. Turnbow and Ruth H. Turnbow, Petitioners, v. Commissioner of Internal Revenue, RespondentTurnbow v. CommissionerDocket No. 69429United States Tax Court32 T.C. 646; 1959 U.S. Tax Ct. LEXIS 148; June 12, 1959, Filed 148 Decision will be entered under Rule 50. Petitioner, who owned all of the stock of Supply, exchanged all of such stock for shares of stock of Foremost Dairies, Inc., and $ 3,000,000. He reported gain limited to $ 3,000,000, less expenses, under section 112(c)(1), 1939 Code. Respondent determined that gain in excess of $ 3,000,000 was taxable because section 112(c)(1) was not applicable. Held, the provisions of section 112(c)(1) are applicable and petitioner's gain is recognized but only in an amount which does not exceed the cash payment. M. W. Dobrzensky, Esq., and S. H. Dobrzensky, Esq., for the petitioners.Nat. F. Richardson, Esq., for the respondent. Harron, Judge. HARRON 646 The Commissioner determined deficiencies in income tax for the taxable years 1952 and 1953 in the amounts of150 $ 264,037.43 and $ 14,786.26, respectively. The question is whether or not section 112(c)(1), 1939 Code, applies to a transaction in which petitioner received cash and stock in an acquiring corporation in exchange for all of the stock in another corporation, which became a subsidiary of the acquiring corporation, so that the taxable gain to be recognized is limited to the amount of cash received.FINDINGS OF FACT.The petitioners, residents of San Francisco, California, filed joint income tax returns for the taxable years with the collector of internal revenue for the first district of California. Since the issue to be decided relates only to Grover D. Turnbow, he is referred to hereinafter as the petitioner.Petitioner owned all of the outstanding stock of International Dairy Supply Co. (a Nevada corporation) and International Dairy Engineering Co. (a California corporation). International Dairy Supply Co. (a Nevada corporation) owned 60 per cent of the stock of Diamond Dairy, Inc., and a group of individuals represented by petitioner owned the remaining 40 per cent of the stock of Diamond Dairy, Inc.Foremost Dairies, Inc., a New York corporation (hereinafter called Foremost), 151 which has its principal place of business in Jacksonville, 647 Florida, is engaged in the business of processing and distributing milk, cream, and other dairy products.International Dairy Supply Co. (hereinafter called Supply 1) had, and still has, its principal office in San Francisco. The main part of its business was furnishing reconstituted milk and milk products to the Armed Forces of the United States, located outside the country, under contracts with the United States. Supply prepared dehydrated milk and milk products in this country and shipped such products to plants, which it operated in foreign countries, where the dehydrated milk and milk products were converted into liquid milk, chocolate drinks, ice cream, and similar products. Since it began business, 95 per cent of Supply's gross income has been derived from sources other than sources within the United States. In 1952, Supply was a party to a contract with the United States which had been executed in 1948 and which was a continuing contract in good standing. Supply also had a contract with the United States to furnish milk products to the Armed Forces in the Far East Command.152 In 1952, there was only one class of stock of Supply issued, namely, voting capital stock. There were 5,000 shares outstanding, all of which were owned by Grover D. Turnbow.In 1952, International Dairy Engineering Co. (hereinafter called Engineering) was engaged in constructing a plant at Atwater, California. Its total outstanding stock consisted of 100 shares, which were owned by Turnbow.In 1952, the outstanding capital stock of Diamond Dairy, Inc. (hereinafter called Diamond), consisted of 25,000 shares, of which Supply owned 15,000 shares, 60 per cent, and individuals owned 10,000 shares, 40 per cent.In 1951, Foremost and Turnbow began negotiations and entered into an agreement under which Foremost was to acquire all of the stock of the three corporations above named in what was intended to be a tax-free reorganization. Upon completion of preliminary matters in the early part of 1952, a supplemental agreement, called Amendatory Agreement, was executed by Foremost and Turnbow on February 11, 1952. The amendatory agreement is incorporated herein by this reference. It included in inter alia, the reorganization plan.Under the reorganization plan the following was to be153 done: (1) Foremost was to acquire from Turnbow all of the capital stock of Supply (5,000 shares), and Turnbow was to receive in exchange 82,375 shares of the common stock of Foremost, plus $ 3,000,000. Supply was thereby to become a wholly owned subsidiary of Foremost; 648 it was to continue in the operation of its business. (2) Foremost was to acquire from Turnbow all of the outstanding capital stock of International Dairy Engineering Co. (100 shares), and Turnbow was to receive in exchange 60,000 shares of the common stock of Foremost. International Engineering was thereby to become a wholly owned subsidiary of Foremost, and it was to continue in the operation of its business. (3) Under the first exchange of stock, Foremost would gain control of 60 per cent of the capital stock of Diamond Dairy, Inc., which was owned by Supply. Having acquired control of Diamond, Foremost, pursuant to the plan of reorganization, was to acquire the minority stock of Diamond, 10,000 shares, by giving 10,000 shares of Foremost common stock in exchange for 10,000 shares of capital stock of Diamond, which Turnbow agreed to deliver. Neither Supply, Engineering, Diamond, nor Foremost was to154 make any distribution to its respective shareholders in pursuance of the plan of reorganization, or otherwise.It was contemplated, under the reorganization plan, that the number of directors of Supply and Engineering would be changed so that Turnbow would maintain three directors thereon and Foremost would elect three directors; that Supply would create an executive committee consisting of three members, two of which would be nominated by Foremost; that Turnbow would be the president and general manager of Supply and of Engineering, and that Turnbow's nominee would be president and/or general manager of Diamond; that Turnbow's salary would be in the same amount as the salary of the president of Foremost; that the president of Foremost might become the vice president of Supply and of Engineering, and the chairman of the executive committee of each company; that Turnbow would become a member of the board of directors and of the executive committee of Foremost, and would have the right to nominate two directors, in addition to himself, to Foremost's board of directors; that Turnbow would be elected chairman of Foremost's executive committee; and that Turnbow would execute a formal agreement155 with Foremost not to compete with either Supply, Engineering, or Foremost in the type of business carried on by each, other than the business of farming, cattle raising, or the farm production of milk. Furthermore, it was contemplated by the parties that there would be two divisions of the business of Foremost, the Eastern division, and the Western and International division; and that Turnbow would be known as the general manager of the Western and International division, and Paul E. Reinhold (the president of Foremost) would be known as the general manager of the Eastern division.The closing date under the 1952 agreement was March 3, 1952. Prior to the closing date Turnbow was to do the following things: 649 He was to purchase a ranch and certain personal property for cash from Engineering, and he was to convey all title to a patent application to Engineering. Also, he was to pay $ 500,000 to Engineering as a capital contribution, and it was agreed that the plant which Engineering was constructing at Atwater would cost in excess of $ 600,000, and would be completed, substantially, by April 15, 1952. Turnbow was, further, to purchase for cash from Supply certain notes receivable156 of three stockholders of Diamond for $ 61,142, and a note of a Dr. Kempf for $ 3,150.The terms of the agreement of February 11, 1952, were carried out.On March 3, 1952, the exchange of the stock of Supply for stock of Foremost was consummated, and Turnbow received 82,375 shares of the common stock of Foremost (a minority interest) in exchange for all of the capital stock of Supply. Turnbow also received cash from Foremost in the amount of $ 3,000,000. Since his expenses in connection with the exchange were $ 15,007.23, the net amount of the cash he received was $ 2,984,992.77.On March 3, 1952, the 82,375 shares of common stock of Foremost had a fair market value of $ 15 per share.In the exchange of the stock of Supply, Foremost acquired all of the issued and outstanding shares of stock of Supply, of all classes. In the exchange, petitioner acquired only the 82,375 shares of common stock of Foremost and cash in the amount of $ 3,000,000 ("boot"), and Foremost acquired only all of the issued and outstanding shares of the voting capital stock of Supply.In the income tax return of the petitioner for 1952, he reported long-term capital gain from the above-described transaction 157 in the amount of $ 2,984,992.77, under the provision of sections 112(b)(3) and 112(c)(1).The Commissioner's determination was as follows:In 1952 you exchanged 5,000 shares of International Dairy Supply Company capital stock for $ 3,000,000.00 in cash and 82,375 shares of capital stock of Foremost Dairies, Inc. You determined that the gain to be recognized was limited to the amount of cash received. In your return you reported a gain of $ 2,984,992.77 ($ 3,000,000.00 less $ 15,007.23 expense of exchange). It is held that the entire gain realized upon the exchange constituted taxable income. The adjustment to the income reported in your return is computed as follows:Amount received on exchange:Cash$ 3,000,000.0082,375 shares of Foremost Dairies, Inc.valued at $ 15.00 a share1,235,625.00Total received$ 4,235,625.00Less: Basis of stock exchanged$ 50,000.00Expenses per return20,981.80Add'l. legal fees allowed951.2671,933.06Gain recognized$ 4,163,691.94Gain reported2,984,992.77Additional gain recognized$ 1,178,699.17Adjustment to income -- 50 per cent$ 589,349.59650 OPINION.Petitioner owned all of158 the outstanding stock of Supply, which was voting stock. In 1952, he received in exchange for all of his stock in Supply 82,375 shares of common stock of Foremost and $ 3,000,000 in cash, so-called "boot." The question before us is limited to whether the provisions of section 112(c)(1) of the 1939 Code 2 apply to the transaction. Respondent has determined that section 112(c)(1) does not apply and, that therefore, the entire gain is taxable under section 112(a).159 Petitioner contends that, in considering whether section 112(c)(1) applies to the transaction, it is necessary and proper to look to section 112(b)(3) 3after omitting the cash payment involved in the transaction. Respondent contends that there must be a qualifying reorganization within the meaning of section 112(g)(1)(B) 4 before section 112(c)(1) can come into play insofar as section 112(c)(1) refers to an exchange within the provisions of section 112(b)(3).160 Subsection (b) of section 112 allows various exceptions from subsection (a), which states the general rule that the entire amount of the gain shall be recognized upon the sale or exchange of property. Subsection (b) deals with exchanges solely in kind, whereas subsection (c) deals with the treatment of gain from exchanges which are not solely in kind, but only if an exchange would be within (1), (2), (3), or (5), if it were not for the fact that the property received in exchange consists not only of property permitted by (1), or (2), or (3), or (5), but 651 also of other property or money. Directing our attention to section 112(b)(3), it is noted that among the requirements contained therein is the specification that the property involved must be stock or securities which is exchanged solely for stock or securities. Both of the sections involved here, subsection (b)(3) and subsection (c)(1), are provisions of long standing which were reenacted in the successive revenue acts which preceded the 1939 Code. In both the regulations of the Commissioner and in this Court's interpretation of section 112(c)(1), it has been understood that in order to give effect161 to the provisions of section 112(c)(1) the method to be followed is first to omit the item of cash (or other property) from the transaction and then to determine whether the exchange would be within subsection (b)(3). Otherwise, section 112(c)(1) would have no meaning in the context of its references to particular subsections of section 112(b).In , this Court concluded that the method of applying the statute was as follows:It is necessary therefore to determine whether or not the exchange of * * stock for * * * stock would be within the provisions of subsection (b)(3) if the item of cash had been omitted and only * * * stock had been received in exchange for * * * stock. [Italics supplied.]In , reversing , on the basis of a question which was not reached by this Court, the following was stated:Thus we may conclude that, in determining when these so-called "boot" provisions apply, Congress intended that the transaction is to be considered separately and apart162 from the "boot" received in determining whether it meets the nonrecognition provisions. If the transaction, absent the "other property or money," fulfills the requirements of section 112(b)(3), then gain is to be recognized to the extent that "boot" is received.In the instant case, but for the cash received in exchange for * * common stock of Binkley, the transaction would have met the "solely" requirement of section 112(g)(1)(B) and fallen within the scope of section 112(b)(3). To the extent that "boot" was received, gain would be recognized under our interpretation of section 112(c)(1). * * The view expressed in , corresponds with the opinion which was expressed by this Court in the Bonham case. Our problem here is whether we should adhere to our understanding of the method to be followed in determining whether section 112(c)(1) applies in an exchange of stock solely for stock, plus money.Consideration has been given to the respondent's regulation, Regs. 118, sec. 39.112(g)-4 (issued September 26, 1953, and applicable to taxable years beginning after December 31, 1951), which is set forth in the163 margin. 5 Regs. 111, sec. 29.112(g)-4 (issued by respondent in 652 October 1943 and applicable to taxable years beginning after December 31, 1941), contain provisions which are identical with Regs. 118, sec. 39.112(g)-4. The provisions of section 112(c)(1) of the 1939 Code were reenacted in substantially identical language in section 351(b) of the 1954 Code, and respondent's regulations promulgated under the 1954 Code, section 1.351-2(a) restate in substantially identical language what was stated in Regs. 111, sec. 29.112(g)-4, and Regs. 118, sec. 39.112(g)-4.164 Thus, there has been a long-standing and continuous construction of section 112(c)(1) (and the corresponding section in the earlier revenue acts) which has remained unchanged over the years in the face of the several reenactments of the statutory provision, as well as the amendment in the 1934 Act of section 112(g)(1)(B), when there was introduced into subsection (g)(1)(B) the word "solely," in harmony with the provisions of subsections (b)(2), (b)(3), (b)(4), and (b)(5) which also contained the word "solely," and contained "solely" for many years. The respondent's regulations, therefore, are deemed to have received the approval of Congress. ; . Respondent has not offered any explanation for his departure in this case from his long-standing interpretation of section 112(c)(1) set forth in his regulations.In this circumstance, and since this Court's view of the method to be followed in applying the provisions of section 112(c)(1) is in accord with the respondent's long-standing regulations, we do not find cause for changing our construction165 of section 112(c)(1), and in this case we conclude that it should be followed.The respondent's error is that he has seen fit here not to omit the item of cash in determining whether the transaction of petitioner and Foremost involved an exchange of the stock of Supply solely for stock of Foremost within the provisions of section 112(b)(3).Accordingly it is held, that but for the cash received by petitioner in the transaction involving the exchange of all of the stock of Supply for part of the stock of Foremost, the exchange would have met the "solely" requirement of section 112(g)(1)(B) and fallen 653 within section 112(b)(3). . Therefore, under section 112(c)(1) the gain to petitioner may not be recognized in an amount in excess of $ 2,984,992.77, which is the net amount of $ 3,000,000 less allowable expenses.Recomputations are required under Rule 50 because of concessions or abandonment of the parties in respect to other adjustments.Decision will be entered under Rule 50. Footnotes1. The parties also refer to this corporation as International.↩2. SEC. 112(c). Gain From Exchanges Not Solely in Kind. -- (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (l), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (l) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.↩3. SEC. 112. RECOGNITION OF GAIN OR LOSS.(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.(b) Exchanges Solely in Kind. -- * * * (3) Stock for stock on reorganization. -- No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.↩4. SEC. 112(g). Definition of Reorganization. -- As used in this section * * -- (1) The term "reorganization" means * * , or (B) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation, * *↩5. Sec. 39.112(g)-4 Exchanges in reorganization for stock or securities and other property or money. (a) If in an exchange of stock or securities in a corporation a party to a reorganization, in pursuance of the plan of reorganization, for stock or securities in the same corporation or in another corporation a party to the reorganization, there is received by the taxpayer other property (not permitted to be received without the recognition of gain) or money, then(1) As provided in section 112(c)(1), the gain, if any, to the taxpayer will be recognized in an amount not in excess of the sum of money and the fair market value of the other property, but(2) The loss, if any, to the taxpayer from such an exchange is not to be recognized to any extent (see section 112(e)).(b) The application of paragraph (a) of this section may be illustrated by the following example:Example↩. A, in connection with a reorganization, in 1952, exchanges a share of stock in the X Corporation purchased in 1929 at a cost of $ 100 for a share of stock of the Y Corporation (a party to the reorganization), which has a fair market value of $ 90, plus $ 20 in cash. The gain from the transaction is $ 10 and is recognized and taxed as a gain from the exchange of property. But see section 117. However, if the share of stock received had a fair market value of $ 70, the loss from the transaction of $ 10 would not be recognized.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623166/	FREDERICK J. HAYNES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Haynes v. CommissionerDocket No. 7247.United States Board of Tax Appeals7 B.T.A. 465; 1927 BTA LEXIS 3165; June 23, 1927, Promulgated 3165 Petitioner and his wife held a note and a mortgage securing the payment thereof as joint tenants. Held that only one-half the interest paid on the note is income to the petitioner. John P. O'Hara, Esq., for the petitioner. Bruce A. Low, Esq., for the respondent. ARUNDELL465 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1922 in the amount of $1,624, of which the petitioner contests only $812. The issues are whether petitioner and his wife were joint owners of a certain note and whether the interest received thereon is taxable in whole or in part to the petitioner. FINDINGS OF FACT. The petitioner is an individual residing in Detroit, Mich.In the latter part of the year 1921 the payees of a note given by the Maple Road Land Co., a Michigan corporation, in the principal sum of $48,000, endorsed the note over to petitioner and his wife by the following endorsement: Pay to the order of Frederick J. Haynes and Clara M. Haynes his wife, not as tenants in common, but jointly with full right to the survivor. CHARLES D. MILLER. EMMA E. SNOW. At the time of this endorsement3166 $40,000 of the principal was unpaid. The note was secured by a mortgage on real estate of the Maple Road Land Co. This mortgage was assigned by the mortgagees to petitioner and his wife by an instrument, the body of which reads as follows: KNOW ALL MEN BY THESE PRESENTS, That we CHARLES D. MILLER and EMMA E. SNOW, of Birmingham, Oakland County, Michigan, parties of the first part, for and in consideration of the sum of Forty Thousand ($40,000.00) Dollars, lawful money of the United States of America, to them in hand paid 466 by FREDERICK J. HAYNES and CLARA M. HAYNES, his wife, not as tenants in common, but jointly with full rights of survivorship, parties of the second part, the receipt whereof is hereby acknowledged, have sold, assigned and transferred, and hereby do sell, assign and transfer to the said parties of the second part, not as tenants in common, but as joint tenants, with full rights to the survivor, all their right, title and interest in and to a certain real estate mortgage, dated the 6th day of November in the year one thousand nine hundred and sixteen, made by MAPLE ROAD LAND COMPANY, a Michigan Corporation, to CHARLES D. MILLER and EMMA SNOW, and recorded3167 in the office of the Register of Deeds for the County of Oakland, State of Michigan, in Liber 224 of Mortgages, on page 366. IN WITNESS WHEREOF we have hereunto set our hands and seals this 22nd day of December in the year one thousand nine hundred and twenty-one. CHARLES D. MILLER (Seal) EMMA E. SNOW (Seal) On the same date, December 22, 1921, the petitioner entered into an agreement with the Oakland Hills Country Club extending the Maple Road Land Co. note and increasing the rate of interest from 6 per cent to 7 per cent. The petitioner's wife did not sign this agreement, although she is named therein as a party to it. In 1922 the Oakland Hills Country Club paid $2,800 as interest on the note involved, which amount was returned as income by the wife of the petitioner. The respondent in computing the deficiency appealed from added the interest to the income of the petitioner. OPINION. ARUNDELL: The petitioner admits that $1,400, or one-half of the interest paid on the note in 1922, represents income to him, but contends that the balance was paid to his wife and belonged to her and that he is not subject to tax thereon. It is his contention that he and his wife3168 owned the note and mortgage jointly. The respondent denies the joint ownership and has computed the deficiency on the theory that the petitioner made a gift of the interest to his wife. Although the common law doctrine with reference to joint tenancies in personal property has never been adopted by statute in Michigan, the Supreme Court of that State has recognized that such tenancies may be validly created by specific provision therefor in the instrument of conveyance. Lober v. Dorgan,215 Mich. 62">215 Mich. 62; 183 N.W. 942">183 N.W. 942. It therefore seems clear that the petitioner and his wife held the note here involved as joint tenants. As a result of such ownership each tenant had an equal right to share in the property so held and the income therefrom. Thompson on Real Property, § 1710; 7 R.C.L. 811; Case v. Owen,139 Ind. 22">139 Ind. 22; 38 N.E. 395">38 N.E. 395; Kissam v. McElligott,280 Fed. 212. 467 The Michigan Married Woman's Act, 3 Mich. Comp. Laws, 1915, sec. 11485, provides: That the real and personal estate of every female, acquired before marriage, and all property, real and personal, to which she may afterwards3169 become entitled, by gift, grant, inheritance, devise, or in any other manner, shall be and remain the estate and property of such female, and shall not be liable for the debts, obligations and engagements of her husband, and may be contracted, sold, transferred, mortgaged, conveyed, devised or bequeathed by her, in the same manner and with the like effect as if she were unmarried. As the petitioner and his wife were joint owners of the note here involved and each was entitled to one-half of the income therefrom, we are of the opinion, that in view of the provisions of the Married Woman's Act as set forth above, one-half of the income from the note was properly taxable to the petitioner's wife and only the remaining half was taxable to the petitioner. 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/4623167/	Beulah Eaton McAllister, Petitioner, v. Commissioner of Internal Revenue, RespondentMcAllister v. CommissionerDocket No. 4037United States Tax Court5 T.C. 714; 1945 U.S. Tax Ct. LEXIS 84; September 13, 1945, Promulgated 84 Decision will be entered under Rule 50. Payment to petitioner in return for termination of her life interest in income of trust and in full settlement therefor, held, taxable as ordinary income in year of receipt. Charles B. Collins, Esq., William Diebold, Esq., and Rudolph J. Welti, C. P. A., for the petitioner.Lawrence F. Casey, Esq., for the respondent. Opper, Judge. Van Fossan and Kern, JJ., dissent. Disney, J., dissenting. Black, J., agrees with this dissent. OPPER714 This case involves income tax for the calendar year 1940. Respondent85 has determined a deficiency in the sum of $ 19,468.59.The only question remaining for our consideration is whether the transaction by which the sum of $ 55,000 was paid to petitioner on 715 July 19, 1940, and accepted by her in full settlement of her interest in a certain trust created by the will of Richard McAllister, deceased, under which trust petitioner was entitled to receive the income for life, resulted in the receipt by petitioner of ordinary income taxable in full, or constituted a sale or exchange of a capital asset resulting in a deductible capital loss.FINDINGS OF FACT.We adopt as part of our findings of fact the stipulation of facts filed by the parties, including the exhibits referred to therein and admitted in evidence. Such parts of the stipulation of facts and of the exhibits referred to therein as are necessary to an understanding of the question presented are summarized below. We also include additional findings of fact based upon evidence adduced at the hearing.Beulah Eaton McAllister (hereinafter sometimes referred to as petitioner) is an individual residing in Beverly Hills, California. She filed her Federal income tax return for the calendar year86 1940 with the collector of internal revenue for the second district of New York on February 26, 1941.Petitioner was the lawful widow of John McAllister, who died, leaving no children, on May 1, 1937, on which date petitioner was 32 years, 4 months, 26 days old, having been born on December 4, 1904. John McAllister was the son of Richard McAllister, who died on or about April 6, 1926.The last will and testament (executed March 3, 1921) and codicil thereto (executed September 3, 1921) of Richard McAllister (hereinafter sometimes referred to as the decedent) provided in part as follows: That a trust fund of $ 100,000 be set up, the income to be paid to John McAllister for life and upon his death to his wife (the petitioner herein) in the event John McAllister left no children; the trust to terminate upon the death of the widow of John McAllister; that the residue go to Josephine C. McAllister, the testator's wife, and Richard McAllister, his son. The will and codicil further provided: * * I further direct that the income from the various trusts hereinabove created shall not be subject to any transfers, assignments or encumbrances, made or created by any of the respective beneficiaries, 87 and shall not be subject to any suits, liens, judgments, attachments, or executions resulting from any debts or acts of any of the respective beneficiaries, nor shall the same be subject to any suits, actions or proceedings, of any kind, brought against any of them. * * CODICILSecond: I will and direct that all the shares of principal and income by this my will given to or directed to be held for the use and benefit of the several and respective beneficiaries in the Trusts in this my will mentioned or set out shall 716 not be in any way or manner subject or liable to their or either of their anticipation, sale, pledge, debts, contracts, engagements or liabilities, and not subject or liable to attachment or sequestration under any legal or equitable or other process.The decedent's son, Richard McAllister (hereinafter sometimes referred to as Richard, Jr.,) and John Casey were designated executors and these two, together with the Provident Life & Trust Co. of Philadelphia, were designated trustees. The will and codicil thereto were admitted to probate by the surrogate of Atlantic County, New Jersey, on May 26, 1926, and Richard, Jr., and John Casey were duly authorized 88 to administer the estate.Josephine C. McAllister died on or about April 16, 1935, leaving a last will which was duly admitted to probate and under which Richard, Jr., and Josephine Curtis duly qualified as executors.In a proceeding (Docket No. 119/561 in the Court of Chancery of New Jersey) between Beulah Eaton McAllister, petitioner herein, complainant, and Richard McAllister, John Casey, and Provident Trust Co. of Philadelphia, defendants, a final decree, dated June 2, 1939, was entered, which provided in part as follows: That Beulah Eaton McAllister was the lawful widow of John J. McAllister, upon his death on May 1, 1937, and that she was entitled to receive for life the net income from the $ 100,000 trust fund set up by Richard McAllister, which income the trustees were ordered to pay to her.The $ 100,000 bequeathed in trust by the third clause of the decedent's will was invested in a certain bond and mortgage for $ 100,000 made by Richard, Jr., and decedent's widow on January 3, 1928, to the trustees designated in decedent's will. The mortgage covered premises in Atlantic City, New Jersey, and the investment in this bond and mortgage was the subject of a surcharge decree 89 dated June 8, 1936, rendered by the Chancery Court of New Jersey, against the trustees in a proceeding (Docket No. 110/403) between John McAllister and Beulah Eaton McAllister, his wife, complainants, and Richard McAllister et al., defendants. On April 8, 1940, the Chancery Court directed the trustees to comply with that decree, requiring them to deliver $ 100,000 to themselves as trustees for the purpose of the trust.In a further proceeding in the Chancery Court of New Jersey (Docket No. 125/47), petitioner, individually and as administratrix of the estate of her husband, recovered possession of 120 shares of R. McAllister, a corporation, an asset of the estate of John McAllister which had been pledged as security for payment of legal fees owing by petitioner as administratrix of her husband's estate. These 120 shares were the only assets of the estate of John McAllister. Claims had been filed against the estate for funeral services and doctor's bills; also claims were filed by R. McAllister (the corporation) for $ 471.38 and McAllister Coal Co., a corporation, for $ 5,049.77. An attempt to 717 sell these 120 shares to protect the estate of John McAllister from insolvency90 or bankruptcy resulted in the receipt of an offer to purchase at only $ 210 per share, although the book value of this stock was about $ 800 a share.On June 24, 1940, a proceeding was commenced in the Court of Chancery of New Jersey (Docket No. 129/370) between Beulah Eaton McAllister, complainant, and Richard McAllister, John Casey, and the Provident Trust Co. of Philadelphia, a corporation, as trustees of the trust set up in the third clause of the will of Richard McAllister, deceased, Richard McAllister, individually, and Richard McAllister and Josephine Curtis, as executors of, and trustees under, the will and codicil of Josephine C. McAllister, deceased, defendant. The bill of complaint filed in this proceeding, after setting forth substantially all the facts hereinbefore set forth in our findings of fact, further provided as follows:12. Complainant, by reason of the present economic conditions and a desire to terminate litigation which has been pending for a long period of time, as well as further contemplated expensive litigation, and by reason of her desire to return to Kentucky where her immediate relatives reside, and by reason of the necessity of obtaining money with91 which to pay various claims of the estate of her husband, John McAllister, which to date remain unpaid due to insufficient funds in the estate of said John McAllister, has indicated to the aforesaid trcstees, the remaindermen, the officers of R. McAllister, a corporation, and Richard McAllister, individually, her desire to terminate the trust set forth in the Third clause of the will of Richard McAllister, deceased, and to affect [sic] a sale of said 120 shares of stock of R. McAllister, a corporation. Complainant is advised and verily believes that said trustees and remaindermen, hereinabove mentioned, are willing to consent to the termination of said trust and will pay to complainant the sum of $ 55,000, together with all accumulated income from the trust corpus, which is payable to her at 6% per annum, computed to the date on which she receives the said sum of $ 55,000, in full consideration of the surrender by her of her life interest in said trust, which settlement figure is based to a large extent upon her present life expectancy. Complainant, however, is unwilling to terminate said trust as hereinbefore stated unless Richard McAllister, or his nominee, agrees to purchase92 from her individually and as administratrix of the estate of John McAllister, deceased, said 120 shares of stock of R. McAllister, a corporation, for the sum of $ 50,000, to the end that all litigation regarding said stock may be finally terminated. Said Richard McAllister has advised complainant, individually and as administratrix, that he or his nominee will purchase from her, in said capacity, the said 120 shares of stock of R McAllister, a corporation, for $ 50,000, in the event that the trust is terminated as hereinbefore set forth, and that all claims of R. McAllister, a corporation and McAllister Coal Company, a corporation, against the estate of John McAllister will be settled upon payment of $ 5,000 by complainant as administratrix to said corporation and the mutual exchange of general releases between all interested parties herein.Complainant is without adequate remedy in the courts of law, and therefore prays:* * * That the trust set up in and by the Third clause of the will of Richard McAllister, deceased, be terminated by the decree of this Honorable Court, conditioned, 718 however, upon full payment of the various sums of money and performance of the various93 acts more particularly set forth in paragraph 12 of this bill of complaint and that upon termination of said trust the trustees thereof be directed to make distribution of the trust corpus remaining after satisfaction of all the administration expenses to the remaindermen or their personal representatives.At the time of the filing of the bill of complaint in Docket No. 129/370, the Provident Trust Co., a trustee under decedent's will, filed a claim against the executors under the will of Josephine McAllister, deceased, for $ 100,000 and interest based upon the original investment of the corpus of the trust under the third paragraph of the will of Richard McAllister, deceased, and upon the basis of which investment the surcharge decree had been entered.A stipulation of facts was filed in the proceeding in the Chancery Court of New Jersey (Docket No. 129/370) and, after reciting in substance the various facts which have been hereinbefore set forth in our findings of fact, it further provided in part as follows:11. That all the parties in interest in this cause, [naming the parties] * * are desirous of settling and determining the protracted litigation which has for sometime been94 in progress and to eliminate further future litigation among the respective parties in the premises, to terminate the trust set up in the third clause of the will of said Richard McAllister, deceased, including the sale by said Beulah Eaton McAllister, individually and as administratrix aforesaid of the said 120 shares of stock of said R. McAllister, a corporation, and have agreed among themselves and each with the other in consideration of the premises to settle and adjust all of their said differences, disputes and litigation, as follows:1. That the trust set up in the third clause of the will of Richard McAllister, deceased, hereinbefore specifically referred to, be completely terminated and ended by the payment to the widow of John McAllister, deceased, Beulah Eaton McAllister, and by the acceptance by her of the sum of Fifty-Five Thousand Dollars, in lawful money of the United States of America, to be paid by Richard McAllister, subject to the approval of this Honorable Court, in full settlement of the termination of said trust, which payment is to be made to her after the approval of this Honorable Court and upon the execution and delivery by her of good and sufficient releases95 to the said trustees, of said trust, consenting, among other things, to the termination and cancellation thereof and to the assignment by said trustees to Richard McAllister of a certain bond and mortgage made by Richard McAllister and Josephine C. McAllister, to said trustees as trustees of the trust set up in said third clause of the will of said Richard McAllister, deceased, dated January 3, 1928, in the amount of $ 100,000, which mortgage covers premises in the City of Atlantic City, New Jersey, and is recorded in the Clerk's Office of Atlantic County, N. J., in Book No. 488 of Mortgages, page 249, etc.It was further provided that Beulah Eaton McAllister, individually and as executrix of the estate of John McAllister, transfer to Richard McAllister the 120 shares of stock of R. McAllister, a corporation, and any stock owned or controlled by her in the corporations McAllister Coal Co., R. McAllister, or R. McAllister, Inc., upon payment to her of $ 50,000.A final decree was entered in the proceeding in the Chancery Court of New Jersey (Docket No. 129/370) on July 19, 1940, approving the 719 settlement referred to in the pleadings and stipulation filed in that cause. The96 final decree, after a recitation of various facts, "the court being of the opinion that it * * * [was] to the best interests of the complainant and all of the parties in interest to terminate the said trust," provided in part as follows:1. That Richard McAllister pay to Beulah Eaton McAllister and that she forthwith accept the sum of $ 55,000. in lawful money of the United States of America, in full settlement of the termination of the trust created by the third clause of the will of Richard McAllister, deceased, upon the execution and delivery by her of good and sufficient release to the said trustees of said trust, consenting among other things to the determination and cancellation thereof, and Josephine C. McAllister, to said trustees as trustees of the trust set up in said third clause of the will of said Richard McAllister, deceased, dated January 3, 1928, in the amount of $ 100,000. * * It was further provided that Beulah Eaton McAllister, individually and as executrix of the estate of John McAllister, transfer to Richard McAllister the 120 shares of stock of R. McAllister, a corporation, together with any other stock owned or controlled by her in McAllister Coal Co. and 97 the corporations of R. McAllister and R. McAllister, Inc., upon payment to her of $ 50,000 and upon execution by her of releases to such corporations; also:7. That upon the said settlement being fully made and consummated in all respects as set forth herein, the said trustees under the third clause of the will of Richard McAllister, deceased, shall together with the complainant, individually and as administratrix of the estate of John McAllister, deceased, and the said Richard McAllister, report to this Honorable Court the consummation of said agreement, and forthwith make application to this Honorable Court for the discharge of said trustees from the duties and tasks imposed upon them under the will of said Richard McAllister, deceased, as to the trust set up in the third clause of said will, in accordance with the rules and practices of this Honorable Court.8. * * It is further ordered, adjudged and decreed that upon the said settlement being fully made and consummated in all respects, as set forth herein, the whole of the trust under the third paragraph of the last will and testament and codicil of Richard McAllister, deceased, shall terminate and end and the trustees of said98 trust shall be thereby freed and discharged from any and all duties, rights, tasks and liabilities imposed upon them under the third clause of said will and codicil of said Richard McAllister, deceased.The foregoing decree was consented to by petitioner, her counsel, and all the other parties referred to therein and their respective counsel.On September 3, 1940, the parties to the proceeding in the Chancery Court of New Jersey (Docket No. 129/370) filed a "Report of Consummation of Settlement under Decree of July 19, 1940." This report provided in part as follows:1. Richard McAllister, Jr. paid to Beulah Eaton McAllister the sum of Fifty-five Thousand ($ 55,000.) Dollars, accepted by her in full settlement of the termination of the trust created by the third clause of the will of Richard McAllister, deceased, upon the delivery by her of a good and sufficient release to 720 the trustees aforesaid, releasing them of everything pertaining to said trust, and consenting to the determination and cancellation of said trust, and to the assignment by said trustees to said Richard McAllister, Jr. of the bond and mortgage referred to in paragraph one of said decree on page 7 thereof99 and of her personal receipt for said sum.It was also provided that Beulah Eaton McAllister individually and as executrix of the estate of John McAllister assigned and delivered the 120 shares of stock in Richard McAllister, a corporation, to McAllister Coal Co., designated as purchaser by Richard McAllister, Jr., together with all her right in any other stock in which she, individually or as executrix of estate of John McAllister, had in the corporations R. McAllister, R. McAllister, Inc., or McAllister Coal Co., together with release of her claims, and that she received $ 50,000 from McAllister Coal Co.; also:8. That the settlement among the parties making this report, approved and authorized by this Court in its final decree made in the above stated cause on July 19, 1940, has been fully, completely and in all respects performed, carried out and consummated and the whole of the trust set up under third clause of the Last Will and Testament and codicil thereto of Richard McAllister, deceased, has thereby ended and determined and the said trustees of said trust, said Richard McAllister, Jr., John Casey and Provident Trust Company of Philadelphia, were, thereupon, under the provisions100 of the said final decree of July 19, 1940, aforesaid, freed and discharged from any and all duties, rights, tasks and liabilities imposed upon them under the trust aforesaid.On September 6, 1940, an "ORDER CONFIRMING SETTLEMENT AUTHORIZED IN FINAL DECREE DATED JULY 19, 1940, MADE IN THIS CAUSE, TERMINATING TRUST THEREIN REFERRED TO AND DISCHARGING TRUSTEES" was entered in the proceeding in the Chancery Court of New Jersey (Docket No. 129/370). The order provided in pertinent part as follows:It Is Thereupon, on this 6th day of September, 1940, Adjudged, that the said settlement made among all of the parties in interest in manner and form as set forth in said report was made by all of the said parties in interest in full and complete accordance with all of the terms and provisions of the said final decree made in the above stated cause on July 19, 1940, and the consummation of the said settlement and all of the terms and provisions thereof approved and authorized by the said final decree, the payment of the moneys, the execution and delivery of the respective releases, papers and documents provided for therein and the actions and doings of the respective parties in interest in the101 performance of the terms and provisions of the said authorized and approved settlement be and are hereby ordered ratified and confirmed; andIt Is Further Ordered that the said trust created under the third clause of the will and codicil of Richard McAllister, deceased, be and the same is hereby ended, terminated and extinguished and the said trustees of said trust, Richard McAllister, John Casey and Provident Trust Company of Philadelphia, Pennsylvania, be and they are hereby freed and discharged from any and all duties, rights, tasks and liabilities imposed upon them, or any of them, under the third clause of the Last Will and Testament and Codicil of Richard McAllister, deceased.721 The release dated July 19, 1940, of Beulah Eaton McAllister to Richard McAllister, John Casey, and Provident Trust Co. of Philadelphia, trustees under the third paragraph of the last will and testament of Richard McAllister, deceased, provides in part as follows:Whereas it is provided inter alia in said settlement agreement that said Beulah Eaton McAllister is to receive the sum of One Hundred Five Thousand Dollars ($ 105,000.00) of which Fifty Five Thousand Dollars ($ 55,000.00) is to represent102 the value of her life interest in the aforesaid trust, created in the third paragraph of the last will and testament of Richard McAllister, deceased.Now, Therefore, in consideration of the premises and in consideration of the sum of Fifty Five Thousand Dollars ($ 55,000.) * * * to me in hand paid by Richard McAllister and in consideration of the consummation of all the terms and provisions of the aforesaid settlement agreement, I, Beulah Eaton McAllister, * * * have released * * * and forever discharged Richard McAllister, John Casey and Provident Trust Company of Philadelphia individually and as trustees under the third paragraph of the last will and testament of Richard McAllister, deceased, * * * particularly from any and all matters arising or to arise in connection with the trust set up under the third paragraph of the last will and testament of Richard McAllister, deceased* * * And I do further consent and agree that my estate in the aforesaid trust, created under the third paragraph of the last will and testament of Richard McAllister, deceased, shall be and the same is hereby terminated absolutely, and I do decline to accept further any benefits therefrom or interest therein, 103 and further do promise and agree to execute such paper or papers as may be proper and necessary to enable the decree entered in the New Jersey Court of Chancery on June 8, 1936, above recited, to be marked satisfied in full.On July 19, 1940, petitioner received from Richard McAllister, Jr., the sum of $ 55,000.Petitioner received and reported for income tax purposes the following amounts of income from the Provident Trust Co., trustee, under the third paragraph of decedent's will:1937$ 1,594.7219383,831.3919395,847.5219402,850.00In her Federal income tax return for the calendar year 1940 petitioner reported losses including a loss of $ 8,790.20 which was explained in the return as the difference between the $ 55,000 received upon sale of the life interest under the will of Richard McAllister, and $ 63,790.20, the value thereof computed in accordance with I. T. 2076, based on the age of petitioner, stated as 36 years in December 1940.Respondent in his deficiency notice adjusted petitioner's net income by adding thereto the sum of $ 63,790.20 and in explanation of this adjustment stated as follows:It is held that the sum of $ 55,000.00 received by you in 1940104 upon the termination of the trust created under the will of Richard McAllister, is includible in 722 your income as ordinary income. Accordingly, the amount of $ 63,790.20 deducted thereagainst is disallowed.During the year 1940 petitioner, individually, paid deductible expenses totaling $ 7,500 for services in the above proceedings.OPINION.Sooner or later it is probable that the precise question involved in Estate of F. S. Bell, 46 B. T. A. 484; reversed (C. C. A., 8th Cir.), 137 Fed. (2d) 454, will have to be definitely settled. The then Board of Tax Appeals, one member dissenting, there concluded that sale of a life estate having no cost basis resulted, not in capital gain, but in ordinary income, a conclusion which was subsequently reversed by a divided Court of Appeals.This proceeding, however, does not present the occasion for a reconsideration of that question, for the distinction in the present facts, limited as that may appear, seems to us to require that respondent's determination be sustained, regardless of the principle of the Bell case.The general subject narrows in these cases to a resolution 105 of the possible conflict between Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, on the one hand, and Hort v. Commissioner, 313 U.S. 28">313 U.S. 28, and Irwin v. Gavit, 268 U.S. 161">268 U.S. 161, on the other, or at least to the question of which line of authority is more nearly applicable.In reversing the Bell case, the court relied upon Blair v. Commissioner for the proposition that a life estate constituted property, and concluded that its sale gave rise to capital gain. It distinguished the Hort case in the following language: " * * Blair v. Commissioner does not conflict with Hort v. Commissioner * * * which involved the extinguishment of a contractual right to future rentals, and not an assignment of an interest in property."In the Hort case the Supreme Court had assumed that the lease in question was "property" and continued: "Simply because the lease was 'property' the amount received for its cancellation was not a return of capital * * * the disputed amount was essentially a substitute for rental payments * * * and it is immaterial that for some purposes the contract 106 creating the right to such payments may be treated as 'property' or 'capital.'"The distinction drawn by the court in the Bell case must accordingly have been limited to the circumstance that the rights in the Hort case were "extinguished," as opposed to being "assigned," since, in both, the element of some sort of "property" was concededly present. That being so, we view the present situation as falling within that distinction, petitioner having received the payment in question in return for surrendering her rights under the trust to receive future income payments, 723 just as the taxpayer in the Hort case surrendered its rights to the rental payments under the lease. She did not assign her interest in the trust, as did petitioners in the Bell case. See also Sayers F. Harman, 4 T. C. 335; Estate of Johnson N. Camden, 47 B. T. A. 926; affirmed per curiam (C. C. A., 6th Cir.), 139 Fed. (2d) 697. The facts show with unmistakable clarity, by repeated reference in the various documents, that the payment here in question was made "in full consideration of the surrender by her107 of her life interest in said trust" and upon her "consenting to the determination and cancellation of said trust." There was no transfer or assignment any more than there was in Hort v. Commissioner.When it is considered further that the payment was "to represent the value of her life interest in the aforesaid trust," which consisted purely of the right to receive income, and that the "settlement figure is based to a large extent upon her life expectancy," as the documents recite, it becomes apparent that this was a current payment of income in anticipation, in exchange for the relinquishment of rights to receive that same income over the future years. Since Irwin v. Gavit, supra, makes it clear that such income, whenever received, is included in the definition of gross income, and, as such, is taxable to petitioner, the analogy to the Hort case is complete, and "Where, as in this case, the disputed amount was essentially a substitute for * * payments which § 22 (a) * * * characterizes as gross income, it must be regarded as ordinary income * * ." Hort v. Commissioner, supra.That the applicability108 of the Hort case must proceed at least so far seems to us the necessary outcome of what actually occurred here, as disclosed by the record. Petitioner was in need of funds. She was under "the necessity of obtaining money with which to pay various claims of the estate of her husband * * ." She proposed to the trustees -- or they proposed to her -- an immediate lump sum payment in lieu of the periodic future installments. "Complainant [petitioner] is advised and verily believes that said trustees and remaindermen * * will pay to complainant the sum of $ 55,000, together with all accumulated income from the trust corpus, which is payable to her at 6% per annum, computed to the date on which she receives the said sum of $ 55,000, in full consideration of the surrender by her of her life interest in said trust, which settlement figure is based to a large extent upon her present life expectancy. * * "It is difficult to envisage circumstances from which it could more clearly appear that by agreement of the parties petitioner's future income payments were to be delivered to her immediately at their discounted value; and, of course, since they would not again be due, the trust 109 must end. Such payments, as we have had occasion to note, 724 were taxable in full as ordinary income, whenever received. It is inconceivable that, by the agreement to anticipate, the parties could convert taxable income into a deductible loss.It follows that there was no error in respondent's action.Decision will be entered under Rule 50. DISNEYDisney, J., dissenting: The majority opinion in my opinion is opposed to statute, departmental regulation and attitude, and decisions both of this Court and others.The life estate sold by the petitioner was received by devise. Section 113 (a) (5) provides that property received by devise has a basis of the value at the time of acquisition -- in this case value at the date of the death of petitioner's husband. That a life interest in a trust fund (not inalienable by its terms) is a property interest is too firmly established to require argument. Blair v. Commissioner, 300 U.S. 5">300 U.S. 5. That a life estate is alienable (in the absence of restrictions upon alienation) can not be denied in the face of many decisions. Bell v. Commissioner, 137 Fed. (2d) 454, reversing110 46 B. T. A. 484; Sayers F. Harman, 4 T. C. 335 (acquiescence by Commissioner, I. R. B. No. 6, Mar. 26, 1945); Estate of Johnson N. Camden, 47 B. T. A. 926; affd., 139 Fed. (2d) 697; Orrin G. Wood, 40 B. T. A. 905; Elmer J. Keitel, 15 B. T. A. 903. It is alienable "like any other property," Commissioner v. Field, 42 Fed. (2d) 820. Indeed, I do not understand that the majority opinion disagrees with those decisions or denies the alienability. That the life estate here was not inalienable as set up by a spendthrift trust is settled for us by the decision of the local court allowing the alienation. Though only by inference so holding, that court could not, without so holding, have rendered the decision it did, and such opinion, though only by inference, binds us. Irving National Bank v. Law, 10 Fed. (2d) 721.We have, then, in this case, sale of alienable property having a base provided by statute. Of course that value must be ascertained, 111 and the Treasury Department has devised a way to so value a life interest -- by the use of expectancy tables based upon the life expectancy of the recipient of the life interest at the date of acquisition. I. T. 2076, C. B. III-2, p. 18, provides specifically for such valuation. The use of such tables is too well settled to be arguable. I. T. 2076 is altogether consistent with the statute, section 113 (a) (5). Thus we arrive at the petitioner's base for her life estate. But Regulations 103, section 19.113 (a) (5)-1 (e), specifically provides that such base is always the same (except of course for the necessary adjustment for depreciation or depletion upon property subject thereto). There being 725 no such depreciation or depletion applicable here, the basis petitioner had at acquisition of the property remains the same, and when she sold for $ 55,000 she took a capital loss, the basis being a greater amount.The majority opinion is obviously based upon some idea or fear that the petitioner should not be allowed her original base because she had enjoyed the income from the life estate from acquisition to date of sale. The answer is, first, that base in property112 is not affected or adjusted by the mere receipt of income therefrom; and, second, that if there should be adjustment of the base because of lapse of time, it is the function of Congress, and not of this Court, to provide the adjustment. I see no reason to indulge here in judicial legislation, most particularly when Congress has specifically prescribed the base in section 113 (a) (5), and the Treasury Department has followed it in regulation and ruling.Section 24 (d) offers no aid on this subject. The words of the section referring to "deduction" may not, with reason, be held to apply to the computation of gain or loss on sale of property; and the Committee Report thereon plainly shows such to be the intent. H. R. No. 350, 1st sess., 67th Cong., Aug. 16, 1921 (C. B. 1939-1, pt. 2, p. 177). The regulations, too, make it clear that the only intent of the section was to prevent capitalization of a life interest and deduction of a portion thereof by amortization. Regulations 103, section 19.24-7, after quoting the pertinent part of the statute, adds: "In other words, the holder of such an interest so acquired may not set up the value of the expected future payments as corpus or principal113 and claim deductions from shrinkage or exhaustion thereof due to the passage of time. (See section 113 (a) (5).)" I suggest that the situation so explained is a long step from computing gain or loss upon sale of the property interest.Finally, I see no reason on this question to refuse to follow either our own opinion on this particular question in Sayers F. Harman, supra, and that of the Circuit Court of Appeals for the Eighth Circuit, reversing our earlier view, in Bell v. Commissioner, supra. The latter reviews the field of authority, including Irwin v. Gavit, 268 U.S. 161">268 U.S. 161, upon which the majority opinion here leans, and Helvering v. Horst, 311 U.S. 112">311 U.S. 112; and Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, held assignments of life interests to be transfers of interest in trust assets and not merely assignments of income and concluded that a sale of a life interest resulted in capital gain. I think we should follow it. Fear that the petitioner may have a loss is offset by the fact that it might have been a gain -- for the114 trust fund might well have appreciated, by wise investment.As pointed out in the Bell case, the Supreme Court has had opportunity to overrule the Blair case, and has not "either expressly or 726 by implication," done so. That case squarely decrees that a property interest was owned by the petitioner, and such cases as Harrison v. Schaffner, involving mere assignment of income, do not apply. I think it late to hold, as the majority opinion does in essence, that sale of the life estate here involved is anticipation of income. I respectfully dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623169/	C. Franklin Hubble and Adeline Hubble v. Commissioner.Hubble v. CommissionerDocket No. 92928.United States Tax CourtT.C. Memo 1963-86; 1963 Tax Ct. Memo LEXIS 256; 22 T.C.M. (CCH) 395; T.C.M. (RIA) 63086; March 27, 1963Clarence A. Bradford, Esq., for the petitioners. Carl W. Kloepfer, Esq., for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined a deficiency in the income tax of petitioners for the year 1958 in the amount of $1,886.44. The sole issue for determination is whether the sum of $5,000 expended by petitioner C. Franklin Hubble in connection with his acquisition of the Neblett Insurance Agency is properly257 deductible as advertising expense under section 162 of the Internal Revenue Code of 1954, or, as contended by respondent, represents a capital expenditure for the purchase of good will which is forbidden deduction by section 263 of that Code. 1Findings of Fact Some of the facts were stipulated by the parties. Their stipulation, together with attached exhibits, is incorporated herein by reference. C. Franklin Hubble and Adeline Hubble are husband and wife residing in Wayne County, Michigan. Their joint return for the year 1958, made on the cash basis and for the calendar year258 period, was filed with the district director of internal revenue, Detroit, Michigan. Adeline Hubble has been joined herein solely by virtue of her participation in the filing of a joint return. Therefore, as used hereinafter, the term "petitioner" will refer only to C. Franklin Hubble. Petitioner has been engaged in the operation of a general insurance business as sole proprietor in the Detroit area since 1932. He initially conducted his business under the name "Riverside Agency" but changed to "Riverside and Crawford Agency" in 1948 when he acquired the business of the Crawford insurance agency. For many years prior to his death on January 1, 1958, James D. Neblett, Sr., had conducted a general insurance agency in Detroit, Michigan, under the names "James D. Neblett Agency" and "Neblett Insurance Agency." On or about January 14, 1958, petitioner conferred with the attorney for the estate of James D. Neblett, Sr., relative to the purchase of the Neblett Insurance Agency. As a result, petitioner, on January 15, 1958, submitted to the administratrix of the Neblett estate the following written offer: I hereby offer to purchase the insurance business of James D. Neblett, Sr., Deceased259 which includes all contingent commissions that are earned and outstanding as of this date; all records pertaining to the business including policy expirations, renewals, dailys, policy register; alphabetical and numerical cards, files and containers; correspondence relative to insurance, daily reports and forms on hand for the sum of Two Thousand Seven Hundred Thirty Four and 69/100 Dollars, ($2,734.69). I further agree to pay Five Thousand Dollars ($5,000.00) for the unrestricted use of the name (James D. Neblett Agency) for advertising purposes. This offer was accepted on behalf of the estate on the same day, and a bill of sale of even date, reciting in part as follows, was prepared by the estate's attorney and executed by the administratrix: Known all men by these presents, that Eleanor V. Boyce, Administratrix of the estate of James D. Neblett, Sr., * * for and in consideration of the sum of $7,734.69 * * * to her paid by C. Frank Hubble, * * * has bargained and sold, and does grant and convey, unto the said [C. Frank Hubble], * * * all of the following goods and chattels, to wit; Unrestricted use of the names JAMES D. NEBLETT Agency or NEBLETT INSURANCE AGENCY, for which260 item is allocated the sum of $5,000.00 of the purchase price, all records pertaining to the former operation of said business by the deceased, including policy expirations, renewals, dailys, policy register, alphabetical and numerical cards, files and containers other than cabinets, correspondence relative to insurance daily reports and forms on hand, and all contingent commissions earned and outstanding as of this date. * This transfer is intended to be a sale of the Agency as a going business, other than the physical equipment and location, and it is understood that the Estate will assume and pay all debts incurred by the Agency prior to the date hereof, settlement with the companies represented to be made by the Estate forthwith. Pursuant to the sale the insurance records of the James D. Neblett Agency were transferred to petitioner. As of January 15, 1958, there were 452 policies of insurance in force with the Neblett Agency. Of this number 84 were automobile policies, written for a period of one year, and the remainder fire and marine and casualty policies written for periods of one, three or five years. The records transferred to petitioner showed the date on which261 each policy of insurance then in force which had been written by the James D. Neblett Agency would expire, the name and address of the person holding such policy, the type of policy, the type of property insured, the amount of insurance provided and the name of the issuing insurance company. The acquisition of the Neblett Agency thus placed petitioner in an advantageous position to secure insurance business from the former Neblett customers by providing him with the means to be aware of, and to make timely calls upon, such customers. Armed with the information contained in the records which he had obtained, petitioner circularized the Neblett policyholders by card, advising them of his purchase of the Neblett agency and his desire to be of service should any losses be incurred, or additional insurance be required, by them. Petitioner also contacted each of the Neblett insureds shortly before his policy expiration date for the purpose of soliciting renewals. The record indicates that petitioner was successful in securing an undetermined number of renewals in this manner. In order to protect his right to the "unrestricted use" of the name "James D. Neblett Agency" petitioner, on262 May 6, 1958, registered that name with the State of Michigan, by filing a Certificate of Conducting Business Under an Assumed Name. After his acquisition of the Neblett Agency petitioner continued during the years 1958, 1959 and 1960 to have the "James D. Neblett Agency" listed in the Detroit telephone directory. However, the address listed for the Neblett Agency was petitioner's own office address, and petitioner arranged to have all telephone calls to the "James D. Neblett Agency" received at his own office telephone. Opinion The total price which petitioner paid the Neblett estate in connection with his acquisition of the insurance business of James D. Neblett, Sr., deceased, was $7,734.69. Under the terms of petitioner's offer, $5,000 of this amount was ostensibly paid for "the unrestricted use of the name (James D. Neblett Agency) for advertising purposes," and petitioner has claimed that amount as an ordinary and necessary business expense for "advertising." Respondent's position is that the $5,000 expenditure claimed by petitioner was not an ordinary and necessary business expense within the meaning of section 162(a)2 of the 1954 Code, but was an expenditure for the263 acquisition of a capital asset in the nature of good will, deduction of which is specifically disallowed by section 263(a)(1)2 and the regulations thereunder. Sections 162 and 263 of the Code being mutually exclusive, a determination that deduction of the claimed expense is disallowed by the latter makes moot the question as to whether it is "ordinary and necessary" within the meaning of the former. In general, section 263 prohibits the deduction of expenditures for the acquisition of capital assets, or "capital expenditures." Section 1.263(a)(2)(h), Income Tax Regs., provides that "the cost of good will in connection with the acquisition of the assets of a going concern is a capital expenditure," and therefore nondeductible. 264 What is at issue, then, in the instant case is whether the $5,000 paid by petitioner to the Neblett estate represents "the cost of good will in connection with the acquisition of the assets of a going concern." That petitioner acquired the assets of a "going concern" as a result of his offer "to purchase the insurance business of James D. Neblett, Sr., Deceased" seems clear to us. Neblett had been in the insurance business for many years; only 15 days elapsed between his death and the transfer of his business to petitioner; there is no evidence that any of the policies in force at the time of Neblett's death were cancelled during the interim before the business passed to petitioner; the bill of sale which consummated the transaction described what was being sold as a "going business," and both the offer and bill of sale specified that petitioner was to receive all contingent commissions earned and outstanding (i.e., accounts receivable) as of the date of the transfer. Having thus determined that what petitioner acquired was a "going business," the only remaining question is whether the $5,000 in issue represents the cost to petitioner of the good will of that business. The question265 as to whether or not good will was sold is one of fact. Cf. Paramount Pest Control Service v. United States, 304 F. 2d 115 (C.A. 9, 1962). Although good will is not among the assets specifically referred to by the parties to the sale of a going business, this does not mean that none is being transferred. In such a case we are entitled to inquire whether it is perhaps bound up with the assets for which a stated payment is being made. Cf. Copperhead Coal Company, Inc., v. Commissioner, 272 F. 2d 45 (C.A. 6, 1959) affirming a Memorandum Opinion of this Court. Based on our analysis of all the facts, it is our view that the $5,000 which petitioner paid ostensibly for the unrestricted right to use the name "James D. Neblett Agency" was in fact a payment for the good will of the Neblett insurance business which was transferred as a result of the sale. However, even were we to assume, as petitioner would have us do, that no good will existed with respect to the Neblett business or name, we would still be compelled to find that the right to use the Neblett name, unrestricted as it was both as to time and method, was a capital asset in petitioner's hands. Charles P. Limbert Co., 9 B.T.A. 1390">9 B.T.A. 1390, 1398,266 (1928). Because whatever benefits which might be derived from the exercise of this right cannot be confined, at the very least, to the year (1958) in which it was acquired, its cost certainly may not be fully deducted from income in that year, as petitioner has attempted to do. Clark Thread Co., v. Commissioner, 100 F.2d 257">100 F. 2d 257, 258 (C.C.A. 3, 1938). Moreover, we are inclined to agree with respondent that because the right to use the Neblett name was "unrestricted" both as to time and method it was therefore nonexpiring, and, as such, its cost not only is nondeductible but also neither depreciable nor amortizable. Decision will be entered for the respondent. Footnotes1. In his statutory notice of deficiency respondent also disallowed to petitioner as advertising expense an additional $465 because of failure to establish that the same was an ordinary and necessary business expense. While technically the pleadings placed this $465 in issue, no evidence was introduced by petitioner on the point, nor was any argument submitted with respect to it on brief. The Court will therefore assume petitioner to have abandoned the point, and that part of the total deficiency due to the disallowance of this item will not be considered to be in controversy.↩2. SEC. 162. TRADE OR BUSINESS EXPENSES. (a) In General. - There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * ↩2. SEC. 263. CAPITAL EXPENDITURES. (2) General Rule. - No deduction shall be allowed for - (1) Any amount paid out for * * * permanent improvements made to increase the value of any property or estate.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623171/	Benjamin Fairman and Minnie Fairman v. Commissioner.Fairman v. CommissionerDocket No. 16538.United States Tax Court1949 Tax Ct. Memo LEXIS 290; 8 T.C.M. (CCH) 30; T.C.M. (RIA) 49006; January 18, 1949290 Percentage of proft earned in operation of a grocery store determined. Stephen T. Dean, Esq., 1421 Chestnut St., Philadelphia, Pa., for the petitioners William D. Harris, Esq., for the respondent. VAN FOSSAN Memorandum Opinion VAN FOSSAN, Judge: Respondent determined a deficiency of $3,132.19 in petitioners' income tax for the year 1944. Petitioners allege error in two respects: 1. The determination that the profit from petitioners' grocery store should be increased in the amount of $10,042.97, 2. The increase of $332.39 in income from rents291 received consequent on the disallowance of a deduction for interest in the amount of $280.42 and the disallowance of $51.97 for fuel oil for personal use. In the course of his audit, respondent concluded that petitioners' books did not accurately reflect profit from petitioners' store and, pursuant to section 41, Internal Revenue Code, recomputed the profits by taking 25 per cent of gross sales and making various other adjustments. The record does not reveal the exact details of the computation. [The Facts] In this case, as in all cases before this Court (with the exception of instances not here present) a presumption of correctness is accorded to the finding of respondent and the burden of proof of error rests on petitioners. Respondent has held that petitioners' books did not accurately reflect income from the store and petitioners undertook to prove the contrary, i.e., that the books accurately reflected income. Such an objective should be established by submission of supporting data by which the accuracy of the accounts can be tested, - by invoices, receipts, canceled checks, vouchers and similar data. It is not adequately established by the self-serving292 opinion of taxpayers' auditor based on the same data and information that was available to respondent's agent. Petitioners submitted no such supporting data and undertook to account for its absence by an explanation which did not commend itself to the Court that all receipts, canceled checks, and similar papers were stored in a box in the cellar; that "we had a new boy after school and we sent him down in the cellar to clean up the rubbish and he probably thought it was rubbish also. * * He probably threw them out and gave them to the rubbish man." Putting the validity and authenticity of this explanation aside, the record is so scanty and so lacking in conviction as to make it impossible for us to conclude that the respondent erred in holding that the books did not accurately reflect petitioners' income. Since petitioners have failed to prove respondent to be in error in his conclusion as to taxpayers' books, there remains to be decided only the accuracy of the several items entering into respondent's computation. The agent testified that the figure of 25 per cent profit based on gross sales was the percentage used by him. Various other adjustments as to deductions were made. 293 Petitioners undertook to disprove the accuracy of the figure of 25 per cent. The testimony convinces us that a figure of 20 per cent would be more nearly accurate in the present case and we so find. In the computation consequent on this opinion the figure of 20 per cent of gross sales will be used. Of the deductions disallowed by respondent, petitioners contest only that of $332.39 (classed as rents received but consisting of excess interest on mortgage, $280.42, and fuel oil for personal use, $51.97), together with a deduction "other business expense" amounting to $1,500. The record fails to establish error as to the item of $332.39 rents received. [Opinion] The only other item attacked by petitioners was the disallowance of a deduction 1 of $1,500 listed as "other business expense" but actually representing "dues" paid to Moore Street Retail Meat Cooperative Association. The record reveals that this payment was made in a scheme to get around the ceiling prices fixed by the Office of Price Administration (O.P.A.) for certain meats. That the scheme was illegal and worked a fraud is implicit in the final decree of the Federal District Court for the Eastern District of Pennsylvania294 in a suit brought by the O.P.A. against the Moore Street Retail Meat Cooperative Association and others, which decree enjoined and restrained the Meat Association from further action in violation of Revised Maximum Price Regulation No. 169, and gave judgment to the Government against the defendants, including judgments against the Moore Street Retail Meat Cooperative Association in amounts aggregating in excess of $100,000. Petitioners endeavored to justify the deduction of the sum of $2,000 on the ground that at the time the payments were made "they had been advised and had every reason to believe that the cooperative met with the approval of government officials" and that, accordingly, the payment was an ordinary and necessary expense of doing business within the meaning of section 23 (a) (1), I.R.C. We cannot agree. Petitioners have failed on the record made to establish the deductibility of such item and respondent's determination in this respect, of which the disallowance of the deduction formed a part, must be sustained. *295 Decision will be entered under Rule 50. Footnotes1. Petitioners' return shows deduction "Meat Assns., $1,500.00" but petitioners contended at the hearing that respondent actually disallowed an additional $500 as to this item and that they paid a total of $2,000.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623172/	PACIFIC SOUTHWEST REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pacific Southwest Realty Co. v. CommissionerDocket No. 102605.United States Board of Tax Appeals45 B.T.A. 426; 1941 BTA LEXIS 1115; October 24, 1941, Promulgated 1115 1. In conformity with its articles of incorporation petitioner issued and sold two series of "Cumulative Preferred Serial Stock." The certificates stated that they were redeemable at par, plus all unpaid, accrued, or accumulated dividends, and that the holders should have the right to enforce payment the same as on any unconditional claim or debt against the corporation. The articles also authorized the corporation to issue bonds, though the total indebtedness of the corporation could not exceed 50 percent of the appraised value of the property subject thereto. First mortgage bonds in an amount substantially equivalent to the face amount of the preferred stock were issued and sold at about the same time that the stock was issued. The stock was represented to be free from the personal property tax of the state and free from the normal Federal income tax. The periodic payments were made from profits, were denominated "dividends" and no payments were ever made except following the declaration of a dividend. Held, that the certificates were what they purported to be and not merely evidence of the relation of debtor and creditor; held, further, that the amounts paid as "dividends" 1116 may not be deducted as "interest" nor may the discounts allowed or the premiums paid in connection with the sale and redemption of the stock in the taxable years be allowed as deductions from gross income. 2. Real estate sold by petitioner in 1929 under a conditional sales contract was repossessed in 1935, following default by the purchaser in the payment of the purchase price. Held, payment by petitioner in 1936 of the real estate taxes which had been assessed in 1935, prior to the repossession, does not entitle it to a deduction for taxes paid. Bayley Kohlmeier, Esq., and Stuart Baron, Esq., for the petitioner. E. A. Tonjes, Esq., for the respondent. MELLOTT426 OPINION. MELLOTT: The Commissioner determined deficiencies in income tax for the calendar years 1936 and 1937 in the respective amounts of $842.75 and $13,878.81. The petition alleges that there is no deficiency for either year and that petitioner overpaid its income taxes for the year 1936 in the amount of $53,900.53. The two general questions are: (1) Whether securities issued by petitioner and designated either 6 1/2 percent or 5 1/2 percent cumulative preferred1117 serial stock represented an indebtedness rather than a proprietary interest in the corporation; and (2) whether an amount paid by petitioner is deductible as taxes. The proceeding was submitted upon a stipulation of facts with attached exhibits and the testimony of three witnesses. We find the facts to be as stipulated and, from the testimony of the witnesses, find 427 that the two classes of preferred stock issued by petitioner as hereinafter set out were not listed upon any stock exchange but were dealt in, in "over-the-counter" transactions, in which accrued dividends, prior to the actual declaration of a dividend, were generally taken into consideration in substantially the same manner and to the same extent as accrued interest upon bonds is usually taken into consideration upon purchase or sale. All other facts hereinafter set out are taken from the stipulation of the parties. Petitioner is a corporation organized in 1923 under the laws of Delaware and is qualified to do business in the State of California. Its principal place of business is in Los Angeles, California, and its income tax returns for the taxable years were filed with the collector of internal revenue1118 for the sixth district of California. Its books of account were kept and its returns of income were made on the cash basis. Petitioner was incorporated by persons affiliated with the Pacific Southwest Trust & Savings Bank and the First National Bank of Los Angeles for the purpose of acquiring, and thereafter owning and operating, all of the real estate properties owned by the first mentioned bank and one parcel of real estate owned by the second mentioned bank, and for the further purpose of providing additional bank premises as the growth of the banks required. The principal reason for organizing petitioner was to avoid "the locking up of too great a proportion" of the capital and surplus of the banks in real estate owned by them. The total authorized capital stock of the corporation was 100,000 shares, divided into 50,000 shares of preferred of the par value of $100 each and 50,000 shares of common with no nominal or par value. The original articles of incorporation provided for the issuance of 23 series of 6 1/2 percent cumulative preferred serial stock, to be designated by the betters A to W, both inclusive, each series to be for the number of shares shown (ranging between1119 1,100 and 3,950) and to be "redeemable at their par value plus all unpaid, accrued, or accumulated dividends thereon." Such cumulative preferred serial stock could be issued as and when the board of directors should determine, but it could not be issued except for the purpose of acquiring property suitable for one or more of the purposes of the corporation. The articles of incorporation also provided: * * The aggregate indebtedness of the corporation secured by mortgage, deed of trust, or otherwise, shall not exceed in amount Fifty per cent (50%) of the appraised value of the property subject thereto. The total amount of preferred stock of the corporation at any time outstanding shall not, together with the total bonded indebtedness of the corporation, exceed One Hundred per cent (100%) of the appraised value of the property of the corporation * * . 428 The 6 1/2 percent cumulative preferred serial stock was "entitled to receive in each year out of the surplus or net profits of the business of the corporation, dividends at the rate of 6 1/2% per annum, and no more, upon the par value of said stock from date of issue, payable quarterly * * ." The dividends were cumulative1120 and "if in any year or years the dividends * * * shall not have been paid, such dividends shall be paid in full before any dividends shall be paid or set apart upon the common stock. The amount of any serial redemption of said preferred stock, if overdue, shall be paid before any dividends shall be paid or set apart on the common stock." In the event of liquidation, dissolution, or winding up of the corporation, the holders of the preferred stock were entitled, before any distribution could be made to the holders of the common stock, "to be paid out of the surplus profits * * , or in case such profits shall be insufficient, then from the general assets of this corporation, an amount equal to 105% of the par value of said stock." Upon the maturity date specified in each series the shares were to "be redeemed at par, plus unpaid, accrued, and accumulated dividends thereon * ." In the event the corporation should fail to redeem the stock at such time and place, the holders were to "have the right to enforce payment of the par value of said stock so agreed to be redeemed, together with the amount of any unpaid, accrued, or accumulated dividends thereon, the same as on any unconditional1121 claim or debt against the corporation * * ." The preferred stock was to have no voting power, the sole voting rights being vested in the holders of the common stock. In the event that any dividend on the preferred stock should not be paid when payable and should remain unpaid for ninety days, then so long as such dividend or any part thereof should remain unpaid, the issued and outstanding preferred stock was to be exclusively entitled to the voting power. All of the common stock of petitioner, except directors' qualifying shares, was issued to the First Securities Co., an affiliate of petitioner. All of the stock of First Securities Co. and all of the stock of the two banks above named was owned by the Los Angeles Trust & Safe Deposit Co. as trustee in trust for the benefit of the owners of beneficial certificates issued by the trustee. All of the stock of the trustee was likewise owned by the First Securities Co. Pursuant to the original articles of incorporation during the years 1923, 1924, and 1925 petitioner issued and sold 6 1/2 percent cumulative preferred serial stock of the total par value of $4,500,000 in 23 series designated A to W, inclusive. Series A matured1122 and became payable on July 1, 1929, and one of the remaining series matured and became payable on July 1 of each year thereafter to and including the year 1951. The certificates were redeemable at par "plus all unpaid, accrued, 429 or accumulated dividends thereon", and entitled the owners "to receive in each year out of the surplus or net profits of the business of the corporation, dividends at the rate of 6 1/2% per annum, and no more, upon the par value of said stock from date of issue * ." The certificates also contained the essence of article fourth of the original articles of incorporation, including the provisions quoted above. During the years 1924 and 1925 petitioner also issued and sold its 5 1/2 percent coupon bonds of a total face value of $3,000,000. The proceeds derived from the sale of the preferred stock and bonds were used for the purchase of real estate suitable for the purposes of the corporation. In connection with the issuance and sale of petitioner's 6 1/2 percent cumulative preferred serial stock in 1923 a prospectus was published by the First Securities Co. Therein it was stated that petitioner proposed to issue at that time $3,000,000 of 51123 1/2 percent first mortgage bonds and $3,000,000 6 1/2 percent cumulative preferred stock and to hold in its treasury the balance of the authorized preferred stock for issuance from time to time as the needs of the company should require. The prospectus also stated: "it is the intention of the Realty Company [petitioner] to finance its present needs by equal amounts of Preferred Stock and Bonds * * . The annual maturities of bonds and stocks will serve to increase the original equity as the different series mature and are retired", and "The 6 1/2% Cumulative Preferred Serial Stock is, in opinion of counsel, free from the Personal Property Tax in California and likewise free from the Normal Federal Income Tax." Series A of the 6 1/2 percent cumulative preferred serial stock matured and was redeemed on July 1, 1929. Series B to G, inclusive, matured and were redeemed respectively on July 1 of each year thereafter to and including 1935. At the beginning of the year 1936 6 1/2 percent cumulative preferred serial stock of a total par value of $3,766,500 was issued, outstanding, and unmatured. During the year 1936 all of said securities were redeemed and retired. During the year1124 1936 petitioner made payments to the holders of said 6 1/2 percent cumulative preferred serial stock at the rate of 6 1/2 percent per annum of the par value thereof, or $65,300.63 as provided in the certificates. At the time the securities referred to above were issued petitioner had a lease agreement with the Pacific Southwest Trust & Savings Bank under which the bank had obligated itself to pay as rental a sum which, with the other income of petitioner, would be sufficient to pay all of petitioner's operating expenses and in addition all interest, dividend, and amortization charges on its outstanding bonds and preferred stock. The bank, as lessee, agreed to pay petitioner $420,000 430 per annum for said property, the term of the lease being 30 years from and after July 1, 1923. On December 16, 1927, petitioner's articles of incorporation were amended. A copy of article fourth as amended is attached to the stipulation of facts. There were no substantial changes made with respect to preferences, privileges, and other rights of the holders of preferred stock, but the amended article provided for a total authorized capital stock of 125,000 shares, divided into 75,0001125 shares of preferred stock of the par value of $100 each and 50,000 shares of common stock having no nominal or par value. During the year 1928, pursuant to the authority contained in the article as amended, petitioner issued and sold its securities designated 5 1/2 percent cumulative preferred serial stock of the total par value of $1,000,000. The proceeds derived therefrom were used for the purchase of real estate suitable for the purposes of the corporation. The certificates were issued in 22 series designated AA to VV, inclusive, payable on July 1, 1939, and successively thereafter on July 1 of each year to and including the year 1960. Each certificate recited that on April 20, 1928, the board of directors "determined upon the issuance of $1,000,000 (10,000 shares) fixed dividend rate, 5 1/2%, fixed redemption premium, 2% ($102.00 per share), designations and maturities as follows: [Schedule]." The prospectus issued in connection with the 5 1/2 percent cumulative preferred serial stock stated: With the completion of the present stock sale, the Pacific Southwest Realty Company will have outstanding $4,500,000 6 1/2% Cumulative Preferred Serial Stock, and $1,000,000 5 1/2%1126 Cumulative Preferred Serial Stock, in addition to 50,000 shares Common Stock of no par value, owned by the First Securities Company. With the completion of the present financing on or about July 2, 1928, there will be outstanding $5,100,000 of first mortgage bonds. The aggregate total par value of outstanding preferred stocks and bonds will then be $10,600,000. The prospectus also stated that the stock being offered was, "in opinion of counsel, free from the Personal Property Tax in California and likewise free from the Normal Federal Income Tax." During the year 1936 all of the 5 1/2 percent cumulative preferred serial shares of the par value of $1,000,000 were outstanding. All of them were redeemed and retired during the year 1937. During the years 1936 and 1937 petitioner made payments to the holders of said securities as provided in the certificates at the rate of 5 1/2 percent of the par value thereof or $55,000 during the year 1936 and $41,250 during the year 1937. The payments made by petitioner to the holders of its 6 1/2 percent cumulative preferred serial stock and 5 1/2 percent cumulative preferred serial stock were authorized by resolutions of the board of1127 directors 431 of petitioner. A true copy of one of the resolutions is attached to the stipulation. It declares a "regular quarterly dividend of $1.37 1/2 a share on the 5 1/2% Cumulative Preferred Serial Stock of this corporation, amounting to $13,750 * * out of the earned surplus of the corporation" and directs "that the amount thereof be set aside and transferred to 'Dividend Declared" account." The 5 1/2 percent cumulative preferred serial stock had been sold by the petitioner at discounts of $3 and $5 per $100 par value, the discount aggregating $46,858. It is stipulated that if the discount at which said securities were sold was a deductible expense, it was an expense which it was proper to amortize and deduct over the life of the securities and $1,833.26 of said discount expense was properly allocable to the year 1936 and $31,275.39 was properly allocable to the year 1937. During the year 1936 petitioner redeemed and retired all of its then outstanding 6 1/2 percent cumulative preferred serial stock for the face value thereof ($3,766,500) plus a total premium of $182,025. During the year 1937 it redeemed and retired all of its then outstanding 5 1/2 percent1128 cumulative preferred serial stock for the face value thereof ($1,000,000) plus a total premium of $20,000. During the year 1929 petitioner sold certain real property located in the city of Los Angeles, California, under a conditional sales contract. Under the provisions of the contract petitioner retained title to the property until the purchase price was paid. On November 15, 1935, by reason of the default of the purchaser of the property, petitioner canceled the sales contract and repossessed the property. At the time the property was repossessed by petitioner there were assessed but unpaid property taxes against it in the amount of $5,618.35. These taxes were payable one-half on or before December 5, 1935, and one-half on or before April 20, 1936. During the year 1936 petitioner paid said property taxes in full. Petitioner deducted said sum of $5,618.35, under the provisions of section 23(c) of the Revenue Act of 1936, in computing its net taxable income for the year 1936. In its income tax return for the year 1936 petitioner failed to take deductions for the payments made on its securities designated 6 1/2 percent cumulative preferred serial stock and 5 1/2 percent1129 cumulative preferred serial stock, failed to take deduction for the portion of the discounts at which its securities designated 5 1/2 percent cumulative preferred serial stock were issued and sold which was allocable to the year 1936, and failed to take a deduction for the premium paid upon the redemption of its securities designated 6 1/2 percent cumulative preferred serial stock. In its income tax return for the year 1936 petitioner reported net taxable income in the amount of $562,740.52 and a tax liability in the amount of $83,251.08. Petitioner paid this tax in installments as follows: $20,812.77 on March 15, 1937, and like 432 amounts on June 12, September 13, and December 13, 1937. Petitioner's return for the year 1936 was filed on March 15, 1937. Upon examination of petitioner's income tax return for the year 1936 the Commissioner disallowed the deduction taken by petitioner for real estate taxes in the amount of $5,618.35 and determined the net income of petitioner for the year 1936 to be $568,358.87. The deficiency for the year 1936 in the amount of $842.75 resulted from the disallowance of said deduction and the consequent increase in petitioner's net income. 1130 In redetermining petitioner's net income for the year 1936 the Commissioner did not allow any deductions for the payments made by petitioner during said year on its securities designated 6 1/2 percent cumulative preferred serial stock and 5 1/2 percent cumulative preferred serial stock, did not allow a deduction for any portion of the discount at which petitioner's securities designated 5 1/2 percent cumulative preferred serial stock were issued, and did not allow a deduction for the premiums paid by petitioner upon the redemption of its securities designated 6 1/2 percent cumulative preferred serial stock. On March 6, 1940, petitioner filed with the collector of internal revenue for the sixth district of California, at Los Angeles, California, its written claim for refund of income taxes overpaid by it for the year 1936 in the amount of $53,900.53, setting forth therein the same facts and grounds herein alleged and relied upon. A true copy of said claim for refund is attached to the petition herein. In its income tax return for the year 1937 petitioner deducted as interest paid the payments made on its securities designated 5 1/2 percent cumulative preferred serial stock in1131 the amount of $41,250, deducted the sum of $31,275.39 as the portion of the discount at which said securities were issued and sold which was properly allocable to the year 1937, and deducted the premium paid in the amount of $20,000 upon the redemption of the securities. The Commissioner refused to allow these deductions. On May 22, 1940, petitioner paid to the collector of internal revenue for the sixth district of California the deficiencies in income taxes proposed to be assessed against it for the years 1936 and 1937. The payments were as follows: $842.75 tax and $161.09 interest, or a total payment of $1,003.84 for the year 1936, and $13,878.81 tax and $1,820.21 interest, or a total payment of $15,699.02 for the year 1937. Petitioner contends that the securities designated 6 1/2 percent or 5 1/2 percent "Cumulative Preferred Serial Stock" were not what they purported to be - evidence of a proprietary interest in the corporation - but that collectively they represented an obligation of the corporation to make repayment to the holders and in the meantime to pay them interest. It therefore argues that it is entitled to deduct, as interest, the amounts paid under and pursuant1132 to the corporate resolutions as 433 dividends. It also contends that it is entitled to deduct the portion of the discount properly allocable to the year 1936 and the premium paid during each of the years in connection with the redemption of the two classes of stock. Inasmuch as the latter deductions are proper if the securities were in fact obligations and the amount paid was interest (art. 22(a)-18, Regulations 94), the three contentions may be considered together. Numerous cases have been decided by the courts or this Board involving the same general question. None of them attempt to lay down any "comprehensive rule by which the question presented may be decided in all cases, and 'the decision in each case turns upon the facts of that case'." Proctor Shop, Inc.,30 B.T.A. 721">30 B.T.A. 721, 725, and cases cited. "If it be shown that dividends paid are, according to the intent of the parties, in fact interest, and the stock on which the dividends are paid is merely held by the creditor as security, it makes no difference what the reason was for paying in that form. The courts look to the real character of the payment * ." 1133 Wiggin Terminals, Inc. v. United States, 36 Fed.(2d) 893, 898, quoted with approval by the Circuit Court of Appeals for the Ninth Circuit in affirming the decision of the Board in Proctor Shop, Inc., supra;82 Fed.(2d) 792. Cf. Bolinger-Franklin Lumber Co.,7 B.T.A. 402">7 B.T.A. 402; Commissioner v. O. P. P. Holding Corporation, 76 Fed.(2d) 11, affirming O. P. P. Holding Corporation,30 B.T.A. 337">30 B.T.A. 337; Jewel Tea Co. v. United States, 90 Fed.(2d) 451; Helvering v. Richmond, F. & P.R. Co., 90 Fed.(2d) 971, affirming Richmond, Fredericksburg Potomac Railroad Co.,33 B.T.A. 895">33 B.T.A. 895; Brush-Moore Newspapers, Inc.,37 B.T.A. 787">37 B.T.A. 787; Commissioner v. Palmer, Stacy-Merrill, Inc., 111 Fed.(2d) 809, affirming Palmer, Stacy-Merrill, Inc.,37 B.T.A. 530">37 B.T.A. 530; and Commissioner v. Schmoll Fils Associated, Inc., 110 Fed.(2d) 611, reversing 1134 Schmoll Fils Associated, Inc.,39 B.T.A. 411">39 B.T.A. 411. It is true, as petitioner points out upon brief, that the cited cases establish some general principles - the name given by the parties to a particular security or to the payments made thereunder is not conclusively determinative; the true nature and character are to be determined not only from the terms and conditions of the security, but also from a consideration of all the facts and circumstances surrounding its issuance, including evidence aliunde the contract; and in every case the basic difference between the relationship of corporation and stockholder on the one hand and debtor and creditor on the other must always be kept in mind. We therefore examine the evidence and the stipulated facts in the light of these principles. The only evidence aliunde the contract in the instant proceeding is that upon which we have based our finding to the effect that generally, in the purchase and sale of the certificates, dividends, though not declared, 434 were taken into consideration in substantially the same manner and to substantially the same extent as accrued interest upon bonds is usually taken into consideration1135 upon purchase and sale. There was no evidence, as in Proctor Shop, Inc., and some of the other cited cases, indicating either that the issuing company desired to borrow money or that the holders were unwilling "to stand in the relation of a stockholder to the corporation." The facts show quite the contrary. The letter sent to prospective purchasers of the preferred stock, inviting them to subscribe for it, advised that the company proposed to finance its "present needs through the issuance of approximately equal amounts of preferred stock and bonds." The enclosed prospectus contained the same general statement, each indicating that the initial capital was to be obtained by borrowing 50 percent of the necessary amount through the issuance of bonds, while the remainder was to be obtained through the sale of preferred stock. This plan was carried out and $3,000,000 of each was issued and sold. Both were later increased, so that prior to April 1, 1928, the company - in the language of its second prospectus - "had * * sold for cash to institutions and investors an aggregate of $5,000,000 First Mortgage 5 1/2% Bonds and $4,500,000 6 1/2% Cumulative Preferred Serial Stock." At that1136 time $985,000 of its bonds had been retired. Then it was that the company decided to amend its articles of incorporation to permit it to issue $1,000,000 5 1/2 percent cumulative preferred serial stock so that "with the completion of the present stock sale" there would be, as there ultimately were, $5,500,000 outstanding cumulative preferred serial stock and $5,100,000 of first mortgage bonds. The facts referred to above indicate that petitioner intended the holders of the certificates to become, and to be, stockholders rather than creditors. It is apparent from the articles that petitioner never intended to "borrow" more than 50 percent of its funds. Thus it is stated: "The aggregate indebtedness of the corporation secured by mortgage, deed of trust, or otherwise, shall not exceed in amount Fifty per cent (50%) of the appraised value of the property subject thereto. The total amount of preferred stock of the corporation at any time outstanding shall not, together with the total bonded indebtedness of the corporation, exceed One Hundred per cent (100%) of the appraised value of the property of the corporation." If the preferred stock be held to be indebtedness, "secured by mortgage, 1137 deed of trust or otherwise", and unless the appraised value of the property was greatly in excess of its actual cost, which we hesitate to assume, then this provision of petitioner's charter was violated; for while the aggregate of the admitted bonds, plus the "so-called" preferred stock was $10,600,000, "the aggregate cost of the Company's properties including 435 those heretofore owned with those now being purchased, and including the new buildings which have been erected, [according to the prospectus] will be in excess of $11,200,000." Moreover, there are several other circumstances which collectively convince us that both the issuing corporation and those who ultimately became holders of the securities intended that the relationship between them was to be that of corporation and stockholder rather than debtor and creditor. Each prospectus contained in its heading, in bold type, "In opinion of counsel, exempt from Normal Federal Income Tax," and a more detailed statement to the same effect in the body of the document. No evidence was introduced to show whether the holders of the securities so treated the income derived from the securities - i.e., as dividends and1138 subject only to surtax (see for example section 25, Revenue Act of 1928) - but it may be assumed, in the absence of any proof to the contrary, that they relied upon the statements contained in the prospectuses. In any event it is not wholly without significance that petitioner treated the payments as dividends upon its books and in all of its returns of income prior to 1937. Manifestly the representation that the income was "free from Normal Federal Income Tax" would be true only if the securities were preferred stock. In determining whether they were, or were not, what they purport to be, we must look, not only to the language of the certificates, but to the articles and amended articles of incorporation. They specify, in considerable detail, not only that preferred stock be issued, but also require that "Before the issuance of any such stock, the President of the Corporation shall file a certificate in the office of the corporation setting forth in detail the property purchased or to be purchased with the proceeds of the sale of such stock." The stock so issued was to "be entitled to receive in each year out of the surplus or net profits of the business of the corporation, dividends1139 at the fixed dividend rate" specified in the certificates. If in any year "the dividends" on such stock have not been paid "such dividends shall be paid in full before any dividends shall be paid or set apart upon the common stock." The use of the word "dividends" many times in the articles of incorporation and the requirement that payment of such be made "out of the surplus or net profits" can not be ignored. Wholly absent from the articles is any requirement that the annual payments upon the certificates be made regardless of earnings, except for the provisions which we shall now discuss and upon which petitioner places its chief reliance. Each series was to "be redeemed at par, plus unpaid, accrued, and accumulated dividends thereon." "In the event that the corporation shall fail to redeem * * at such time and place, the holders 436 thereof shall have the right to enforce payment of the par value of said stock so agreed to be redeemed, together with the amount of any unpaid, accrued, or accumulated dividends thereon, the same as on any unconditional claim or debt against the corporation * ." "In the event of any liquidation, dissolution, or winding up of the corporation, 1140 * * * the holders * * * shall be entitled, before any distribution shall be made to the holders of the common stock, to be paid out of the surplus profits arising from the business of this corporation, and then remaining intact, or in case such profits shall be insufficient, then from the general assets of this corporation, an amount equal to 105% of the par value of said stock." These provisions, petitioner contends, make the securities an "indebtedness." Respondent denies that they have any such effect, points out that the right to enforce the payment as an unconditional claim or debt appears to be limited to the holders of any series then in default, which, so far as this record shows, never occurred, and argues that "the interest of any person in the assets of a corporation must necessarily be either as a creditor or as a proprietor", but can not be both at the same time. In practically every case decided by the courts or this Board it has been pointed out that each case must be decided on its own particular facts. Dayton & Michigan Railroad Co.,40 B.T.A. 857">40 B.T.A. 857; 1141 Trianon Hotel Co.,44 B.T.A. 1073">44 B.T.A. 1073. "The authorities afford us no very certain guide in solving the difficult problem before us, but very with the particular facts of each case." Commissioner v. Schmoll Fils Associated, Inc., supra.Many facts and circumstances in the instant proceeding indicate that the corporation and the purchasers of the securities intended that the relation should be proprietary rather than that of a creditor and debtor. Some of the significant facts and circumstances upon which we have relied in reaching our conclusion have already been referred to. Others are: The name given to the securities by petitioner in its articles of incorporation, in its letters and prospectuses, and in the securities themselves. While the name given is not determinative, it should not lightly "be assumed that the parties have given an erroneous name to their transaction." Schmoll Fils Associated, Inc., supra; I. Unterberg & Co.,2 B.T.A. 274">2 B.T.A. 274; Kentucky River Coal Corporation,3 B.T.A. 644">3 B.T.A. 644; 1142 H. R. DeMilt Co.,7 B.T.A. 7">7 B.T.A. 7. There is no evidence in the record indicating that either petitioner or the holders prior to the taxable years ever contended that there was any misnomer. Nor should it be overlooked that the certificates specifically referred to the holders as "stockholders" and to the payments as "dividends", that no payments were ever made except following the declaration of a dividend, and that all payments were made from profits. The dividends, after declaration, were set aside and transferred to "dividend declared" account. 437 Meridian & Thirteenth Realty Co.,44 B.T.A. 865">44 B.T.A. 865, decided since briefs were filed in the instant proceeding lends some support to petitioner's contention. It was there held that a security designated preferred stock, having a fixed maturity date, and requiring the payment of the agreed 6 percent regardless of profits represented an indebtedness. The proceedings are distinguishable in that in the cited case there was no evidence that any bonds had been issued by the corporation or that it had any other outstanding evidence of debt; a conclusion that the securities were in fact obligations did not1143 require a holding that the corporation had violated its articles of incorporation; no representations were made that the securities were free from the normal Federal income tax; the company had not represented in connection with the issuance of such stock that it proposed to finance its needs through the issuance of equal amounts of preferred stock and bonds; and the issuing company had not, as in the instant proceeding, given the holders of the preferred stock a right to vote in the event of default in the payment of dividends, though withholding from the bondholders such privilege. Moreover, we think it is quite doubtful, in spite of the provision contained in the articles of incorporation and in the certificates purporting to give the holders of the preferred stock rights which they might enforce as creditors, that any such rights could be enforced under the stipulated facts to the detriment of general creditors or bondholders. We are of the opinion and hold that the securities were what they purported to be. Compare Brown-Rogers-Dixson Co. v. Commissioner (C.C.A., 4th Cir.), 122 Fed.(2d) 347. It follows that the respondent committed no error in denying1144 the claimed deductions for interest, discount, and premiums. The petitioner's next contention is that it is entitled to a deduction of $5,618.35, for real estate taxes paid by it in 1936. The amount in question was assessed on May 1, 1935, when the real estate was in the possession of petitioner's vendee under the conditional sales contract. Petitioner repossessed the property on November 15, 1935, the vendee having defaulted in the payment of the purchase price. The taxes were payable one-half on or before December 5, 1935, and one-half on or before April 20, 1936. Petitioner paid the entire amount during 1936 and in its income tax return for that year claimed a deduction in that amount as "taxes." Respondent disallowed the deduction on the ground that the amount paid constituted additional cost of the property repossessed. The petitioner contends that it was the legal owner of the property and, as such, legally responsible for the payment of the taxes at the time of assessment. It argues, therefore, that it should be allowed the deduction since the amount represented taxes paid after, but which 438 accrued before, repossession of the property. In support of its1145 contention it cites and relies upon two unreported memorandum decisions of this Board wherein lessors of property were allowed to deduct taxes assessed during the time repossessed property was in the possession of the lessees. The conclusion that a lessor may deduct the taxes paid by him upon his property, notwithstanding the fact that a lessee may have covenanted to pay them as part of the consideration for the occupancy of the property, is not particularly helpful in determining the question now before us. Respondent concedes that petitioner retained the legal title to the property which it sold in 1929. He takes the position, however, that it was a bare, naked legal title; that the equitable title was in the purchaser from the time of the sale in 1929; that it remained in him until the property was repossessed by the petitioner in November 1935; and that petitioner, having sold the property, had no alternative except to give the purchaser legal title upon payment of the agreed purchase price. He therefore contends that petitioner was holding the legal title to the property more in the nature of a trustee for the benefit of the purchaser than as an owner of the property as1146 that term is ordinarily understood. He insists that, inasmuch as the taxes in question were assessed and became a lien against the property in March 1935, petitioner was paying an obligation, or an accrued liability, of its vendee when it, in 1936, paid the 1935 real estate taxes. The parties have stipulated that the property was sold by petitioner during 1929 under a conditional sales contract. The contract was not introduced in evidence. A "conditional sale" has been defined to be a contract for the sale of property under which possession is delivered to the buyer, but title is retained in the seller until the performance of some condition, usually the payment of the purchase price. 55 C.J. 1192. The rights of the vendor and vendee under such a contract have been discussed by the courts of California in a number of cases. In Oaks v. Kendall,73 Pac.(2d) 1255; 23 Cal.App.(2d) 715, the court pointed out that the vendor under such a contract retains an absolute right to hold the property as security for the payment of the purchase money according to the express terms of the contract, and quoted with approval the following excerpt from 25 California1147 Jurisprudence, p. 762, sec. 930: * * In the ordinary executory contract for the sale of real property the vendor retains title as security for the payment of the purchase money and as trustee for the purchaser, who has only an equitable estate in the land. The position of the vendor is similar in some respects to that of a mortgagee. He has no greater rights than he would possess if he had conveyed the land and taken back a mortgage for unpaid purchase money, or than is held by a mortgagee who takes for his security a conveyance absolute in form instead of a formal mortgage, except that he is not restricted to a remedy by foreclosure. A 439 vendor is frequently said to have a lien on the property so long as he retains title, though properly speaking he has no lien, nor any need of one, since he has the complete legal title which he holds as a pledge for payment of the purchase money. In San Diego County ex rel. Whelan v. Davis,33 Pac.(2d) 827, involving the question of liability for property tax on an automobile, the Supreme Court of California, per curiam, said: The tax must be levied on the owner of the property, but this does not necessarily1148 mean the holder of the legal title. In a conditional sale, the title in the seller is for security only, to assure the payment of the purchase price. It carries with it none of the ordinary incidents of ownership. The buyer has the possession and use of the property to the complete exclusion of the seller subject only to the seller's remedies in case of default. Both in a practical and a legal sense the buyer is the beneficial owner. In Thompson on Real Property, vol. 5, sec. 4526, the author states: "There can be no sensible distinction between the case of a legal title conveyed to secure the payment of a debt and a legal title retained to secure payment." While there are some points of difference between the relation of vendor and vendee under a conditional sales contract and that of equitable mortgagee and mortgagor where the vendee holds an equity which is subject to foreclosure by the vendor, we do not think the difference is of such a substantial nature as to warrant the allowance of a deduction for taxes when paid by the vendor after the property is repossessed although such allowance would not be granted following foreclosure of the mortgage by the equitable mortgagee. 1149 Under the laws of California, the liability for county and city taxes is determined by the ownership of property on the first Monday in March. California Sanitary Co., Ltd.,32 B.T.A. 122">32 B.T.A. 122; Crown Zellerbach Corporation,43 B.T.A. 541">43 B.T.A. 541 (on appeal C.C.A., 9th Cir.). (Sec. 3628, Political Code of California.) Petitioner's vendee was the beneficial owner and had possession and control of the property on that date, and thus became liable for the payment of the real estate taxes here involved. Petitioner's payment of such taxes in 1936, after it had repossessed the property in November of 1935, does not in our opinion make such taxes its taxes or entitle it to the claimed deduction. Cf. Commissioner v. Coward, 110 Fed.(2d) 725; Lifson v. Commissioner, 98 Fed.(2d) 508; certiorari denied, 305 U.S. 662">305 U.S. 662; Estate of Lucy S. Schieffelin,44 B.T.A. 137">44 B.T.A. 137; Helvering v. Missouri State Life Insurance Co., 78 Fed.(2d) 778; 1150 John Hancock Mutual Life Insurance Co.,10 B.T.A. 736">10 B.T.A. 736. Finding no error in the deficiencies determined by the respondent, they must be approved. It follows that petitioner's claim for overpayment can not be allowed. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623173/	DOUGLAS P. RAUCH AND ROSALIE RAUCH, JUDAL CONSTRUCTION CO., INC., DOUGLAS P. RAUCH, (TRANSFEREE), Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRauch v. CommissionerDocket No. 591-81.United States Tax CourtT.C. Memo 1984-161; 1984 Tax Ct. Memo LEXIS 509; 47 T.C.M. (CCH) 1398; T.C.M. (RIA) 84161; April 2, 1984. John J. O'Toole and Andrew Fradkin, for the petitioners. Daniel K. O'Brien, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in income510 tax and additions to tax against petitioners for the following periods and in the following amounts: TAXABLE YEARADDITION TO TAX UNDERENDINGDEFICIENCY1 SECTION 6653(b) Douglas P. Rauch and Rosalie RauchDec. 31, 1966$880.36$ 440.18Dec. 31, 19675,583.002,792.00Dec. 31, 19684,753.002,377.00Dec. 31, 19693,733.001,869.00Judal Construction Co., Inc.Nov. 30, 1966$3,268.05$1,634.03Nov. 30, 196711,726.226,741.73Nov. 30, 196814,576.607,288.30Nov. 30, 19692,641.651,320.83Douglas P. Rauch (Transferee)Nov. 30, 1966$3,268.05$1,634.03Nov. 30, 196711,726.226,741.73Nov. 30, 196814,576.607,288.30Nov. 30, 19692,641.651,320.83After concessions, the sole issue remaining for our determination is whether Douglas P. Rauch is liable for the deficiencies and additions to tax of Judal Construction Co., Inc., as the transferee of that corporation within the meaning511 of section 6901. The case was submitted to the Court without trial under the provisions of Rule 122, and based upon a written stipulation of facts and numerous joint exhibits which were filed by the parties. Such stipulation of facts and joint exhibits form the basis of the Court's findings of fact herein. FINDINGS OF FACT Petitioners Douglas P. Rauch and Rosalie Rauch, husband and wife, were residents of Upper Saddle River, New Jersey, at the time of filing their petition herein. Their joint Federal income tax returns for the calendar years 1966 and 1967 were filed with the Internal Revenue Service at Newark, New Jersey, and their returns for the years 1968 and 1969 were filed with respondent's Mid-Atlantic Service Center in Philadelphia, Pennsylvania. 2During its fiscal years ending November 30, 1966, through November 30, 1969, petitioner Judal Construction Co., Inc. (hereinafter "Judal") was a corporation organized under the laws of the State of New Jersey with its principal office at Hackensack, New512 Jersey. Its Federal corporate income tax returns for its fiscal years 1966 and 1967 were filed with the District Director of Internal Revenue at Newark, New Jersey, and its returns for its fiscal years 1968 and 1969 were filed with respondent's Mid-Atlantic Service Center in Philadelphia, Pennsylvania.Judal was an accrual basis taxpayer during the relevant fiscal years, but its income tax returns were prepared by outside accountants based upon deposits to and disbursements from Judal's checking account. During the years at issue, Judal was engaged in the business of light construction and remodeling work. It operated its business from offices located in Hackensack, New Jersey, which premises it leased from one John Zajac. Irving Cohen (hereinafter "Cohen") was president of the corporation and owned 50 percent of the common stock. Rauch was secretary-treasurer of the corporation and also owned 50 percent of the common stock. Judal was liquidated in November of 1971. In each of its fiscal years 1966 through 1969, Judal, being under the control of Cohen and Rauch, caused a number of checks to be drawn on its corporate checking account payable to John Zajac. These checks were513 charged to business expenses on the cash disbursement records of Judal, and were claimed as business deductions on its income tax returns. The total amount of such checks in each of Judal's fiscal years was as follows: Fiscal Year EndingTotal Amount ofNovember 30Checks1966$10,854.78196734,557.63196835,236.77196913,915.89Such checks were thereafter deposited in checking and/or savings accounts maintained by Rauch and/or his wife, Cohen and/or his wife, or in some cases to the bank account of a partnership called Raco Company, in which Rauch and Cohen were partners, in amounts totalling an approximate equal division of the proceeds of such checks between Rauch and Cohen for each year. The distribution of such funds to Rauch and Cohen were made without consideration, were recorded falsely in Judal's books and records and on its tax returns, and were done with the intention of defeating and evading Judal's Federal income tax for each of the years in question. As the result of the above diversion of corporate funds to Rauch and Cohen, and the false and fraudulent income tax returns filed by Judal consistent therewith, Judal is liable for deficiencies514 in income tax, and additions to tax under section 6653(b), for each of the years in question as follows: 3Additions toFiscal YearDeficiency inTax UnderEnding November 30TaxSection 6653(b)Total1966$3,048.05$1,524.03$4,572.0819677,266.494,512.1211,778.61196812,552.656,276.3318,828.9819692,641.651,320.833,962.48Of the above totals of funds diverted from Judal by Rauch and Cohen in each of the years in issue, the following amounts were received by Rauch for his personal benefit: Fiscal Year EndingDiverted Funds ReceivedNovember 30By Rauch1966$3,927.00196715,778.00196816,118.0019695,457.00As the result of the diversion of Judal's funds for the benefit of Rauch, as detailed above, there are deficiencies in individual income tax due from Rauch, as well as additions to tax under section 6653(b), for the calendar years 1966 through 1969 as follows: 4Calendar YearAdditions to Tax UnderEndingDeficiencySection 6653(b)1966$762.29$381.1519674,094.302,147.1519684,417.352,208.6819693,686.801,843.40515 OPINION The parties having resolved all of the differences between them, so far as petitioners Douglas P. Rauch (individually), Rosalie Rauch and Judal Construction Co., Inc. are concerned, as evidenced by the comprehensive stipulation of facts filed with the Court herein, it remains only for us to determine whether respondent was correct in attempting to collect from petitioner Douglas P. Rauch, as transferee, the admitted liabilities for tax and additions to tax of Judal, under the provisions of section 6901. 5516 Two important characteristics of section 6901 must be noted.First, this section does not create or impose any liability as such for the taxes of another, but only gives respondent a mechanism for collecting such tax otherwise determined to be due. Kreps v. Commissioner,351 F.2d 1">351 F.2d 1 (2d Cir. 1965), affg. 42 T.C. 660">42 T.C. 660 (1964). Second, the liability of an individual as the transferee of another is to be determined "at law or in equity" under the law of the state whose laws are applicable, there being no controlling Federal law in this area. Commissioner v. Stern,357 U.S. 39">357 U.S. 39, 42 (1958).Finally, it must be remembered that the burden of proof to show the individual's status as the transferee of another under the applicable state law is upon respondent, but such burden does not extend to the liability for tax of the transferor. Section 6902(a)6; Rule 142(d). 517 In this case the applicable state law is that of New Jersey, where the parties resided and where all of the relevant happenings occurred. Although New Jersey has continued to retain the distinction between law and equity in its laws and in its administration of justice, and although the parties have argued the question of Rauch's liability as transferee at law and in equity separately, the distinction is more apparent than real, since the New Jersey statutes giving rise to equitable rights in the area of fraudulent conveyances are almost identical to provisions of the New Jersey corporation laws regarding fraudulent transfers, compare N.J. Stat. Ann. sec. 25:2-10 through 25:2-13 (West 1970) (hereinafter "N.J.S.A.") with N.J.S.A. 14A:14-10, and the two sets of laws have been held in New Jersey to be in pari materia. Hartwell v. Hartwell Co., Inc.,167 N.J. Super. 91">167 N.J. Super. 91, 400 A.2d 529">400 A.2d 529 (N.J. Ch. 1979). To establish Rauch's liability under New Jersey law as a transferee herein, respondent relies primarily upon the provisions of N.J.S.A. 14A:14-10(4), and secondarily upon the provisions of N.J.S.A. 14A:14-10(3). 7 We address respondent's primary contention first. 518 The stipulated facts in this case, upon which our findings are based, clearly show that Judal, one of the petitioners herein, distributed substantial funds in each of its fiscal years 1966 through519 1969 through a straw party to Rauch and Cohen, its officers and shareholders. Such distributions were concealed in its books and records by falsely recording them as business expenses, and were falsely claimed as deductions in its corporate tax returns. The parties have stipulated, and we have found, that this course of conduct resulted in an understatement of the taxes properly owing by Judal to the Internal Revenue Service, and that the tax returns filed by Judal were fraudulent within the meaning of section 6653(b). It is thus clear that the gratuitous transfers of funds by Judal to Rauch and Cohen were done with the "actual intent * * * to hinder, delay, or defraud" the Federal fisc of its lawful taxes, within the precise language of N.J.S.A. 14A:14-10(4). The Federal government is a "creditor," and its taxes receivable are a "debt" within the meaning of the above statute. N.J.S.A. 14A:14-1(b), (c). 8 In view of the broad sweep of the cited New Jersey statutes, we need not hesitate over whether Judal's liability for tax in each of its fiscal years was fully matured or even known at the time the fraudulent transfers were made. See also Kreps v. Commissioner,supra;520 Swinks v. Commissioner,51 T.C. 13">51 T.C. 13, 17 (1968); Papineau v. Commissioner,28 T.C. 54">28 T.C. 54, 58 (1957). In this case, we therefore hold that respondent has fully carried his burden of proof to show that Rauch is a transferee of Judal for the years here in issue under New Jersey law. We further hold that such transferee liability includes the liability for additions to the tax, as well as the tax itself, Estate of Gryder v. Commissioner,T.C. Memo 1981-466">T.C. Memo. 1981-466, affd. 705 F.2d 336">705 F.2d 336 (8th Cir. 1983). Furthermore, where, as here, actual fraudulent intent has been shown, as opposed to constructive intent, it is not necessary for respondent521 to show that the transfers in question were done at a time when Judal was insolvent or was rendered insolvent thereby. The applicable New Jersey statute imposes no such requirement. N.J.S.A. 14A:14-10(4); cf. EstateofGryder v. Commissioner,supra;United States v. 58th Street Plaza Theatre, Inc.,287 F. Supp. 475">287 F.Supp. 475, 498 (S.D.N.Y. 1968). In opposition to respondent's position, petitioners argue that respondent has failed to carry his necessary burden of proof to show that Rauch is liable under New Jersey law as a transferee of Judal. In support of this argument, petitioners make the following points: (a) The cases of Judal and Mr. and Mrs. Rauch (individually) were completely settled between the parties prior to trial herein on the basis of "stipulated decisions." (b) Such "stipulated decisions" were the result of compromise and negotiation between the parties, and do not provide any basis in this record for a factual finding by the Court that the gratuitous diversion of corporate funds from Judal to Rauch in the years in question was done with the actual intent to defraud or defect the collection of tax by respondent from Judal. 522 (c) The submission of much "stipulated decisions" in the "separate dockets" of Judal and Rauch (individually) cannot form the basis of the necessary factual findings of transferee liability in the case of Rauch as transferee, since, say petitioners, [w]hen the Court accepts the stipulated decisions it makes only a "pro forma" decision based upon an agreement between the parties to settle for reasons undisclosed. These decisions cannot be concluded, as respondent contends, to be admissions by Rauch which would suffice to sustain his burden of proof as to fraudulent intent to hinder or delay. [Citing United States v. International Building Company,345 U.S. 502">345 U.S. 502 (1953).] Petitioners' arguments reveal a fundamental misunderstanding as to the posture of the parties before this Court, and the record which is before us. First, there are no separate dockets involving the three petitioners in this case. There is only one case before this Court, in which all the petitioners were joint petitioners. The extensive stipulations of fact which were entered into herein were made by all the petitioners, through their counsel, in a single case, and all the parties523 are equally bound thereby. Rule 91(e). Second, contrary to petitioners' arguments, there were no "pro forma" stipulated decisions tendered to the Court by Judal and the Rauchs individually. Instead, this case was submitted to the Court under the provisions of Rule 122, based upon an extensive written stipulation of facts together with numerous joint exhibits. Such stipulation of facts included, in detail, the course of conduct by which Judal diverted its corporate funds into the hands of Rauch and Cohen in each of its fiscal years 1966 through 1969, and the amounts thereof. The stipulation further included the facts that the deficiencies of Judal, to which the parties agreed as part of the stipulation, directly grew out of the illegitimate diversion of corporate funds to Rauch and Cohen, and that the books of the corporation and the tax returns filed by Judal in conformity therewith, were false and fraudulent. 9524 Although it is certainly true that the Court can and will enter decisions of deficiences in tax and additions to tax in accordance with the stipulations of the parties, we do not have in this case the situation where the parties (or some of them) present to the Court, a "stipulated decision" as to liabilities, which the Court simply enters without making any findings of underlying facts. Rather, this case -- a single case including all petitioners -- was presented to the Court for decision on the basis of complete written stipulations of facts and joint exhibits. The case was thus presented to the Court for a full resolution on the merits, including the finding of all relevant facts, and is entirely different from a case where a decision is entered by the Court pursuant to a stipulation of the parties, without any findings of fact or opinion going to the merits. Cf. United States v. International Building Company,supra.Under our Rule 91(e), stipulated facts are just as effective in carrying a party's necessary burden of proof as unstipulated facts which may be525 received into the record, e.g., by oral testimony of a witness or by the submission of exhibits by one party alone. 10As the Court of Appeals for the Second Circuit said in Kreps v. Commissioner,supra,351 F.2d 1, at 6: We hold this evidence [stipulated facts] was sufficient to discharge the Commissioner's burden on the issue of fraud. Surely the fact that the stipulated facts played a key role in establishing the Commissioner's case is irrelevant. A great many tax cases are litigated on stipulations of fact. If such stipulations establish the Commissioner's burden of proof, he need do no more. See Jaffee v. Commissioner,18 B.T.A. 372">18 B.T.A. 372, affd. [on other grounds] 45 F.2d 679">45 F.2d 679 (2d Cir. 1930). In sum, then, we hold that the stipulation of facts upon which this case was submitted contained all the necessary factual elements to establish the liability of Rauch as a transferee of Judal under the provisions of N.J.S.A. 14A:14-10(4); that respondent was entitled to rely on such stipulation of facts to526 carry his necessary burden of proof on the transferee issue; that all parties to said stipulation of facts are equally bound thereby; and that Rauch is liable under New Jersey law as a transferee of Judal for each of the years before us, but not to exceed the amounts received from Judal in each such year, as shown in our findings of fact. United States v. 58th Street Plaza Theatre, Inc.,supra;Scott v. Commissioner,117 F.2d 36">117 F.2d 36 (8th Cir. 1941); Transo Oil Corp. v. Commissioner,2 T.C.M. (CCH) 974">2 T.C.M. 974 (1943), 12 P-H Memo T.C. par. 43,473. Having so found and held, we need not consider respondent's alternative contention that Rauch is liable as a transferee "in equity" of Judal. To give effect to the stipulations of the parties with respect to the petitioners herein other than Rauch as transferee, Decisions will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect in the years in issue, and all Rule references are to the Rules of Practice and Procedure of the Tax Court, except as otherwise noted.↩2. Since the only issue presented herein for our decision is the transferee liability of petitioner Douglas P. Rauch, he will be referred to hereinafter as "Rauch."↩3. So stipulated by the parties.↩4. So stipulated by the parties, who further stipulated that petitioner Rosalie Rauch was not liable for said deficiencies or additions, pursuant to section 6013(e).↩5. In pertinent part, section 6901 reads as follows: Section 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), * * (h) Definition of Transferee. -- As used in this section, the term "transferee" includes donee, heir, legatee, devisee, and distributee, * * .↩6. Section 6902 reads as follows, in pertinent part: SECTION 6902. PROVISIONS OF SPECIAL APPLICATION TO TRANSFEREES. (a) Burden of Proof.--In proceedings before the Tax Court the burden of proof shall be upon the Secretary or his delegate 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.↩7. The cited provisions of the New Jersey statutes reads as follows: 14A:14-10. Fraudulent Transfers. * * (3) Every transfer made and every obligation incurred without fair consideration when the corporation making the transfer or entering into the obligation intends to or believes that it will incur debts beyond its ability to pay as they mature, is fraudulent as to both present and future creditors. (4) Every transfer made and every obligation incurred by a corporation with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors of the corporation, is fraudulent as to both such present and future creditors. The corresponding provisions of N.J.S.A. 25:2-12 and 25:2-13↩ (the "equity" provisions) are identical, except that they are not limited solely to acts by corporations, but include other persons as well.8. The cited statute, in relevant part, reads as follows: 14A:14-1. Definitions. As used in this chapter, and unless the context requires otherwise * * * (b) "creditor" means the holder of any claim, of whatever character, against a corporation, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, absolute or contingent; (c) "debt" includes any legal liability, whether matured or unmatured, liquidated or unliquidated, absolute, fixed or contingent; * * *.↩9. Both as to Judal and as to Mr. and Mrs. Rauch (individually), the parties stipulated that the deficiencies in tax were directly traceable to the diverted funds of Judal, and that the respective petitioners (except Mrs. Rauch) were liable for additions to tax under the provisions of section 6653(b)↩, meaning that such returns were fraudulent.10. Indeed, stipulated facts may be even better, since the parties have already agreed to their truth and accuracy.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623174/	GARY GLASS, TRANSFEREE, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Glass v. CommissionerDocket Nos. 5529-86; 5530-86; 27170-86.United States Tax CourtT.C. Memo 1988-550; 1988 Tax Ct. Memo LEXIS 579; 56 T.C.M. (CCH) 764; T.C.M. (RIA) 88550; December 5, 1988Arthur Pelikow and Larry Kars, for the petitioners. Roland Barral and Jeannette D. Schmelzle, for the respondent. TANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined the following deficiencies in petitioners' Federal income tax: Docket No.PetitionerYear EndedDeficiency5530-86Three G TradingSept. 30, 1980$ 1,325,876Corp., TransferorSept. 30, 198137,588June 30, 19824,2765529-86Gary Glass,Sept. 30, 19801,325,876TransfereeSept. 30, 198137,588June 30, 19824,27627170-86Gary Glass andDec. 31, 1982298,624Dale GlassBy amendment to answer, respondent determined that there is a deficiency due for 1982 2 from Three581 G Trading Corp., Transferor, and Gary Glass, Transferee, of $ 938,892, with respect to the nonapplication of section 337 3 to the 1982 transactions involved herein, and that, under section 6621(c), part of the deficiencies for each year were substantial underpayments attributable to tax-motivated transactions so that Three G Trading Corp., Transferor, and Gary Glass, Transferee, are liable for interest on such part at 120 percent of the statutory rate. After concessions, the issues for decision are whether Three G Trading Corp. is entitled to deduct certain losses incurred in trading commodity futures contracts during 1980, and, if so, whether it is required to recognize certain gain realized from trading commodity futures contracts during 1982 and whether part or all of the underpayment, if any, for 1980 is attributable to a tax-motivated transaction. 4582 Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by reference. For convenience, we have combined our findings of fact and opinion. Three G Trading Corp. (hereinafter referred to as petitioner) was a New York corporation with taxable year ending September 30, and Gary Glass and Dale Glass were residents of Merrick, New York, at the time their petitions were filed. Petitioner dissolved on June 30, 1982, pursuant to a plan of liquidation adopted on September 30, 1981. Mr. Glass was president and sole shareholder from its inception to its dissolution. All of its assets, subject to liabilities, were distributed to Mr. Glass on June 30, 1982. The parties have stipulated that Mr. Glass was transferee of petitioner for Federal income tax purposes. From December 15, 1975, through December 31, 1981, petitioner was a clearing member of the New York Mercantile Exchange (NYMEX). It had no customers, maintained no inventory of commodity futures contracts and did not engage in hedging operations. During the years in issue, Mr. Glass was a member of the Commodity Exchange, Inc. (COMEX) and NYMEX. Mr. Glass traded commodities583 futures contracts only for petitioner during the years in issue. A commodity futures contract is a commitment to deliver or receive a specified quantity of a commodity during a designated future month. Where a person selling a commodity futures contract is obligated to deliver the commodity, it is known as a short position. Where a person buying a commodity futures contract is obligated to accept delivery, it is known as a long position. The obligation to accept or make delivery may be avoided by purchasing or selling an offsetting contract. A straddle 5 is a simultaneous holding of a long and a short position (each of which is a leg) in the same commodity for different delivery months. A long straddle is a straddle where the distant leg (that is, the leg with the later delivery month) is the long position; a short straddle is one in which the distant leg is short. A straddle has less risk than an outright position, because the prices for each leg tend to move together. The price at which the straddle trades is the differential between the prices of the two legs; prices for the individual legs are set by the traders, and under the COMEX rules must fall within the daily584 trading range of prices for each leg. A butterfly straddle is a combination of two straddles with the middle legs, either both long or both short, in the same month. A butterfly straddle typically has less risk than a straddle. 6On its Form 1120 (Corporation Income Tax Return) for 1980, petitioner reported ordinary income of $ 3,237,260 and ordinary loss of $ 3,321,200, for a net loss of $ 83,940. If allowable, the loss is a capital loss. See Three G Trading Corp., Transferor v. Commissioner,T.C. Memo. 1988-131. The parties agree that the reported ordinary income represents capital gain from trading commodity futures contracts not related to the transactions585 involved herein. Petitioner's claimed loss arose from a series of trades, including straddles and butterfly straddles, in gold futures contracts, all of which were executed on COMEX and cleared through Heinold Commodities, Inc. (Heinold). 7 All of the trades, except for the January 19, 1982 trades, were executed personally by Mr. Glass on petitioner's behalf. Each trade was entered into after open outcry on the COMEX trading floor, and prices assigned to the legs were within the limits imposed by COMEX. Each required margin, and petitioner complied with the COMEX margin requirements. On June 13, 1980, petitioner entered into the following contracts: DescriptionNumberContractPrice 8New/Offset 9Sold200December 1981702.00NewBought400February 1982713.00NewSold200April 1982724.00NewThe trader586 opposite petitioner in each of these trades was Richard Buccellato (Buccellato), who was trading for three accounts, one of which was his own. These contracts created a butterfly straddle. On June 30, 1980, petitioner entered into the following transactions: DescriptionNumberContractPriceNew/OffsetSold200October 1981756.00NewSold200October 1981758.00NewBought200December 1981770.00OffsetBought200April 1982801.00OffsetThe trader opposite petitioner in each of these trades was Milton Kaufman (Kaufman). These transactions closed one of the two straddles that had made up the butterfly straddle entered into on June 13, 1980, leaving one open straddle (short 400 in October 1981 and long 400 in February 1982). Petitioner claimed a loss of $ 2,900,600 on these transactions. 10587 On July 2, 1980, petitioner entered into the following transactions: DescriptionNumberContractPriceNew/OffsetBought200October 1981765.00OffsetBought200October 1981770.00OffsetSold200December 1981784.00NewSold200April 1982808.00NewThe trader opposite petitioner in these transactions also was Kaufman. These transactions closed the October 1981 leg of the straddle that had resulted from the June 30, 1980, transactions and put back the butterfly that had been opened on June 13, 1980. The prices of the contracts for December and April were, however, higher. Petitioner claimed a loss of $ 420,600 on these transactions, for a total loss in 1980 of $ 3,321,200. As of July 2, 1980, the settlement prices, which are the prices used to clear trades with the exchange's clearinghouse and are based on the range of closing prices for all contracts and delivery months, of the contracts making up the legs of the butterfly straddle held by petitioner were as follows: ContractSettlement PriceOctober 1981$ 778.00December 1981792.20April 1982806.40These prices resulted in an open588 trade equity (the sum of the products of the differences between the prices assigned to the legs and the settlement prices multiplied by the number of contracts and the number of ounces involved in each contract) 11 of $ 3,320,000. Subsequently, on November 20, 1981, petitioner entered into the following transactions: DescriptionNumberContractPriceNew/OffsetBought200December 1981397.64OffsetSold242February 1982404.32OffsetBought42June 1982419.00NewThese transactions closed one straddle of the butterfly straddle entirely, partially closed another and opened a new straddle partially to replace the one that had been closed. Petitioner held a "tilted" butterfly -- one in which one leg has fewer contracts than the other -- at this point, because it held 158 February 1982 contracts and 42 June 1982 contracts. The net gain on the transactions was $ 256,481 in 1982. On January 19, 1982, petitioner closed out the butterfly straddle, put in place on November 20, 1981, as follows: DescriptionNumberContractPriceNew/OffsetSold158February 1982379.30OffsetBought158April 1982386.40OffsetBought42April 1982386.50OffsetSold22June 1982394.40OffsetSold20June 1982394.50Offset589 The net gain on these transactions was $ 3,055,400. Petitioner's overall net loss on the entire series of transactions set forth above was $ 9,319. During the period from October 1, 1979, through June 30, 1982, there were no investigations undertaken by the COMEX against either petitioner or Mr. Glass. The threshold question that we must face is whether the loss claimed by petitioner in 1980 is allowable. Section 108 of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 630, as amended by the Tax Reform Act of 1986, sec. 1808(d), Pub. L. 99-514, 100 Stat. 2085, 2817, which we will refer to as section 108, provides in pertinent part: (a) General Rule. -- For purposes of the Internal Revenue Code of 1954, in the case of any disposition of 1 or more positions -- (1) which were entered into before 1982 and form part of a straddle * * any loss from such disposition shall be allowed for the taxable year of the disposition if such loss is incurred in a trade or business * * . (b) Loss Incurred in a trade or business. -- For purposes of subsection (a), any loss incurred590 by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business. We note at the outset that, for purposes of the transactions herein, the term "dealer" has two different definitions. First, for purposes of characterizing gains and losses as capital or ordinary, a person is a dealer if he has customers. King v. Commissioner,89 T.C. 445">89 T.C. 445, 458 (1987); Three G Trading Corp., Transferor v. Commissioner, supra.Second, for purposes of section 108, a commodities dealer is "a person who is actively engaged in trading section 1256 contracts and is registered with a domestic board of trade which is designated as a contract market by the Commodities Futures Trading Commission." Sec. 1402(i)(2)(B), cited in sec. 108(f). Thus, one can be a dealer for purposes of section 108 but not a dealer for the purpose of categorizing gains and losses. King v. Commissioner,89 T.C. at 459 n.6. Respondent has conceded that if section 108 applies, petitioner's losses are allowable. 12 For section 108 to apply, 591 however, petitioner must establish that the transactions were not fictitious, prearranged or in violation of the rules of COMEX. Katz v. Commissioner,90 T.C. 1130">90 T.C. 1130 (1988); Cook v. Commissioner,90 T.C. 975">90 T.C. 975, 984-985 (1988). 592 Respondent has not asserted that any of the COMEX transactions involved herein were fictitious, that is, that they did not take place. Respondent does argue that, based on the pattern and timing of the trades, as well as the alleged fact that they did not have a profit potential, the transactions were prearranged. Petitioner argues that the testimony of the two principal persons with whom he made the trades involved herein, the place and manner in which the trades were executed, and the prices at which they were executed shows that the trades were not prearranged. Whether the transactions were prearranged is a question of fact; petitioner bears the burden of proof. Katz v. Commissioner,90 T.C. at 1136; Rule 142(a). Mr. Glass testified that he made no agreements concerning the trades at issue. We found much of his testimony, however, to be vague in several respects, particularly as to the specific reasons for entering into the straddles involved herein. Moreover, he failed to remember many details, particularly those involving asserted sanctions by the Commodities Futures Trading Commission, which respondent attempted to prove for impeachment. While we do593 not believe that the alleged violations impeached Mr. Glass's credibility (particularly since respondent did not offer in evidence the documentary material which he used to cross-examine Mr. Glass in this respect), we are not required to accept Mr. Glass's testimony as gospel. See Fleischer v. Commissioner,403 F.2d 403">403 F.2d 403, 406 (2d Cir. 1968), affg. a Memorandum Opinion of this Court; Leong v. Commissioner,T.C. Memo. 1977-19, affd. without published opinion 573 F.2d 1291">573 F.2d 1291 (2d Cir. 1977). 13 We therefore will consider the objective evidence.At the outset, we recognize that, generally, in determining whether a commodity straddle activity was entered into for profit, consideration is given to the entire scheme. See, e.g., Glass v. Commissioner,87 T.C. 1087">87 T.C. 1087, 1174 (1986), affd. sub nom. Yosha v. Commissioner, F.2d (7th Cir., Nov. 8, 1988). But we are satisfied594 that this rule is not absolute and that it does not preclude examining separate steps in a series of transactions, see 87 T.C. at 1175-1176, particularly where the issue is determining the existence of prearrangement, even though the profit objective may be one element. Although the facts that a transaction was executed by open outcry on a regulated exchange, cleared through normal channels, and priced within the daily limits imposed seem to indicate that it was not prearranged (see King v. Commissioner,87 T.C. 1213">87 T.C. 1213, 1217 (1986); Perlin v. Commissioner,86 T.C. 388">86 T.C. 388, 416 (1986)), these elements are not determinative. 14595 We find that, with respect to the June 30, 1980, and the July 2, 1980, transactions, the objective evidence is sufficient to overcome the other evidence of record that indicates that the transactions were not prearranged. Several facts influence this finding. First, all the transactions on these days were executed with Kaufman as the opposite trader. Thus, his results were an exact mirror of petitioner's. Second, from Kaufman's perspective, the transactions produced a complete wash in results (ignoring transaction costs) -- that is, the gain on the October legs is equal to the loss on the December and April legs. Similarly, if petitioner had not had the open positions from the June 13, 1980, transactions, it would have had wash results on the June 30 and July 2 transactions. To be sure, because some of the June 30 transactions offset positions from some of the June 13 transactions (the February 1982 position remained unaffected), petitioner seemingly realized a loss while being left with the potential for gain remaining in the newly acquired (December 1981 and April 1982 legs), albeit subject to the risk of the market. But the fact of the matter is that after the June 30 and596 July 2 transactions were completed, petitioner was in the identical position in which it had been immediately prior to June 30, i.e., as it had been as a result of the June 13 transactions. Furthermore, petitioner's open trade equity was exactly equal to its claimed losses less transaction costs. Petitioner made no attempt either through Mr. Glass's testimony or on brief to deal specifically with any of these elements of the June 30 and July 2 transactions. In short, petitioner had no profit motive in entering into the June 30 and July 2, 1980, transactions and thus fails to meet the standard of Cook v. Commissioner, supra, namely that, for the purpose of section 108(b), a transaction need not be entered into primarily for profit and that a commodities dealer need only show that there was some profit potential in order to avoid the curse of "prearrangement." See 90 T.C. at 985-986. See also Yosha v. Commissioner, F.2d , (7th Cir., Nov. 8, 1988) ("A transaction not 'entered into for profit' is, at the least * * * a transaction that lacks597 economic substance."). We view this case as reflecting the same lack of any profit motive which existed in Glass v. Commissioner, supra, and which was the foundation of our holding in Cook.We hold that petitioner has not met its burden of showing that the June 30 and July 2 transactions were not prearranged, so that those transactions should be disregarded in determining the tax consequences of petitioner's commodity futures activity. 15Respondent also argues that section 108 should not apply because these trades were wash trades and they were noncompetitive. Both situations would be violations of the COMEX rules and as such would constitute an independent ground for disallowing the claimed losses. In view of our holding that the June 30 and July 2 transactions were prearranged, we find it unnecessary to resolve the question of whether any of these transactions violated the COMEX rules. With respect to 1982, respondent has conceded598 that the gains for that year should be reduced by the losses disallowed for 1980. See Glass v. Commissioner,87 T.C. at 1177. The result of this concession is to eliminate any gain for 1982.16 To the extent that there may be a net loss for 1982, it will not be recognized by virtue of section 337, and we do not understand that petitioner would contend otherwise. With respect to the further application of section 337 claimed by respondent, his position was predicated upon our recognition of the June 30 and July 2, 1980, transactions which respondent contends would have produced a locked-up profit to petitioner prior to the adoption of the place of liquidation on September 30, 1981 -- a profit that, according to respondent, would have constituted an assignment of income upon petitioner's liquidation and therefore without the scope of section 337. Compare Carborundum Co. v. Commissioner,74 T.C. 730">74 T.C. 730, 740-742 (1980), and S. C. Johnson & Son, Inc. v. Commissioner,63 T.C. 778">63 T.C. 778 (1975), with Peterson v. United States,723 F.2d 43">723 F.2d 43 (8th Cir. 1983). In view of our holding that the June 30 and July 2 transactions should599 be disregarded, this section 337 issue is mooted. We turn to respondent's determination that petitioner is liable under section 6621(c) for interest on the underpayment at 120 percent of the statutory rate. That section provides that additional interest will be due if a "substantial underpayment" is attributable to a "tax motivated transaction." Certain transactions are deemed to be "tax motivated" by section 6621(c)(3), including "any straddle." Sec. 6621(c)(3)(A)(iii). Petitioner's disallowed losses were attributable to straddles. Therefore, we find that this was a tax-motivated transactions, and respondent is entitled to additional interest on the interest accruing on the portion of the underpayment attributable to such transaction after December 31, 1984. See Patin v. Commissioner,88 T.C. 1086">88 T.C. 1086, 1129 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner,856 F.2d 186">856 F.2d 186 (4th Cir. 1988).600 To reflect the foregoing, Decisions will be entered under Rule 155.Footnotes1. Cases of the following petitioners are consolidated herewith for trial, briefing and opinion: Three G Trading Corp., Transferor, docket No. 5530-86, and Gary Glass and Dale Glass, docket No. 27170-86.↩2. We will refer to Three G Trading Corp.'s fiscal years by the year in which they ended. ↩3. Unless otherwise indicated, all section 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.↩4. Respondent has conceded that there is no deficiency due from Gary and Dale Glass in docket No. 27170-86.↩5. The parties use the synonymous term "spread" to refer to straddle positions. Because the relevant case law and statutes use the term "straddle," we will use that term as well. See Perlin v. Commissioner,86 T.C. 388">86 T.C. 388, 391↩ n.8 (1986). 6. For a more complete description of trading commodity futures contracts and the strategy thereof, see Smith v. Commissioner,78 T.C. 350">78 T.C. 350, 354-357 (1982). See also Perlin v. Commissioner, supra↩ at 391-394.7. None of petitioner's transactions executed on NYMEX are at issue.↩8. Each contract represented 100 ounces of gold. Prices are quoted in dollars per ounce. ↩9. This column indicates for all transactions involved herein whether the trade opened a new position or was an offset that closed a position already held.↩10. Gain or loss is the difference between the price per ounce in the opening contract and the price per ounce in the closing contract, multiplied by the number of contracts and the number of ounces per contract. All loss and gain figures also include transaction costs, which were $ 1.50 per closed position (that is, transaction costs were paid only when offsetting a position, not when opening a new position).↩11. For example, the open trade equity of the December 1981 leg was (784.00-792.20) x 200 contracts x 100 ounces per contract.↩12. In his trial memorandum, respondent states "respondent will not require petitioner to prove the * * * elements of being in a trade or business of trading commodities. Consequently, if petitioner's trades were found to be bona fide (not prearranged), the losses therefrom would be allowable as incurred in a trade or business under section 108." In his brief, respondent seeks to withdraw the concession. We are not inclined to accept such withdrawal, however, as it would put petitioner at a disadvantage, since it tried and argued the case in light of the concession. Nor are we prepared to accede to respondent's attempts to extend the parties' stipulation that petitioner "was not a dealer in commodity futures contracts" to the section 108 definition. It is clear to us that this stipulation was included only as confirmation of our holding in Three G Trading Corp. v. Commissioner,T.C. Memo. 1988-131↩, that the gains and losses involved herein were capital and not ordinary and was not intended to extend to the section 108 definition of dealer. Moreover, we note that, after the stipulation was filed, respondent's counsel stood mute when, in response to a question from the Court, petitioner's counsel stated "The Respondent has conceded section 108 if the losses are held to be bona fide."13. Petitioner's reliance on the testimony of the persons with whom he made the trade is misplaced, as neither's testimony pertained to the trades at issue herein.↩14. Petitioner makes much of the fact that COMEX authorities neither imposed nor threatened sanctions in respect of, nor threatened sanctions during, the time period up to petitioner's liquidation. We give this fact only minimal weight in determining whether the transactions involved herein were prearranged, however, because the record does not reveal whether any such actions were taken after petitioner's liquidation or by some authority other than the exchange, e.g., the Commodities Futures Trading Commission.↩15. As a result, there should be no adjustment for petitioner's related transaction costs nor any claim for higher cost for determining gain or loss from the subsequent closing of the December 1981 and April 1982 legs.↩16. The net gains for 1982 were $ 3,055,400, and we have disallowed losses of $ 3,320,000 for 1980. The impact of the concession and our decision on 1981 can be accounted for in the Rule 155 computation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623150/	APPEAL OF MAXWELL E. BESSELL.Bessell v. CommissionerDocket No. 4971.United States Board of Tax Appeals3 B.T.A. 567; 1926 BTA LEXIS 2630; February 3, 1926, Decided Submitted October 27, 1925. 1926 BTA LEXIS 2630">2630 A partner is required to return as income only the share of the partnership profits which he is entitled to receive. Edward F. Dalton, Esq., for the taxpayer. Ellis W. Manning, Esq., for the Commissioner. PHILLIPS 3 B.T.A. 567">567 Before GRAUPNER, TRAMMELL, and PHILLIPS. This is an appeal from the determination of a deficiency of $427.97 income tax for 1919, due to an increase in the amount of income alleged to have been received from the partnership of Bayne, Hine & Co. FINDINGS OF FACT. On January 1, 1918, taxpayer became a partner in the firm of Bayne, Hine & Co. Prior to that date taxpayer had been an employee of a partnership doing business under the same name and consisting of the same individuals who, with taxpayer, formed the new partnership. The capital originally invested in the preceding partnership had been impaired and it was provided in the partnership agreement that, except for salaries, no profits should be distributed until this impairment of the capital of the other partners had been replaced. Taxpayer had no interest in such capital. It was further agreed 3 B.T.A. 567">568 that, after payment of salaries and the restoration1926 BTA LEXIS 2630">2631 of the capital investment of the other partners, taxpayer should receive 10 per cent of the profits. During 1918 and 1919, taxpayer withdrew his salary, but the partnership profits were all used to restore the capital of the other partners, and no part thereof was paid or credited to taxpayer. Taxpayer's membership in the firm ceased on December 31, 1919, and he never received from the firm any profits other than such salary. No part of the partnership assets was contributed by the taxpayer. In his 1919 income-tax return, taxpayer returned the salary as income. Upon an audit of the return, the Commissioner increased this income by 10 per cent of the profits of the partnership, after deducting salaries. DECISION. The deficiency determined by the Commissioner is disallowed. OPINION. PHILLIPS: It is apparent from the findings of fact that the Commissioner has charged taxpayer with income which is properly chargeable to the other members of the partnership. The senior members of the partnership had originally contributed capital in the business which had been impaired during the continuance of the previous partnership. One of the conditions of the new partnership1926 BTA LEXIS 2630">*2632 was that all profits in excess of salaries should be credited to such senior partners until the original capital invested was restored, and this disposition was made of the profits for 1919.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623151/	CONCORD & PORTSMOUTH RAILROAD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Concord & P. Railroad v. CommissionerDocket No. 8848.United States Board of Tax Appeals8 B.T.A. 505; 1927 BTA LEXIS 2868; October 4, 1927, Promulgated 1927 BTA LEXIS 2868">2868 Many years prior to the taxable year petitioner leased its railroad and property for a term of years, the lessee agreeing to pay all Federal income taxes imposed upon the lessor with reference to the rental. The lessee paid the Federal tax upon the net income returned by petitioner for each year subsequent to the lease. Held, the amount of tax so paid constitutes additional income to the petitioner for the year in which such tax became due and was paid. J.S.Y. Ivins, Esq., and O. R. Folsom-Jones, Esq., for the petitioner. M. N. Fisher, Esq., and P. J. Rose, Esq., for the respondent. LITTLETON8 B.T.A. 505">505 The Commissioner determined a deficiency in income and profits tax for the calendar year 1919 in the amount of $288.39. The issue involved is whether the payment, under the terms of a lease, of the lessor's income tax by the lessee constitutes additional income to the lessor. FINDINGS OF FACT. During the taxable year petitioner was a New Hampshire corporation with principal office at Manchester. It was the owner of a railroad which it had leased to the Boston & Maine Railroad under a lease which provided, inter alia, that1927 BTA LEXIS 2868">2869 the lessee would pay the Federal income tax of the lessor. The income tax of the lessor for each year was payable and was paid by the lessee in the following year. The Commissioner computed a Federal income tax of $2,283.95 on the petitioner's income of $24,839.46 for the year 1919, as revised by him, and added the said amount of $2,283.95 to petitioner's income for the year 1919, and computed an additional tax constituting the deficiency involved herein. The income-tax return of petitioner for the calendar year 1918 showed a tax liability of $2,765.77, computed upon the income of the petitioner for that year without the inclusion therein of any amount on account of the tax paid by petitioner's lessee. This tax of $2,765.77 was paid by petitioner's lessee during the calendar year 1919. Petitioner kept its books and rendered its returns upon an accrual basis. OPINION. LITTLETON: In , the Board held that the amount of tax upon the 8 B.T.A. 505">506 income of the lessor and paid by the lessee, under the terms of a lease such as we have here, constituted additional taxable income to such lessor in the1927 BTA LEXIS 2868">*2870 year in which such tax was paid by the lessee. On the authority of that decision petitioner's tax for 1919 should be recomputed by including therein the amount of $2,765.77, representing the tax upon petitioner's income for 1918 and paid by the lessee in 1919. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623152/	LOUISVILLE VENEER MILLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Louisville Veneer Mills v. CommissionerDocket No. 10180.United States Board of Tax Appeals12 B.T.A. 1352; 1928 BTA LEXIS 3352; July 16, 1928, Promulgated 1928 BTA LEXIS 3352">3352 The statute of limitations prescribed by the Revenue Act of 1921 is applicable to a return filed for the fiscal year ending in 1921, although filed prior to the passage of the 1921 Act, where the taxpayer is subjected to no additional tax under the provisions of that Act for such fiscal year. R. S. McGlassen, C.P.A., for the petitioner. Harry LeRoy Jones, Esq., for the respondent. VAN FOSSAN 12 B.T.A. 1352">1352 This is a proceeding for the redetermination of the income taxes for the fiscal year ended June 30, 1921, as to which the Commissioner has determined a deficiency of $489.30. It is alleged that the deficiency is barred by the statute of limitations. All of the material allegations of fact contained in the petition are admitted by the answer and the case is submitted upon the pleadings and argument of the parties. At the hearing the Commissioner moved that the appeal be dismissed on the ground that the facts as alleged and admitted are insufficient to sustain the error alleged. FINDINGS OF FACT. The petitioner is a Kentucky corporation, having its principal office at Louisville, Ky.On September 14, 1921, petitioner filed with the collector1928 BTA LEXIS 3352">3353 of internal revenue its income and profits-tax return, on Form 1120, for the fiscal year ending June 30, 1921, showing a net income subject to normal tax of $23,822.17. No other or additional income-tax return for the fiscal year ending June 30, 1921, was filed by the petitioner. On November 25, 1925, the respondent mailed to the petitioner the 60-day notice of a deficiency in income tax for the fiscal year ending June 30, 1921, in the sum of $489.30. No assessment of any deficiency for said fiscal year has been made. No part of said deficiency is due to any differences between the Revenue Act of 1921 and the Revenue Act of 1918. The Revenue Act of 1921 imposed no additional tax upon the petitioner for the fiscal year ending June 30, 1921. OPINION. VAN FOSSAN: The only question presented in this case is whether the statute of limitations prescribed by the Revenue Act of 1918 or the statute of limitations prescribed by the Revenue Act of 1921 controls the assessment and collection of the deficiency. The Revenue 12 B.T.A. 1352">1353 Act of 1921 was passed November 23, 1921, and the return in this case was filed September 14, 1921. It is contended by the respondent that, since the1928 BTA LEXIS 3352">*3354 return was filed prior to the passage of the 1921 Act, it could not be a return under that Act and consequently it must necessarily be a return under the 1918 Act and controlled by the statute of limitations prescribed in the latter Act. The Board has already considered this question in a number of cases and decided the same adversely to the contention of the respondent. ; ; ; ; and . Under the authority of those cases we hold that the statute of limitations prescribed by the Revenue Act of 1921 is applicable to the return filed by this petitioner for the fiscal year ending June 30, 1921, and, since the deficiency letter was mailed more than four years after the filing of the return, that the assessment and collection of the deficiency is barred. Accordingly, there is no deficiency. The motion of the respondent made at the hearing is denied. Judgment of no deficiency will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623120/	Floyd W. Estes v. Commissioner. Mame Estes v. Commissioner. Harry E. Leadley v. Commissioner.Floyd W. Estes v. CommissionerDocket Nos. 7560, 7561, 7562.United States Tax Court1947 Tax Ct. Memo LEXIS 242; 6 T.C.M. 401; T.C.M. (RIA) 47099; April 21, 19471947 Tax Ct. Memo LEXIS 242">242 Thomas J. Bailey, Esq., and M. D. Harris, C.P.A., 1102 Olds Tower Bldg., Lansing, Mich., for the petitioners. Clarence E. Price, Esq., for the respondent. MURDOCKMemorandum Findings of Fact and Opinion The Commissioner determined deficiencies in income tax for the calendar year 1941, as follows: Floyd W. Estes$6,091.29Mame Estes6,388.48Harry E. Leadley953.92 The only issue for decision is whether the Commissioner erred in holding that a corporation distributed among its assets in liquidation valuable good will, thus increasing the reported gain of the stockholders upon the disposition of their shares through cancellation. Findings of Fact Floyd W. and Mame Estes are husband and wife. They and Harry E. Leadley each filed separate individual income tax returns for 1941 with the collector of internal revenue for the district of Michigan. Estes came to Lansing about 1914, at which time he and his wife purchased a one-half interest in the Elmer L. Jarvis Company, Inc., a corporation carrying on a retail furniture and undertaking business in Lansing. The name of the corporation was changed shortly thereafter to Jarvis-Estes Company. A1947 Tax Ct. Memo LEXIS 242">243 funeral home was erected in the center of the city in 1923. The activities of the corporation were confined to the undertaking business after April 24, 1929. Leadley purchased a small interest in the business in 1929 and became assistant manager. The Estates purchased the entire 47 1/2 per cent interest which the Jarvises owned in the company. That purchase was made on July 30, 1930. The purchase price was $89,774.26, of which $9,000 was paid for "Good-will of Jarvis-Estes Company." It was recited in the agreement that the sale covered the good will of the Jarvis-Estes Company. The Jarvises agreed not to engage in the funeral business in or near Lansing for a period of 15 years, and the contract provided in case they violated their agreement in this respect "that in addition to any other rights or remedies which second parties [Estes] may have, that the said first parties [Jarvises] will pay to the second parties as liquidated damages for the breach of said agreement, as to the funeral business, the sum of Nine thousand ($9,000.00) dollars, * * * and that such amount may be deducted from the consideration herein provided for." Jarvis had not actively participated in the undertaking1947 Tax Ct. Memo LEXIS 242">244 business since 1914. The name of the corporation was changed after the aforesaid sale to Estes-Leadley Company. Any person desiring the services of the Estes-Leadley Company usually initiated business by calling the funeral home on the telephone. A representative of the company then called upon the family of the deceased. The call, in about 60 per cent of the cases, was made by either Estes or Leadley, but in all instances they eventually met the family and participated in making the arrangements for the funeral, including the arrangement for a minister, pall bearers, and interment. The service sometimes included assistance in the selection of a cemetery lot. Estes and Leadley took a prominent part in conducting the funerals handled by the corporation. Neither did any embalming. That work was done by other employees who were licensed embalmers. Estes had taken a three-month course in embalming and had worked with funeral directors for about a year before he went into business for himself in 1910. He has been in Lansing since 1914. He was County Coroner there from 1916 to 1924. He has been president and a member of the board of the Y.M.C.A., president of the Rotary Club, a Mason, 1947 Tax Ct. Memo LEXIS 242">245 chairman of a county commission for crippled children, president of the National Society of Selected Morticians, president of the Michigan Funeral Directors and Embalmers Association, and a member of the legislative committee of that association which helped codify the laws of Michigan pertaining to funeral directors. He was personally acquainted with about 60 per cent of the people who employed the company during the years 1937 to 1941: About 51 per cent of the customers had been served previously by the company. Leadley attended Detroit Business University, took a course in embalming lasting 18 months, and served a one-year apprenticeship as an embalmer. He was formerly a conductor on an interurban transportation line, but since 1923 has been engaged continuously in the undertaking business. He was County Coroner for 16 years. He is a Mason and a member of the Kiwanis Club, the Y.M.C.A., Eastern Star, and the Chamber of Commerce. Estes received a salary of $15,000 and Leadley one of $7,000 during the years 1937 to 1941. The company owned ambulances, hearses, limousines, and a modern funeral home. It conducted funerals at this funeral home and also from residences, churches, 1947 Tax Ct. Memo LEXIS 242">246 and fraternal halls. It had 12 or 13 regular employees in 1941. It spent about 5 per cent of its gross income for advertising during the period from 1937 to 1941. It paid dividends on its stock in almost every year, but the record does not disclose the amount thereof. It did about 41 per cent of the funeral directing business in Lansing, although there were about 5 or 6 competing firms in the city. The Estes-Leadley Corporation was liquidated on December 31, 1941, at which time its assets, subject to its liabilities, were transferred to its stockholders in cancellation of their stock. The Estes owned 90 per cent of the stock at that time and Leadley owned 10 per cent. The net book value of the assets transferred in the liquidation was $157,297.65. Each stockholder reported his prorated share thereof as the amount realized on his stock in computing his capital gains for 1941. The [] stockholders immediately assigned the assets, thus received, to a partnership having the same name, which they had formed to continue in the undertaking business. The Commissioner, in determining the deficiencies, added $78,729.48 as good will to the book value of $157,297.65 and increased the long-term1947 Tax Ct. Memo LEXIS 242">247 capital gain of each petitioner accordingly. He established the value of good will as follows: DateSurplusStockTotalYearEarnings1-1-37$113,497.15$15,000.00$128,497.151937$ 20,421.501-1-38117,202.3515,000.00132,202.35193826,426.301-1-39131,455.4015,000.00146,455.40193915,732.281-1-40133,148.0715,000.00148,148.07194026,151.881-1-41137,172.4315,000.00152,172.43194126,913.21Total$632,475.40$75,000.00$707,475.40$115,645.17Average Investment141,495.08AverageEarnings23,129.03Fair rate8%of return11,319.61Fair rate of return on tangible assets$ 11,319.61Excess$11,809.42Excess earnings of $11,809.42 capitalized at 15%78,729.47The stipulation of facts is incorporated herein by this reference. Opinion MURDOCK, Judge: The petitioners contend that the customers of the Estes-Leadley Company were obtained solely by reason of the skill and personal attributes of Estes and Leadley and absolutely no good will attached to the business, as distinguished from those two individuals. The Commissioner maintains that the substantial1947 Tax Ct. Memo LEXIS 242">248 earnings of the corporation, in excess of a reasonable return on the capital invested in the business, are attributable to good will possessed by the corporation. So much of the success of the business as is attributable solely to the personal abilities, attributes, or acquaintanceship of the two men should not be considered in computing the value of any good will which may attach to the business and which could be transferred as a part of its assets. Providence Mill Supply Co., 2 B.T.A. 791">2 B.T.A. 791; D. K. MacDonald, 3 T.C. 720">3 T.C. 720; Howard B. Lawton, 6 T.C. 1093">6 T.C. 1093. Any competitive preference or advantage which attaches to a particular business may be described as good will. A satisfactory definition is elusive. A name, a location, a group of satisfied customers or other elements of a going business may contribute to the good will of that business. Estes and Leadley have testified and they have introduced some other evidence to show that a part, and allegedly a large part, of the success of the business was due to the personal abilities and attributes of the two men. That evidence has not been disbelieved but, on the contrary, has been given due consideration. 1947 Tax Ct. Memo LEXIS 242">249 It seems clear that the wide acquaintanceship of these two men in the community and their recognized ability to conduct funerals properly has drawn customers to the business. But the evidence as a whole fails to convince the Court that no good will attached to the business itself. It seems reasonable to believe that another funeral director, contemplating a purchase of the business, would have been justified in paying something over and above the value of the physical assets. The Commissioner has determined that the corporation had good will which it distributed to the stockholders along with the other assets and which they continued to use as partners in the same line of business. The evidence shows how he computed that value after allowing substantial deductions for the salaries of the two individuals. He concluded that the earnings of the business for a representative period, to the extent that they exceeded a reasonable return on the capital invested, were attributable to intangibles or good will possessed by the corporation. There were earnings of that kind, and the Court is not satisfied that the personal services of the two individuals were not adequately recognized in the1947 Tax Ct. Memo LEXIS 242">250 computation. The two Estes in 1930 paid to Jarvis a substantial amount for good will of the undertaking business. The amount which they paid him for his stock in 1930 was substantially more than the book value of a like portion of the stock in 1941, when the corporation was liquidated, although the business was apparently increasing and becoming more valuable during the intervening period. This would also tend to show that they paid Jarvis for good will and that there was good will in 1941. The conclusion has been reached, after considering all of the evidence in the record, that the business, as distinguished from the individuals, possessed some good will at the time of the liquidation. That disposes of the only issue in the case because the petitioners do not challenge the method used by the Commissioner to value the good will. They are not contending that there was good will of lesser value than the value determined by the Commissioner and the record does not afford a proper basis for the determination of any other value. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623121/	SYLVIA L. BECKEY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBeckey v. CommissionerDocket No. 23249-92United States Tax CourtT.C. Memo 1994-514; 1994 Tax Ct. Memo LEXIS 522; 68 T.C.M. 945; October 17, 1994, Filed 1994 Tax Ct. Memo LEXIS 522">522 Decision will be entered under Rule 155. Sylvia L. Beckey, pro se. For Respondent: Gerald L. Brantley COUVILLIONCOUVILLIONMEMORANDUM OPINION COUVILLION, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) 1 and Rules 180, 181, and 182. Respondent determined a deficiency of $ 6,305 in petitioner's Federal income tax for 1989. The issues for decision are: (1) Whether certain payments received by petitioner are excludable from income under section 104(a)(2) as damages received on account of personal injuries, and (2) whether petitioner is entitled to deductions under section 162(a) for unreimbursed employee business expenses. Some of the facts were stipulated and are found accordingly. The stipulation and attached exhibits are incorporated herein by reference. Petitioner resided at Austin, Texas, 1994 Tax Ct. Memo LEXIS 522">523 at the time her petition was filed. Petitioner has a juris doctor degree in law, a master's degree in law, and a master's degree from Johns Hopkins School of Advanced International Studies. In November 1986, petitioner was employed as a trial attorney by an agency (the agency) of the United States at New York, New York. Sometime in 1987, petitioner became embroiled in a dispute with her employer. Petitioner filed a labor grievance and reserved her rights for a claim with the agency's Equal Employment Opportunity (EEO) office. Although petitioner never commenced an EEO claim, she did pursue her labor grievance with her employer to protect her job. In late July 1989, petitioner attempted to file a Jane Doe 2 tort suit with the New York Supreme Court against her employer. The Supreme Court, however, would not accept that type of suit, without the proper names of the parties. Petitioner never filed an amended complaint. 1994 Tax Ct. Memo LEXIS 522">524 At some point, petitioner hired a Washington, D.C., attorney to represent her against her employer. With the assistance of her attorney, Ms. Lyons, and an attorney associated with Ms. Lyons, petitioner negotiated a settlement agreement 3 with her employer, which was signed by petitioner on August 21, 1989. During the negotiations, neither petitioner nor her attorney considered or discussed the tax consequences of the agreement. Moreover, the tax consequences of the agreement are not addressed in the document. Petitioner and the agency agreed that petitioner resigned her position with the agency effective Friday, August 18, 1989, in consideration of the conditions provided in the agreement. In accordance with the agreement, petitioner was reemployed by the agency for a period not to exceed 6 months, effective1994 Tax Ct. Memo LEXIS 522">525 August 21, 1989, and ending February 21, 1990. Petitioner was reemployed as a temporary employee without loss of salary, health insurance, or pension benefits and had the same obligations imposed on her as an agency employee. Petitioner agreed that, during the period of temporary employment, she would prepare a written report to the agency's general counsel concerning the treatment of foreign judgments by United States courts. In preparing the report, petitioner was to use only library resources and only those located outside the agency offices. If petitioner needed office supplies in connection with her research, the agency would reimburse her for such costs, up to $ 100. Petitioner agreed that the report, "like the research papers that any other employee" prepared, was the sole property of the agency and could not be published or submitted for publication by petitioner. The agency agreed that, during petitioner's period of temporary employment, petitioner could seek outside employment, but could do so only if she obtained the approval of the director of personnel of the agency. Also, any outside employment could not interfere with petitioner's obligation to prepare the 1994 Tax Ct. Memo LEXIS 522">526 report for the agency general counsel. 4The agency further agreed to expunge from petitioner's personnel file her 1987-1988 performance appraisal rating and replace it with a "presumed fully successful" rating; that petitioner would be given the same "presumed fully successful" rating on her 1988-1989 performance appraisal; that the agency would refrain from including in petitioner's personnel file a narrative description of her performance for the years in question; and that the agency would refer all questions concerning her work to the director of personnel. Additionally, the agency agreed that petitioner would receive, like other departing agency employees, a certificate recognizing the time she spent with the agency. Such a certificate was presented to petitioner, and it bears the date of August 18, 1989. Petitioner and the agency agreed that the existence or terms of1994 Tax Ct. Memo LEXIS 522">527 the agreement were confidential. If petitioner violated the nondisclosure provisions, the agency could terminate her temporary employment and the payment of salary or benefits. Petitioner and the agency agreed that the actions being taken pursuant to the agreement were for the purpose of settlement, and that no action agreed to in the agreement constituted a finding, implication, or admission of wrongdoing, tort, or discrimination, or violation of any rule, regulation, law, or executive order, on the part of the agency, any official, employee, or former employee of the agency, or by petitioner. Petitioner and the agency agreed that, if any provision of the agreement was found to be invalid by a court of competent jurisdiction, the agency was not bound to continue petitioner's temporary employment and the payment of salary or benefits. Petitioner and the agency agreed that the terms of the agreement constituted a complete and final resolution of any and all pending differences, disputes, or grievances relating to or arising out of her employment, separation from, and period of temporary employment with, the agency. Petitioner and the agency further agreed that, if petitioner attempted1994 Tax Ct. Memo LEXIS 522">528 to file any claim against the agency, the agency could terminate petitioner's temporary employment and the payment of salary or other benefits. During the 6-month period of petitioner's temporary employment, she completed the research project according to the terms of the agreement. The research project included 100 pages of discussion and an appendix with a 50-page, 50-State study with charts. During the 6-month period, petitioner was paid her salary at the end of each pay period. For the period from August 21, 1989, to December 31, 1989, petitioner received $ 22,224. With each payment, petitioner received a pay stub listing the income as "taxable earnings". The agency withheld amounts for FICA, retirement, and health and life insurance. Additionally, during this period, petitioner earned annual and sick leave. Finally, the agency set aside retirement benefits for petitioner. For petitioner's 1989 taxable year, the year at issue, the agency issued an Internal Revenue Service (IRS) Form W-2, Wage and Tax Statement, reflecting "Wages, tips, other compensation" of $ 57,083.20, "Federal income tax withheld" of $ 4,055.90, "Social security tax withheld" of $ 3,604.81, and "Social1994 Tax Ct. Memo LEXIS 522">529 security wages" of $ 48,000. On her 1989 Federal income tax return, petitioner deducted $ 22,224 from her gross income, claiming the amount received pursuant to the agreement was nontaxable under section 104(a)(2). Petitioner also deducted $ 34,688.13 as Schedule A itemized deductions for unreimbursed employee expenses. In the notice of deficiency, respondent determined that the $ 22,224 was not excludable from gross income and also disallowed portions of the Schedule A itemized deductions claimed by petitioner. The determinations by respondent in a notice of deficiency are presumed correct, and the burden is on the taxpayer to prove that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Regarding the first issue, whether the $ 22,224 is includable in gross income, section 61 provides that gross income includes "all income from whatever source derived". Section 104(a)(2), however, provides that gross income does not include the "amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness". The term "damages received" 1994 Tax Ct. Memo LEXIS 522">530 on account of personal injuries or sickness means an amount received through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of prosecution. United States v. Burke, 504 U.S. , 112 S.Ct. 1867, 1870 (1992); Horton v. Commissioner, 100 T.C. 93">100 T.C. 93, 100 T.C. 93">97 (1993), affd. F.3d (6th Cir. 1994); sec. 1.104-1(c), Income Tax Regs. Section 104(a)(2), however, does not exclude damages received on account of the prosecution or settlement of economic rights arising out of a contract. Metzger v. Commissioner, 88 T.C. 834">88 T.C. 834, 88 T.C. 834">848-850, 88 T.C. 834">858 (1987), affd. without opinion 845 F.2d 1013">845 F.2d 1013 (3d Cir. 1988). Where there is a settlement agreement, the Court looks to the nature of the claim underlying the payment to the taxpayer, rather than the validity of the claim, to determine whether payments are on account of a tortlike personal injury. United States v. Burke, 504 U.S. at , 112 S. Ct. at 1872. Such a determination is factual and is generally made by reference to the settlement1994 Tax Ct. Memo LEXIS 522">531 agreement. Stocks v. Commissioner, 98 T.C. 1">98 T.C. 1, 98 T.C. 1">10-11 (1992). If the settlement agreement lacks express language stating that the payment is made on account of personal injuries, then the most important factor in determining an exclusion under section 104(a)(2) is the "intent of the payor" in making the settlement. Knuckles v. Commissioner, 349 F.2d 610">349 F.2d 610, 349 F.2d 610">613 (10th Cir. 1965), affg. T.C. Memo 1964-33; 98 T.C. 1">Stocks v. Commissioner, supra at 10. The settlement agreement between petitioner and the agency contains no express language that the payment in question was or was not made on account of a personal injury. However, the language in the agreement clearly indicates the agreement was one in contract, obligating the agency to temporarily employ petitioner, and that the agency intended the agreement to be such. The agreement gives every indication that the parties were creating or, more specifically, continuing an employer-employee relationship. The agency's intent that the payments were compensation for temporary employment and not for personal injuries is evidenced1994 Tax Ct. Memo LEXIS 522">532 by the fact that the agency agreed to pay petitioner under the same terms as when she was permanently employed with the agency. The agency also continued petitioner's health insurance and continued to contribute to petitioner's retirement and pension benefits. The agency further issued pay stubs that specifically stated the amounts were "taxable earnings" and withheld FICA taxes from the amounts paid. Additionally, the agency issued an IRS Form W-2, Wage and Tax Statement, to petitioner. Several of the promises made by the agency, and for which petitioner bargained, were related to assurances by the agency that the agency would not impair petitioner's ability to effectively secure future employment. In particular, the agency agreed to expunge from petitioner's personnel file her 1987-1988 performance appraisal rating and replace it with a "presumed fully successful rating", to give petitioner the same "presumed fully successful" rating on her 1988-1989 performance appraisal, to refrain from including in her personnel file a narrative description of her performance for the years in question, to refer all questions concerning her work to the director of personnel, and to give her1994 Tax Ct. Memo LEXIS 522">533 a certificate of recognition. These promises were not intended to compensate petitioner for personal injuries, but instead to benefit petitioner's ability to successfully secure future employment. The agency's intent is further evidenced by the fact that the agency was entitled to all rights to the research paper that the petitioner was required to prepare, "like the research papers any other employee prepares" for the agency. (Emphasis added.) In the event of breach of the agreement by petitioner, the remedy available to the agency was the termination of petitioner's temporary employment and cessation of salary and benefits. Finally, if the agreement was declared invalid by a court of competent jurisdiction, the agency was not bound to continue petitioner's temporary employment. At trial, petitioner insisted that her status as an employee was essentially "fictitious", and that her obligation to prepare the research paper was "not a material element of the contract". Petitioner further asserted that the agreement was signed under "duress ", and that the agency was making "threats" of criminal prosecution. However, petitioner failed to present sufficient evidence to corroborate1994 Tax Ct. Memo LEXIS 522">534 these self-serving statements. Petitioner failed to subpoena or call as witnesses anyone who could have established her claim, such as her attorney, Ms. Lyons, or her attorney's assistant who helped negotiate the agreement. Petitioner introduced into evidence various receipts and notes from several doctors but failed to call any medical experts who could establish either physical or mental injury petitioner may have suffered as a result of her employment or from the negotiation of the settlement. In contrast to petitioner's testimony, the agreement, which petitioner signed, states that "no promise, threat, or offer of any kind, except as reflected in this document, has been extended by either party in order to obtain this agreement." (Emphasis added.) Petitioner also asserts that the fact that her certificate of recognition was dated August 18, 1989, indicates that the agency no longer considered her an employee after that date. The Court does not find this controlling. The agreement speaks for itself and is the best indicator of the agency's intent. Petitioner is an attorney, with two law degrees and a master's degree from Johns Hopkins School of Advanced International1994 Tax Ct. Memo LEXIS 522">535 Studies. She was assisted by other attorneys in the negotiation of the agreement. Petitioner should have realized that the agreement was one in contract, establishing an employment relationship, and was not for personal injuries. Indeed, petitioner and the agency agreed that no action agreed to in the agreement would "constitute a finding, implication, or admission of wrongdoing, tort". (Emphasis added.) Petitioner acknowledged that neither she nor her attorney considered or discussed the tax consequences of the agreement. Petitioner has not sustained her burden of proof on this issue. The payments to petitioner pursuant to the agreement are not excluded under section 104(a)(2) and, therefore, must be included in income. Respondent is sustained on this issue. With respect to the second issue, petitioner claimed on her 1989 income tax return, on Schedule A, Itemized Deductions, unreimbursed employee business expenses totaling $ 34,688.13. She attached to her return a schedule captioned "1989 Professional Related Expenses" itemizing these expenses. In the notice of deficiency, respondent disallowed some of the expenses claimed. Expenses incurred by an employee that are1994 Tax Ct. Memo LEXIS 522">536 not reimbursed by the employer are generally deductible under section 162(a), which allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.5Primuth v. Commissioner, 54 T.C. 374">54 T.C. 374, 54 T.C. 374">377 (1970). To qualify for the deduction, an expense must be both "ordinary" and "necessary" within the meaning of section 162(a). Deputy v. duPont, 308 U.S. 488">308 U.S. 488, 308 U.S. 488">495 (1940). Whether the amount disallowed by respondent constitutes an ordinary and necessary expense incurred in the taxpayer's trade or business as an employee is a question of fact to be determined from the evidence presented with the burden being on the taxpayer to overcome the presumed correctness of respondent's determination. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Allen v. Commissioner, T.C. Memo. 1988-166. 1994 Tax Ct. Memo LEXIS 522">537 Of the $ 34,688.13 claimed by petitioner as unreimbursed employee business expenses, the following table shows those expenses which were claimed by petitioner on her return, the amounts which were allowed by respondent in the notice of deficiency, and the amounts which were disallowed: ItemClaimed on Allowed byAmountReturn RespondentDisallowedStorage expenses$ 2,069.16 $ 2,010.03$ 59 Utilities & telephone1,814.34-- 1,814Postage & faxing cost874.19-- 874New office expenses2,461.491,705.07756Interview/job search3,502.92-- 3,503Home office1,866.00-- 1,866Travel3,266.73-- 3,267Interest on loans9,866.50-- 9,867Insurance251.00251.00-- Out of town expenses2,230.002,230.00-- Totals $ 28,202.33 * $ 6,196.10 * $ 22,006* The total for these two columns is $ 28,202.10. Thedifference of $ .23 from the amount claimed on the return isapparently accounted for by respondent's rounding off in theamounts disallowed. The $ 22,006 disallowed is prior toapplication of the 2 percent floor under sec. 67(a).Deductions are a matter of legislative grace, and taxpayers are1994 Tax Ct. Memo LEXIS 522">538 required to, among other requisites, support their claims. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). A taxpayer is required to maintain records sufficient to establish the amount of his or her income and deductions. Sec. 6001. Under certain circumstances, where a taxpayer establishes entitlement to a deduction but does not establish the amount of the deduction, the Court is permitted to estimate the amount allowable. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930). There must be sufficient evidence in the record to permit the Court to conclude that a deductible expense was incurred in at least the amount allowed. Williams v. United States, 245 F.2d 559">245 F.2d 559, 245 F.2d 559">560 (5th Cir. 1957). In estimating the amount allowable, the Court bears heavily against the taxpayer whose inexactitude is of his or her own making. 39 F.2d 540">Cohan v. Commissioner, supra at 544. With respect to the individual items at issue, respondent, on brief, conceded the $ 59 disallowed for storage expenses. Respondent disallowed the entire $ 1,814.34 claimed by petitioner for utilities1994 Tax Ct. Memo LEXIS 522">539 and telephone on the ground that a portion of the expenses had not been substantiated and the expenses, if incurred, were personal and, therefore, not deductible under section 262. The Court is satisfied from the record that petitioner incurred some telephone expenses that are allowable as an employee business expense and, pursuant to 39 F.2d 540">Cohan v. Commissioner, supra, concludes that petitioner is entitled to a deduction of $ 248 for telephone expenses. The disallowed utility expenses relate to the apartment where petitioner resided. Petitioner contends that the deductions should be allowed as deductible home office expenses. Respondent determined that petitioner was not entitled to a home office deduction, and, therefore, the utility expenses were disallowed. Regardless of whether petitioner was entitled to a home office deduction, which is discussed below, petitioner presented no evidence to substantiate her claimed utilities expenses. In sum, of the $ 1,814.34 claimed by petitioner for utilities and telephone, petitioner is entitled to a $ 248 deduction for telephone expenses. Petitioner claimed a deduction for postage and fax expenses of $ 1994 Tax Ct. Memo LEXIS 522">540 874.19. Respondent disallowed the entire amount for lack of substantiation. At trial, petitioner introduced canceled checks and receipts stapled to an audit worksheet with the notation: "job hunting, labor grievances, related corresp. to DC and NY attorneys, and other professional related correspondence". Again, based on the record and 39 F.2d 540">Cohan v. Commissioner, supra, the Court is satisfied that petitioner is entitled to the full deduction claimed on her return for postage and fax expenses of $ 874.19. Petitioner claimed new office expenses of $ 2,461.49. Respondent allowed $ 1,705.07 of these expenses. Based on petitioner's testimony and evidence introduced at trial to substantiate an additional office expense of $ 756, respondent, on brief, conceded that adjustment. Petitioner claimed a deduction of $ 3,502.92 for interview and job search expenses. From petitioner's testimony and the evidence at trial, these expenses were incurred for clothing, dry cleaning, and fixing petitioner's hair. The expense of uniforms is deductible under section 162(a) if: (1) The uniforms are of a type specifically required as a condition of employment; (2) the 1994 Tax Ct. Memo LEXIS 522">541 uniforms are not adaptable to general usage as ordinary clothing; and (3) the uniforms are not so worn. Yeomans v. Commissioner, 30 T.C. 757">30 T.C. 757, 30 T.C. 757">767-769 (1958). It is clear from petitioner's testimony that the clothing claimed as expenses was adaptable to general use. Therefore, her clothing expenses are not deductible. The remaining expenses for dry cleaning and fixing petitioner's hair constitute personal expenses and are not deductible under section 262. Respondent is sustained with respect to these expenses. Petitioner deducted $ 1,866 home office expenses, of which respondent disallowed the entire amount. Generally, section 280A provides that no deduction otherwise allowable shall be allowed with respect to the use of a dwelling unit that is used by the taxpayer during the taxable years as a residence. Section 280A(c), however, provides an exception if a residence is used for business under certain conditions. These conditions are: (1) The business use must be the exclusive use of the office and be on a regular basis. (2) The home office must be used: (A) as the principal place of business for any trade or business of the taxpayer; (B) 1994 Tax Ct. Memo LEXIS 522">542 as a place of business used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business; or (C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business. (3) In the case of a taxpayer who is an employee, the use must be for the convenience of the employer. All three requirements must be met in order for a deduction to be allowable. Petitioner testified at trial that she used her living room as an office for preparing her tax return and her labor grievance and for her job search. These uses are not uses that come within the exception of section 280A(c). The Court sustains respondent on this item. Petitioner deducted travel expenses of $ 3,266.73, all of which was disallowed by respondent. The deduction for travel expenses away from home, including meals and lodging, under sec. 162(a)(2), is conditioned on such expenses being substantiated by "adequate records" or by sufficient evidence corroborating the claimed expenses pursuant to section 274(d). Sec. 1.274-5(a)(1), Income Tax Regs. To meet the adequate records requirements of section 274(d), 1994 Tax Ct. Memo LEXIS 522">543 a taxpayer "shall maintain an account book, diary, statement of expense or similar record * * * and documentary evidence * * * which, in combination, are sufficient to establish each element of an expenditure". Section 1.274-5(c)(2)(i), Income Tax Regs. (Emphasis added.) The elements to be proven with respect to each traveling expense are the amount, time, place, and business purpose of the travel. Sec. 1.274-5(b)(2), Income Tax Regs. The substantiation requirements of section 274(d) are designed to encourage taxpayers to maintain records, together with documentary evidence substantiating each element of the expense sought to be deducted. Sec. 1.274-5(c)(1), Income Tax Regs.Petitioner claimed travel expenses with respect to 13 business trips. However, at trial, petitioner testified that some of these trips involved nonbusiness purposes as visiting a cousin in France, going to a class reunion, and going to a funeral. Petitioner introduced into evidence audit worksheets with accompanying receipts with respect to several of these claimed expenses. The records are insufficient to satisfy the stringent substantiation requirements of section 274(d). In the case of travel1994 Tax Ct. Memo LEXIS 522">544 expenses, specifically including meals and lodging while away from home, as well as in the case of entertainment, section 274(d) overrides the so-called Cohan doctrine. Sanford v. Commissioner, 50 T.C. 823">50 T.C. 823, 50 T.C. 823">827 (1968), affd. per curiam 412 F.2d 201">412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Therefore, the Court is unable to use its discretion in allowing any of the travel expenses deducted by petitioner. Respondent is sustained with respect to the deductibility of petitioner's travel expenses. Finally, petitioner deducted interest of $ 9,866.50 as an unreimbursed employee business expense on Schedule A. Respondent determined that the interest was not deductible as an employee business expense but was instead personal interest. For 1989, personal interest is deductible only to the extent of 20 percent of the interest. Sec. 163(h). During the audit of petitioner's return, respondent determined that petitioner substantiated interest expenses of $ 11,492, which is more than the amount she claimed on Schedule A of her return but redetermined the interest1994 Tax Ct. Memo LEXIS 522">545 as personal interest. Applying the 20-percent limitation to this amount, respondent allowed petitioner a deduction for personal interest of $ 2,298.39. Petitioner did not present sufficient evidence at trial to overcome respondent's presumption of correctness. Respondent, therefore, is sustained on this issue. Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner attempted to file suit with Jane Doe as the captioned plaintiff and herself as the attorney for plaintiff.↩3. The settlement agreement was confidentially drafted and for purposes of settlement only. The Court record for this case has, therefore, been sealed in order to protect the privacy interests of both parties.↩4. Petitioner did, in fact, secure employment with a New York law firm, commencing work on Aug. 21, 1989, the day the agreement was signed.↩5. For tax years beginning on or after Jan. 1, 1987, as in this case, miscellaneous itemized deductions, including unreimbursed employee expenses, are deductible, under sec. 67(a), only to the extent that the aggregate miscellaneous itemized deductions exceed 2 percent of the taxpayer's adjusted gross income. Tax Reform Act of 1986, Pub.L. 99-514, 100 Stat. 2085.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623122/	JESSIE G. SHEEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sheen v. CommissionerDocket No. 543.United States Board of Tax Appeals6 B.T.A. 114; 1927 BTA LEXIS 3592; February 10, 1927, Promulgated 1927 BTA LEXIS 3592">3592 Petitioner is entitled to a deduction for an amount paid to agents in the sale of real estate. Morey Dunn, Esq., for the petitioner. A. R. Marrs, Esq., for the respondent. KORNER6 B.T.A. 114">114 Proceeding for the redetermination of a deficiency in income tax for the year 1919 in the amount of $727.26. 6 B.T.A. 114">115 Petitioner was formerly Mrs. Jessie G. Sheen, widow, and notice of the determination of the deficiency here in controversy was mailed to her under that name. She has since remarried and is now Mrs. Jessie G. Sheen-Westberry. Her former husband, Franklin Sheen, died testate in 1917, appointing the petitioner his executrix. The petitioner filed an income-tax return for the calendar year 1919, and therein reported $4,448.18 as received from "Estate of Franklin Sheen as fiduciary for beneficiaries," and paid a tax thereon. In the same return the petitioner reported a profit of $3,000 from the sale of certain real estate in the year 1919. This sale was reported as a sale made on the installment or deferred payment plan. The initial payment received by her in this transaction was more than 25 per cent of the selling price and the Commissioner1927 BTA LEXIS 3592">3593 determined that for income-tax purposes the transaction was a cash transaction and the entire profit taxable in the year in which the transaction occurred. The petitioner failed to take a deduction in her tax return for $2,000 commissions paid to agents in effecting the real estate transaction. She paid this commission of $2,000 in the taxable year. OPINION. KORNER, Chairman: The petitioner takes no exception to the determination of the Commissioner that the real estate transaction in 1919 was a cash transaction, but now claims that in computing the profit thereon she is entitled to deduct a commission of $2,000 paid to agents in that transaction. The evidence that she paid this commission is uncontradicted and her contention in this respect is allowed. She is entitled to a deduction of $2,000. The other issue involves the right of petitioner to eliminate from her taxable income $4,448.18 reported by her in her tax return, but which she now claims was so reported in error. Her contention is that the amount in question was received by her in a fiduciary capacity from the estate of her former husband. If proof of this fact had been adduced, the contention of the petitioner1927 BTA LEXIS 3592">3594 might properly be allowable. But such proof is lacking in this record. The petitioner was unable to testify whether the fiduciary capacity under which she claims was that of executrix, guardian or trustee. She testified that her former husband had left a will but no showing of its provisions was offered to the Board. She testified that she had been advised by a former legal adviser that she occupied a fiduciary relationship to the money in question. Beyond that she seemed unable to go. The declarations contained in the tax return 6 B.T.A. 114">116 bearing on this point are clearly self-serving declarations in this proceeding. The petitioner's contention as to this second issue is not sustained. 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/4623177/	GREGORY E. MACDONALD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMacdonald v. CommissionerDocket No. 1079-73United States Tax CourtT.C. Memo 1976-80; 1976 Tax Ct. Memo LEXIS 324; 35 T.C.M. (CCH) 346; T.C.M. (RIA) 760080; March 16, 1976, Filed Gordon J.325 Arnett, for the petitioner. Paul G. Topolka, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent has determined a deficiency in petitioner's Federal income tax for the taxable year 1970 in the amount of $616.91. The issues presented for decision are(1) whether petitioner is entitled to a deduction for real estate taxes on the property located at 1462 Ridge Avenue, Evanston, Illinois, and (2) whether petitioner is entitled to a dependency exemption for his brother, George Macdonald, for the taxable year 1970. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner, Gregory E. Macdonald, resided at 1462 Ridge Avenue, Evanston, Illinois (sometimes referred to as the Ridge Avenue property) at the time his petition was filed herein. Petitioner filed his 1970 income tax return with the internal revenue service center in Kansas City, Missouri. Gertrude Macdonald (Gertrude) is petitioner's aunt and she resided with petitioner at 1462 Ridge Avenue, Evanston, Illinois, during 1970. Petitioner's mother, Jean Macdonald, and his brothers, Robert and George, also resided with petitioner326 at the same address. The La Salle National Bank of Chicago, Illinois, was appointed Conservator of the Estate of Gertrude Macdonald, An Incompetent, in October 1951 and has continued to act as conservator from its appointment until the date of the trial herein. On January 6, 1960, the Circuit Court of Cook County entered a decree finding that the Ridge Avenue property belonged to Gertrude and directing that this real estate be conveyed to her. This decree was upheld by the Supreme Court of Illinois in La Salle Nat. Bank v. MacDonald,27 Ill. 2nd 171, 188 N.E. 2d 664 (1963). Pursuant to the decree, a Master's Deed, dated June 4, 1963, was issued conveying the Ridge Avenue property to La Salle National Bank as conservator of the Estate of Gertrude Macdonald, An Incompetent. The La Salle National Bank has continuously held the Master's Deed for the Ridge Avenue property as an asset of the Estate of Gertrude Macdonald, An Incompetent, from 1963 to the date of trial. On June 16, 1970, the Circuit Court of Cook County, Illinois, Probate Division entered an order, providing, inter alia, that the La Salle National Bank, as conservator of the Estate of Gertrude Macdonald, 327 An Incompetent, be given leave to file a petition for an order that Jean Macdonald, Robert Macdonald, and Gregory Macdonald pay rent for their use and occupancy of the Ridge Avenue property. On July 27, 1970, the same court entered the following order: This estate coming on to be heard upon the petition of La Salle National Bank, successor conservator of this estate, filed on June 16, 1970, and upon the answer of Jean MacDonald, Robert MacDonald and Gregory MacDonald filed in reply to the said petition, and the court being advised in the premises: Finds: that the incompetent, Gertrude MacDonald is the sole owner of the real estate commonly known as 1462 Ridge Ave., Evanston, Illinois, and is now residing in the same; that Jean MacDonald Robert MacDonald, and Gregory MacDonald are now and have been for sometime past residing on the said premises and have not and are not paying rent for their use and occupancy: that the La Salle National Bank, as successor conservator of this estate, is now and has been for sometime past without funds or property to support and maintain the incompetent: that the said Jean MacDonald, Robert MacDonald and Gregory MacDonald have been and are now supporting328 the incompetent, have paid the general real estate taxes on the said property; made required repairs and paid insurance, if any, on the premises, now therefore, it is Ordered (1) that Jean MacDonald, Robert MacDonald, and Gregory MacDonald may continue to occupy the said real estate at 1462 Ridge Ave., Evanston, Illinois, without payment of rent for their use and occupancy (2) the said Jean MacDonald, Robert MacDonald and Gregory MacDonald, from their own funds, shall support and maintain the incompetent, pay the general real estate taxes on the property, pay insurance premiums and for all needed repairs (3) the payments heretofore made by Jean MacDonald, Gregory MacDonald and Robert MacDonald for support of the incompetent, taxes and repairs on the property are hereby waived and Jean MacDonald, Robert MacDonald and Gregory MacDonald are denied reimbursement therefor (4) the La Salle National Bank, as successor conservator, shall take no action for payment of rent against the said Jean MacDonald, Robert MacDonald and Gregory MacDonald as long as they shall comply with the provisions of this order (5) that this order is without prejudice to the pending petition of the La Salle329 National Bank as successor conservator to sell the said real estate at 1462 Ridge Ave., Evanston, Ill. In 1970, petitioner paid real estate taxes on the Ridge Avenue property in the amount of $2,971.47. Respondent disallowed petitioner's deduction of these taxes on the grounds that petitioner did not own the subject property. During 1970 petitioner's brother, George Macdonald (George) was 22 years of age and was a full time student at Ohio State University, Columbus, Ohio. George's gross income from wages in 1970 was $1,053.84. Petitioner claimed George as a dependent on his 1970 income tax return. The dependency exemption was disallowed by respondent. OPINION The first issue is whether petitioner is entitled to deduct $2,971.42 in real estate taxes which he paid on the Ridge Avenue property. While section 164(a) 1 allows a deduction for real estate taxes paid in the taxable year, this item is generally deductible only by the person on whom the liability is imposed. Magruder v. Supplee,316 U.S. 394">316 U.S. 394 (1942); Edward C. Kohlsaat,40 B.T.A. 528">40 B.T.A. 528 (1939); Virginia M. Cramer,55 T.C. 1125">55 T.C. 1125 (1971); section 1.164-1(a), Income Tax Regs.330 In Illinois real estate taxes are a personal liability of the owner of the property. Ill. Ann. Stat. ch. 120, sec. 508a (Smith-Hurd 1970). Cf. People ex rel. McCullough, v. Ladies of Loretto,246 Ill. 403">246 Ill. 403; 92 N.E. 908">92 N.E. 908 (1910); People ex rel. Pearsall, v. Catholic Bishop of Chicago,311 Ill. 11">311 Ill. 11; 142 N.E. 520">142 N.E. 520 (1924). There is no question that Gertrude rather than petitioner is the owner of the Ridge Avenue property. The Supreme Court of Illinois in La Salle Nat. Bank v. MacDonald,supra, specifically upheld a decree entered by the Circuit Court of Cook County, finding that this real property belonged to Gertrude. Since the ownership status of the property remained unchanged 2 at least through 1970, the decision of the Supreme Court of Illinois on the ownership issue is conclusive. Commissioner v. Estate of Bosch,387 U.S. 456">387 U.S. 456 (1967). 3 In addition, petitioner has not produced any evidence tending to show that he himself had an ownership interest in the property. We therefore331 find that Gertrude was the sole owner of the Ridge Avenue property during 1970. Petitioner next contends that since the July 27, 1970 order of the Cook County332 Circuit Court provided that the expenses of the Ridge Avenue property--including taxes--were to be paid by him, his mother, and his brother, he should be able to deduct those taxes. However, the order resolved a controversy over the obligation of petitioner, his mother, and his brother to pay rent for occupying the Ridge Avenue property. The order imposes an obligation to support Gertrude Macdonald that, when the terms of the order are considered in toto, is in the nature of rent, or at least in lieu of rent. One of Gertrude Macdonald's expenses that petitioner assumed pursuant to the order, was the obligation of Gertrude Macdonald to pay taxes on the property she owned and occupied with petitioner. The fact that the expenses of Gertrude Macdonald were assumed pursuant to a court order simply reflects the fact that Gertrude Macdonald's property was being managed by a conservator subject to the jurisdiction of the Probate Court. It has long been settled that in order for real estate taxes to be deductible, the obligation for payment must arise from an interest in the property on the basis of which the tax law creates the obligation for taxes and not created pursuant to some third333 party arrangement. Eugene W. Small,27 B.T.A. 1219">27 B.T.A. 1219 (1933). Certainly, if this arrangement were worked out by the petitioner and Gertrude, petitioner would clearly not be entitled to the deduction. That Gertrude's property was being managed by a conservator and the arrangements were worked out in the Probate Court should not change the result. We therefore hold that petitioner is not entitled to deduct the real estate taxes paid on the Ridge Avenue property in 1970. The second issue is whether petitioner is entitled to a dependency deduction for his brother George. During the taxable year 1970, section 151(e) (1) provided for an exemption of $625 for each of the taxpayer's dependents. The term "dependent" is defined to include certain individuals, over one-half of whose support was received from the taxpayer. Section 152(a) (3) includes the brother of the taxpayer among the qualifying individuals. Section 151(e), however, provides that the exemption may only be taken for those dependents with a gross income of less than $625 for the applicable period or who was a child of the taxpayer (1) under 19 years of age or (2) a student. 4334 Although George was a student during 1970 he was not a "child" of petitioner. The question, therefore, is whether George had gross income greater than $625. Petitioner stipulated that George earned $1,053.84 gross income from wages in 1970, but he now contends that George's earnings for that year cannot be determined. Petitioner then concludes that he is entitled to the exemption. Petitioner argues that since his brother George is missing in action in Laos, and George expressed an intention to amend his return to show a lower income figure, any decision regarding George's return should be postponed until his status is ascertained. We find petitioner's argument to be unpersuasive. First, it is petitioner's return and not George's with which we are concerned. The evidence in the record is more than sufficient to show that petitioner's brother had gross income of greater than $625 in 1970. George's own income tax return shows gross income of $1,053.84. George's wage and tax statement for 1970 (W-2) reflects the same information. Petitioner's return also states that George earned more $625than during 1970. Finally, petitioner stipulated that George's income for 1970 was $1,053.84. 335 In light of these facts we cannot conclude that George's income for that year was less than $625. We therefore hold that petitioner is not entitled to take a dependency exemption for George on his 1970 return. Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Petitioner suggests that the decision of the Illinois Supreme Court was altered in some way by the order entered by the Circuit Court of Cook County, Probate Division on July 27, 1970. In fact, this order, quoted in full supra,↩ found specifically that Gertrude was the sole owner of the property located at 1462 Ridge Avenue, Evanston, Illinois. 3. Petitioner argues that there was fraud in the 1938 determination of Gertrude's incompetency, and that any subsequent judicial action relating to Gertrude and her property are thereby rendered nugatory. First, whether Gertrude was unfairly declared incompetent to handle her affairs is a question for the Illinois courts to decide. We do note, in fact, that issues relating to Gertrude's incompetency were decided by the Illinois Supreme Court in MacDonald v. La Salle National Bank,11 Ill. 2d 122">11 Ill. 2d 122↩, 142 M.E.2d 58 (1957). More importantly, we fail to perceive what bearing Gertrude's competency has on the issue of whether or not she in fact owns the property.4. SEC. 151. ALLOWANCE OF DEDUCTIONS FOR PERSONAL EXEMPTIONS. (e) ADDITIONAL EXEMPTION FOR DEPENDENTS.-- (1) IN GENERAL.--An exemption of $625 for each dependent (as defined in section 152)-- (A) whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than $625, or (B) who is a child of the taxpayer and who (i) has not attained the age of 19 at the close of the calendar year in which the taxable year of the taxpayer begins, or (ii) is a student. * *(3) CHILD DEFINED.--For purposes of paragraph (1) (B), the term "child" means an individual who (within the meaning of section 152) is a son, stepson, daughter, or stepdaughter of the taxpayer.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623179/	Frances Hoffman, Petitioner v. Commissioner of Internal Revenue, RespondentHoffman v. CommissionerDocket Nos. 28212, 36225United States Tax Court17 T.C. 1380; 1952 U.S. Tax Ct. LEXIS 264; February 28, 1952, Promulgated 264 Decision will be entered for the respondent. Held, allowance for board and room sent to son living in California because of the mild climate there does not constitute deductible expense as medical care under section 23 (x), I. R. C., as amended, the son's illness having occurred 9 years before the taxable year, from which he had recovered beyond the period of actual illness and post-illness care. Benjamin Heller, Esq., for the petitioner.S. Jarvin Levison, Esq., for the respondent. Harron, Judge. HARRON 1380 The Commissioner determined deficiencies in income tax for the years 1946, 1947, and 1948 in the amounts of $ 213.60, $ 237.50, and $ 171.82, respectively. In determining the deficiency he disallowed a deduction for medical expense in each year in the amount of $ 1,230, $ 1,230, and $ 1,250, which265 the petitioner alleges was error.FINDINGS OF FACT.The petitioner resided in New York City during the taxable years, and filed her returns with the collector for the fourteenth district of New York. She is a widow and is employed by the government of the city of New York as a bookkeeper. Her earned income amounted to less than $ 3,000 in the taxable years, and her income is limited to whatever she earns. She lived with a relative during the taxable 1381 years, and her son, Walter Hoffman, lived in Los Angeles, California, near the University of California at Los Angeles where he was a student during the years 1946, 1947, and 1948.Walter was born on March 28, 1927. In 1936, he lived with his mother, the petitioner, in New York City. In February of 1936, he suffered his first attack of acute rheumatic fever. He was then nine years old. He was a patient in the Presbyterian Hospital in New York City for four months, during which time he was confined as a bed patient. The diagnosis of his illness was acute rheumatic fever, rheumatoid arthritis, and active rheumatic heart disease. In 1937, Walter had another attack of rheumatic fever which required that he remain in bed266 at his home for 3 months. Walter's physician advised that the New York winter weather was difficult for Walter, and he recommended that he be taken to a place where the climate was warm and the temperature did not vary. Therefore, the petitioner took Walter to Florida in 1937 after he had recovered sufficiently from his 1937 illness. Walter remained in Florida during the remainder of 1937 and during the years 1938, 1939, 1940, 1941, 1942, 1943, 1944, and until the fall of 1945, except for visits to New York in the summers of 1938 and 1941. When he returned to New York, he went to the Presbyterian Hospital to the clinic. His last visit was made on June 21, 1941. The report on the examination made at that time was that "He appeared in excellent physical condition. Signs of mitral and aortic rheumatic disease (inactive) persisted." He did not have any other rheumatic fever attacks after the one he suffered in 1937. He was not under the care of a physician after his illness in 1937, but was examined by his physician in New York in 1938 when his physician determined that he had rheumatic heart disease and recommended that he move to Arizona where a more equable climate exists. 267 During the taxable years 1946, 1947, and 1948, Walter was not ill; he was not under the care of a physician; and he did not go to any clinics or hospitals for examinations or treatments.Walter moved from Florida to Los Angeles in the fall of 1945 and enrolled as a student at the University of California in Los Angeles. He attended the University during the taxable years and graduated in 1949 with a B. S. degree. He visited his mother in New York during the summer of 1949. Thereafter he obtained a position as a sanitation engineer in the Los Angeles Health Department, and he held that position at the time of the trial of this proceeding.Walter lived in Florida for about 8 years before going to California. He had lived in California for 6 years up to the time of the trial of this proceeding. Walter was a little over 18 years old when he enrolled at the University of California. In 1946 he was 19 years of age; and he became 21 years of age in 1948.1382 Walter received an examination by the Student Health Service of the University of California in January 1950. The examining doctor stated in a written diagnosis of Walter's case that he had rheumatic heart disease, mitral268 stenosis and regurgitation, aortic stenosis and regurgitation, and a slightly enlarged heart; and that "residence in a warm climate is very likely beneficial for such conditions."The petitioner sent funds to her son during the years 1946, 1947, and 1948 in the amounts of $ 1,440, $ 1,444.40, and $ 1,745, respectively. Out of these amounts the petitioner's son spent at least $ 300 in each of the taxable years for his education expenses, which amount represents the tuition charged by the University of California for one year's (two semesters') attendance, and he used the rest for the expenses of meals and lodging. The petitioner sent to her son, also, all of his clothing during the taxable years, the cost of which is not included in the above sums. During the taxable years Walter rented a room in Los Angeles.The petitioner does not claim deductions for $ 300 tuition fees paid in each of the taxable years; and, therefore, she now claims deductions only in the net amounts of $ 1,140, $ 1,144.40, and $ 1,445, respectively, in the taxable years.OPINION.The sole question to be decided is whether the petitioner is entitled to deduct as expenses for medical care, under section 23 (x) 269 of the Internal Revenue Code, amounts expended by her in each of the taxable years for the room and board of her son in Los Angeles, California.Section 23 (x) permits the deduction from gross income of expenses paid during the taxable year, not compensated for by insurance or otherwise, for the medical care of the taxpayer, his spouse, or a dependent, to the extent that such expenses exceed 5 per cent of the adjusted gross income. The term "medical care" is defined by section 23 (x) as follows: * * The term "medical care", as used in this subsection, shall include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body (including amounts paid for accident or health insurance.)The petitioner contends that the broad definition of medical care encompasses her expenditures for the board and lodging of her son in Los Angeles during the years 1946, 1947, and 1948 because, upon the advice of his physician, he had moved to Los Angeles so that he could live in a warm and even climate which he understood to be conducive to, if not necessary for, the prevention of the recurrence of rheumatic270 fever. Walter suffered two attacks of rheumatic fever in each of the years 1936 and 1937, from which his heart was impaired and left him 1383 with rheumatic heart disease and mitral and aortic stenosis. The petitioner contends that the expenses in question are deductible under section 23 (x) under the rule of L. Keever Stringham, 12 T. C. 580, affd. per curiam 183 F.2d 579">183 F. 2d 579.The respondent contends that the expenses in question do not come within the scope of section 23 (x), but constitute personal living expenses, and as such are not deductible because of the provisions of section 24 (a) (1). He cites in support of his determinations Edward A. Havey, 12 T.C. 409">12 T. C. 409.It is provided in section 24 (a) (1) that "Personal, living, or family expenses, except extraordinary medical expenses deductible under section 23 (x)" shall not be deducted from gross income, and this provision clearly indicates that section 23 (x) is to be read in conjunction with section 24 (a) (1). Where, as in this proceeding, a taxpayer seeks deduction for the expenses of meals and lodging under the claim that such expenses271 constitute "medical expenses" within the intendment of section 23 (x), inquiry must be made whether the expense is truly "medical expense" or is living expense. A line must be drawn between living expenses which are not deductible under section 24 (a) and "extraordinary medical expenses deductible under section 23 (x)." In this proceeding the deduction is claimed for the lodging and subsistence expenses of a dependent child who went to live permanently, more or less, in Florida, and later in California. In L. Keever Stringham, supra, the taxpayer's child was taken to Arizona immediately following an illness, as soon as it was feasible to make the journey, and we pointed out thatmany expenses are so personal in nature that they may only in rare situations lose their identity as ordinary personal expenses and acquire deductibility as amounts claimed primarily for the prevention or alleviation of disease. Therefore, it appears that in cases such as the one now before us, where the expenses sought to be deducted may be either medical or personal in nature, the ultimate determination must be primarily one of fact.It was noted, also, in the concurring272 opinion of Judge Murdock (page 587) that the question of the deductibility of expenses where someone went permanently to live in a salubrious climate in order to prevent illness was not present in the Stringham case and was not decided.The question presented in this proceeding is primarily a question of fact. The evidence shows that the petitioner's son had not been ill since 1937; that he was not ill during the taxable years; and did not receive any medical attention or treatment during the taxable years. Rheumatic fever very frequently leaves the subject with rheumatic heart disease, and the attacks which the petitioner's son, Walter, suffered, had that result. Nothing in the record to the contrary, it appears that Walter will go through life afflicted with rheumatic heart 1384 disease. The petitioner wisely followed the advice that her son leave New York City and live in a warm and equable climate. Walter's residence in Florida for 8 years, up to the fall of 1945, was beneficial; and when he was examined at the Presbyterian Hospital in New York City in June 1941 it was found that he had had no recurrence of rheumatic fever since 1937 and that although signs of mitral273 and aortic rheumatic disease persisted, it was inactive. No doubt his living in a warm and mild climate in Florida was largely responsible for the comparatively good health which Walter achieved.When Walter went to Los Angeles in the fall of 1945 he immediately enrolled as a student at the University of California. He was 18 years of age, the age at which young people ordinarily enter a university if they are able to continue their education. The evidence shows that Walter did not suffer any illness in 1945, and it is presumed that he went to Los Angeles in order to enroll as a student at the University of California as well as to continue living in a mild climate.We understand that Walter should, and probably will during the rest of his life, select a place for his continuous residence where the climate will be congenial to his impaired heart, and that he will avoid living where there are changes of temperature and the climatic conditions may impose some strain upon him.In other words, during the taxable years petitioner's son was not ill; in fact, he appears to have been in excellent physical condition, able to attend the university where he successfully completed his studies274 and graduated in 1949. In June of 1941, when he last visited the clinic of the Presbyterian Hospital, "He appeared in excellent physical condition" according to the report of that hospital. Under such facts, it is concluded that the expenses in question were personal, living expenses and that they come within section 24 (a) (1) rather than section 23 (x).If the petitioner had been able to elect to go to Los Angeles and establish a home there for her son so that he had been living with her during the taxable years, it is unlikely that the petitioner would claim deduction for his meals and lodging expenses. A taxpayer is allowed an exemption for a dependent but that is all. It is true that the petitioner is a person of modest means so that the support of a dependent child no doubt imposes some sacrifice, but that factor is immaterial. She would have the same burden of the living expenses of her son if she had maintained a home for him in California during the taxable years. The fact that she either could not or did not elect to live in California with her son is not material. The situation here is simply that her son, Walter, found living in one locality more beneficial to his275 health than living in the locality 1385 where his mother lived. The provisions of section 23 (x) are broad, but they are restricted by the provisions of section 24 (a) (1) and do not apply to the facts in this proceeding.We need not again refer to the evidence of the Congressional intent in enacting section 23 (x), other than to refer to the report of the Senate Finance Committee (S. Rept. No. 1631, 77th Cong., 2d Sess., page 6). See also L. Keever Stringham, supra, page 583; and Edward A. Havey, supra, page 411. The Commissioner in his Regulations has emphasized that: * * Allowable deductions under section 23 (x) will be confined strictly to expenses incurred primarily for the prevention or alleviation of a physical or mental defect or illness. Thus, payments for expenses for hospital, nursing * * , and for ambulance hire and travel primarily for and essential to the rendition of the medical services or to the prevention or alleviation of a physical or mental defect or illness, are deductible. (Regulations 111, section 29.23 (x)-1.In considering the above Regulation we observed in L. Keever Stringham, supra, page 584,276 "that a deduction may be claimed only for such expense as is incurred primarily for the prevention or mitigation of the particular physical or mental defect or illness." In this proceeding there was no actual illness; the illness had occurred for the last time 9 years before the first taxable year in this proceeding -- 1946. In Edward A. Havey, supra, we considered it material that the taxpayer's wife, in 1945, was not suffering from any illness, her illness having occurred in 1943. She had suffered no further heart attacks and was not under the care of a physician. We recognized that trips and changes of climate were beneficial but concluded that the expenses there were not deductible because they were not incurred primarily for the prevention or alleviation of illness. The facts in this proceeding differ markedly from the facts in the Stringham case where it was shown that the taxpayer's child was recovering from an illness, and it was concluded that travel expense and the cost of maintaining the child while in Arizona were expenses which were clearly incurred primarily for and essential to the cure and mitigation of the child's277 illness.In cases such as this the real question is whether the disputed expenditures were "paid for * * prevention of disease" and were "extraordinary medical expenses" deductible under section 23 (x) rather than personal, living expenses within the meaning of section 24 (a). The question must always involve the acceptance of one and the rejection of the other one of the above alternatives. A line must be drawn somewhere between that which is a personal expense and that which is incurred primarily for the prevention of illness and disease. One may live in such a way during one's whole lifetime so 1386 as to prevent the recurrence of illness and disease and so as to maintain the best health which is possible after some vital organ has become impaired, or one's health has become less than the health of a thoroughly normal and well person.Under section 23 (x), a taxpayer may claim a deduction for medical expense which he has incurred and paid. The petitioner's son has now attained his majority, is employed, and is earning his living. The decision of the question in this proceeding may very well have some impact upon later years with respect to the income tax liability278 of the petitioner's son rather than her own income tax liability. If we were to hold here, under the facts, that the expenses in question are deductible by the petitioner under section 23 (x), it would follow as a matter of logic, the facts continuing to be the same, that the expenses of his meals and lodging in a later year or years would be deductible by Walter.Each case must stand upon its own particular facts, but we think it is proper and reasonable to conclude that where the expenses of meals and lodging are involved, the line must be drawn at some point very much closer to the time of actual illness and the immediate recovery from such illness than can be found in this proceeding. The expenses for which the petitioner seeks deduction under section 23 (x) are the living expenses of her son. The only justification for claiming that these expenses constituted "medical expenses" within the intendment of section 23 (x) is that the petitioner's son found living in California more beneficial to his health than living in New York. Such expense falls within section 24 (a) (1) rather than section 23 (x). Furthermore, there is strong indication here that one of the reasons the petitioner's*279 son was living in southern California was for the purpose of continuing his education at a university of his choice. However that may be, our conclusion would be the same even if he had continued to live in Florida. The respondent's determination is sustained.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623180/	CONNALLY REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Connally Realty Co. v. CommissionerDocket No. 71149.United States Board of Tax Appeals31 B.T.A. 349; 1934 BTA LEXIS 1114; October 16, 1934, Promulgated 1114 The cost of major alterations of a business building necessitated by the raising of a contiguous street is not a deductible expense. A. W. Clapp, C.P.A., for the petitioner. Philip A. Bayer, Esq., for the respondent. STERNHAGEN 349 OPINION. STERNHAGEN: The Commissioner determined a deficiency of $1,092.84 in petitioner's income tax for 1930. The petitioner assails the disallowance of a deduction of part of the cost of remodeling a business building, occasioned by the city's raising of the contiguous street level. The facts are stipulated in more detail than is needed for the purpose of this opinion. The building was erected in 1916, at a cost of $312,933.17. It stood at the corner of two streets of different levels and had stores fronting on both. The construction, in 1929, of a new viaduct nearby necessitated raising one of the streets as an approach, thereby causing serious economic damage to the building. This the city settled in 1929 by paying petitioner $25,000, of which petitioner paid $6,250 to a lawyer. the alterations made in the building involved shifting the entrance, constructing an arcade, and substantially rearranging1115 the store space and to some extent the elevators. They were completed in 1930, at a cost of $35,015.34, of which petitioner paid $20,315.45 in 1930. Of this amount, it deducted $9,376.47, said to be the excess over the city's award, and this the Commissioner disallowed. "The value of the property was not increased by the construction of the viaduct approach. The life of the property as a whole was not prolonged by the change in this small part of its structure." The rents from the building were less in 1930 than in 1927, but there is no ovidence to show whether this is attributable to the foregoing facts, to general business conditions, or to something else. Upon this foundation, the petitioner contends that so much of the cost of such of the alterations as are properly attributable to the change in street level as exceeds the award (minus attorney fees) is deductible. Deductibility can only be established by a showing that the outlay is within the statutory classification of "ordinary and necessary expenses" of carrying on the trade or business. Revenue Act of 1928, sec. 23(a). This is attempted by petitioner by the indirect argument that because the value of the building1116 was not increased or its life prolonged, the expenditure may not be called capital. It has been said before that this argument does not prove its point. 350 The idea that everything which is not strictly a capital investment must be a deductible expense is unsound. Deductibility must be affirmatively established in the terms of the statute invoked, and if the item does not fit into the statutory description it may not be deducted. . If this results in making the item a nondescript before the law or puts it in a vacuum abhorrent to the accountant, so it must stand. . The statute may not be strained to avoid a clash with a convention of accounting thought. If a taxpayer, adhering to his accounting system, has but the alternative of either capitalizing or charging off an outlay, nevertheless his tax return must conform to the statute even if it be different from the classification of his accounts. Considering the language of the statutory deduction and the idea which it would be commonly thought to express, such an outlay as this is clearly not1117 within it. The circumstances were exceptional, not ordinary, and they were more than a normal incident of carrying on petitioner's business. Whether the inquiry be one of degree or of rule, the alterations can not be called mere repairs, from the standpoint of their nature, or of their relative cost, or of their duration. Treating them as a charge against the income of a single year is in disregard of the obvious theory upon which their cost was based, which was to preserve the investment for its life at its greatest yield. Manifestly an expenditure almost as large as the year's income would not have been justified unless it impinged advantageously on the operations of the future. These alterations were embodied in the whole investment. If they unduly expanded the cost beyond the hope of reasonable financial return, they were still part of the investment cost, for the character of a capital expenditure is not lost because it proves unfortunate. An unsuccessful investment may involve a loss, but it does not thereby become an expense; and as a loss it is only recognized when it is definitively realized. Even, therefore, if we proceed along the line of petitioner's argument1118 to consider, not whether the expenditure was a statutory expense, but whether it was capital, we should be compelled by principle to say it was, and that as part of the cost of the building it increased the depreciation base, as the Commissioner had held. The fact that value was not enhanced does not affect the principle. Many capital additions, improvements, replacements, or major renewals are necessary or compulsory despite their failure to increase the value. This does not characterize then as expense, even if the taxpayer chooses, as he may, to charge them off. Questions of accounting for the purpose of utility regulation involve different considerations, for it may be that a utility expenditure, although capital in principle, is so unwise that it may not be used to measure 351 the reasonableness of the utility's return to be gathered from its public rates. The tests for determining a deductible expense are not easy to state, 1 and consist perhaps more of negation than of definition. Nevertheless, individual decision can be guided by the purpose, result, relative cost and importance, and the duration of function of the item, rather than by the inclination of the*1119 individual taxpayer to account for it as capital or to charge it off, or the fact that value or life has not been expanded. The accounting is often dictated by adventitious interests, value fluctuates with a multiplicity of elusive causes, and economic life is influenced by factors wider than cost. While such evidence may not be disregarded, it is not determinative of the application of the statute. The Commissioner correctly disallowed the deduction claimed. Reviewed by the Board. Judgment will be entered for the respondent.TURNER concurs in the result. ADAMS dissents. Footnotes1. See Harvard Law Review, note, Vol. XLVII, p. 669 (Feb. 1934). ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623181/	JACK BROWN AND CLARA BROWN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrown v. CommissionerDocket No. 34462-83.United States Tax CourtT.C. Memo 1985-564; 1985 Tax Ct. Memo LEXIS 68; 50 T.C.M. (CCH) 1418; T.C.M. (RIA) 85564; November 18, 1985. Remo Tinti, for the petitioners. Victoria Wilson Fernandez, for the respondent. WRIGHTMEMORANDUM OPINION WRIGHT, Judge: Respondetn determined a deficiency of $55,130 in petitioners' 1978 Federal income tax. This case is before the Court on respondent's motion for summary judgment under Rule 121 1 on the issue of whether petitioners may deduct an alleged advanced minimum royalty payment and on respondent's motion to impose damages under section 6673. 69 Petitioners Jack and Clara Brown resided in Whitestone, New Yok, when the petition was filed herein. Clara Brown is a petitioner solely by virtue of having filed a joint return with her husband, Jack Brown (referred to herein as "petitioner"). Petitioners, in their opposition to respondent's motion, claim the following: On April 27, 1978, petitioner executed a Sublease Agreement with Weston Petroleum, Inc. (Weston), a nonrecourse promissory note in favor of Weston, and a Mining Services Agreement with Weston. Under the Sublease Agreement, petitioner acquired the right to mine coal on a specified tract of land. That agreement provides, in relevant part, as follows: MINIMUM ANNUAL ROYALTYA. Sublessee agrees to pay to Sublessor a minimum annual royalty (the "Minimum Annual Royalty") with respect to each year of this Sublease of $120,000.00 regardless of the amount of coal, if any, which actually be mined, removed or sold from the Property during each year. The Minimum Annual Royalty shall be paid on December 31 of each year for the Lease Year that ends on that date with the first payment due on December 31, 1978 to cover the period from the commencement of this Sublease70 until such date. The Minimum Annual Royalty payable with respect to the first year of this Sublease in the amount of $120,000.00 (the "Advanced Minimum Royalty") shall be paid by Sublessee simultaneously with the execution of this Sublease in the following manner: (1) Sublessee shall pay to Sublessor, in cash, simultaneously with the execution hereof, the aggregate sum of $30,000.00. (2) Sublessee shall pay to Sublessor, simultaneously with the execution hereof, by delivering to Sublessor a Promissory Note of even date herewith, in the form of Exhibit "B" attached hereto (the "Note"), the aggregate sum of $90,000.00, which Note shall bear interest at the rate of six (6%) percent per annum, require annual payments, and mature on December 31, 1988. * * * SECURITY INTERESTTo secure the due and punctual payment of the Note, together with accrued interest thereon, and all other amounts from time to time payable by Sublessee under this Sublease, Sublessee grants to Sublessor a mortgage on, and a Security Interest on, the below-described property (the "Collateral"). A. The coal and other rights granted hereunder to Sublessee. B. All improvements, buildings, structures, 71 equipment, machinery and other personal property of Sublessee used in connection with Sublessee's operations on the Property. C. All proceeds realized from such properties described in subparagraphs "A" and "B" above, including, without limitation, insurance proceeds from any loss or damage to the Property and other proceeds of any kind resulting from any event of loss with respect to the Property; provided,however, that except as hereinafter specifically set forth in this provision, this Sublease shall be without recourse to Sublessee; and Sublessor shall look only to the Collateral for payment of Sublessee's obligations secured hereby. The sublease contains no provision requiring payment by nonrecourse promissory note of the minimum annual royalties with respect to any year other than the first year of the sublease. The promissory note executed by petitioner requires that $9,000 of principal plus accrued interest be paid on December 31 of each year until the note is paid in full. The note provides that it is secured by petitioner's interest in the sublease and further provides that "[t]his Note is without recourse to Owner [petitioner]; and Owner shall not72 be personally liable to Sublessor [Weston] for any amounts payable under this Note, including expenses incurred by Sublessor in enforcing payment of this Note. Sublessor shall look only to the collateral described in the Sublease for the payment of this Note." The Mining Services Agreedment engaged Weston, for the term of the lease, to mine coal and to perform all necessary ancillary functions. The agreement further provides, in relevant part, as follows: The Contract Miner [Weston] agrees to use its best efforts to mine at least 27,667 tons of coal in each of 1978, 1979, 1980, 1981, 1982, 1983, 1984, 1985, 1986, 1987 and 1988. To the extent that it does not mine at least 27,667 tons of coal per calendar year, it agrees to credit the Owner [petitioner] an amount of $8.25 per ton for each ton short of 15,000. In responding to interrogatories, petitioner disclosed that no coal was mined in 1978 or in any other year. On their 1978 Federal income tax return petitioners claimed a deduction of $120,000 based on their alleged payment of an advanced minimum annual royalty. Respondent disallowed that deduction in its entirety. Rule 121(b) provides that a decision may be rendered73 upon motion for summary judgment "if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." In considering a motion for summary judgment we must view the facts and inferences to be drawn therefrom in the light most favorable to the party opposing the motion. Jacklin v. Commissioner,79 T.C. 340">79 T.C. 340, 344 (1982). Such party must, however, set forth specific facts showing that there is a genuine issue for trial. Rule 121(d). In his motion for summary judgment respondent argues that petitioners' payment of $120,000 was not made pursuant to a minimum royalty provision and concludes that petitioner is not entitled to a deduction therefor. Generally an advanced royalty is deductible only in the year the mineral product is sold. Sec. 1.612-3(b)(3), Income Tax Regs. However, a current deduction is allowed when the advanced royalty is paid or accrued "as a result of a minimum royalty provision." Sec. 1.612-3(b)(3), Income Tax Regs.Because no coal was sold during the year74 in issue, in order to be deductible the advanced royalty in question must have been paid pursuant to a minimum royalty provision. The requirements for a minimum royalty provision are as follows: For purposes of this paragraph, a minimum royalty provision requires that a substantially uniform amount of royalties be paid at least annually either over the life of the lease of for a period of at least 20 years, in the absence of mineral production requiring payment of aggregate royalties in a greater amount. [Emphasis added.] Sec. 1.612-3(b)(3), Income Tax Regs.To determine whether the requirements for establishing a minimum royalty provision have been met, we must look to the agreement as a whole, along with any pertinent additional information. Wing v. Commissioner,81 T.C. 17">81 T.C. 17, 39 (1983). On numerous occasions this Court has held that where payment of a minimum royalty is made by nonrecourse note, payment of which is contingent upon coal production, there is no enforceable requirement that substantially uniform minimum royalties be paid annually, regardless of production. Oneal v. Commissioner,84 T.C. 1235">84 T.C. 1235, 1240 n. 8 (1985), and75 cases cited therein. In Wing v. Commissioner,supra, one sentence of the sublease agreement required that a certain annual minimum amount be paid uniformly over the life of the lease, but that sentence was contradicted by subsequent provisions allowing payment by nonrecourse promissory note, under the terms of which none of the principal was required to be paid for 10 years. This Court found that payment of the note was contingent on taxpayer's mining coal and concluded that because payment was contingent there was no requirement of annual payment over the life of the lease. In Maddrix v. Commissioner,83 T.C. 613">83 T.C. 613 (1984), the agreement in question provided for an "annual minimum royalty" in the amount of $300,000 for each year of the 10-year sublease, to be paid with $590,000 cash together with nonrecourse notes aggregating $1,950,000, bearing interest at 6 percent and payable in equal quarterly installments of $81,196. Despite the stated payment schedule, the other documents setting forth the terms of the transaction provided that the notes were payable out of coal sale proceeds, that the notes were nonrecourse, and that the holder's sole76 remedy in the event of default was to proceed against the taxpayer's interest in the venture. This Court found that those documents reflected an intention that taxpayer's note be satisfied out of coal sales proceeds. On respondent's motion for partial summary judgment, we held, as a matter of law, that the taxpayer's execution of a nonrecourse note, payments on which were contingent upon coal production, did not establish an enforceable requirement that substantially uniform minimum royalties be paid annually in any event, regardless of production. Maddrix v. Commissioner,surpra at 623. In Vastola v. Commissioner,84 T.C. 969">84 T.C. 969 (1985), the taxpayer was obligated annually to pay to the sublessor a nonrefundable minimum annual royalty of $40,000 per unit. For the most part, however, such payments were to consist of nonrecourse notes, which were payable in monthly amounts calculated per ton of coal shipped with the balances due 20 years after the date of execution of those notes. The holder's sole recourse, in the event of default, was against the taxpayer's interest in the coal and its proceeds. Upon consideration of the substance of the entire transaction, 77 we held that because the nonrecourse notes were payable solely out of the proceeds of coal production, there was no requirement that a substantially uniform amount of royalties be paid at least annually. In the instant case the Sublease Agreement States explicitly that there is no recourse against petitioner and that the sublessor can look only to the collateral described therein for payment of petitioner's obligations under the Sublease Agreement. The effect of these provisions is that petitioner is entirely free of personal liability with respect to his obligations arising from the Sublease Agreement and may, if he so desires, satisfy those obligations by executing a nonrecourse note. Because all payments due under the Sublease Agreement are secured only by the coal mine and proceeds therefrom, we find that those payments are contingdent upon coal production. Thus, we conclude that there is no requirement that a substantially uniform amount of royalties be paid at least annually. Consideration of the terms of the purported minimum annual royalty provision together with the liquidated damages provision of the Mining Service Agreement further evidences the absence of an unconditional78 requirement that an annual payment be made. Under the liquidated damages provision, Weston agreed that if it failed to mine at least 27,667 tons of coal in any given year, it would pay petitioner $8.25 for each ton short of 15,000 tons. Thus, if Weston mined no coal in a certain year, it was obligated to pay poetitioner $123,750 ($8.75 X 15,000 tons). Petitioner's so-called unconditional obligation is therefore a complete "wash" when considered in conjunction with the other documents executed as part of the transaction. Petitioners seek to distinguish Wing v. Commissioner,supra, by arguing first, that the Sublease Agreement in this case required annual payments of $120,000 regardless of whether any coal was mined and, second, that the Sublease Agreement did not provide for payment of these annual minimum royalties by nonrecourse notes on which no payment was due for ten years. With respect to petitioners' first argument, although the Sublease Agreement stated that the payment of $120,000 was due annually regardless of whether coal was mined, these annual payments were secured only by petitioner's interest in the coal mine and proceeds therefrom. Because79 payment of any amounts due pursuant to the Sublease Agreedment can be enforced only insofar as coal is mined or other proceeds are realized from the mining property, we have found that such payment is contingent upon coal production. Therefore, with respect to the requirement of payment of the annual royalties, we find no material distinction between the instant case and Wing. Similarly, the fact that the Sublease Agreement in this case does not expressly provide for payment of the minimum annual royalties with respect to any year other than the first year to be made by nonrecourse note does not distinguish this case from Wing, in light of our conclusion that the use of nonrecourse notes was allowed by the Sublease Agreement. Petitioners further seek to distinguish Maddrix v. Commissioner,supra, and Vastola v. Commissioner,supra, because payment of the nonrecourse notes given in payment of annual minimum royalties in those cases was made expressly contingent upon coal sales proceeds. We find no material distinction between the cited cases and the instant case. Although the documents before us do not contain express language making80 obligations arising thereunder contingent upon coal sales proceeds, as discussed above, that is the clear effect of those documents. Thus, we see no reason to reach a result different from that in Maddrix and Vastola.Finally, petitioner appears to argue that the provision requiring annual payment of $9,000 of the principal of the note meets the requirement in the regulation defining minimum royalty provision. The note under which the annual payment of $9,000 is due is a nonrecourse note, the terms of which expressly state that petitioner is not personally liable thereunder and that said note is secured only by the collateral described in the sublease. Thus, we find no enforceable requirement that annual payments under the note be made. Furthermore, we have held that the fact that the note may, in fact, be paid at some later date is not sufficient to establish the existence of a requirement of annual payment. Wing v. Commissioner,supra at 40-41. On the facts here presented we find no requirement of annual payment. We conclude, as a matter of law, that the royalties paid by petitioners in 1978 were not paid as a result of a minimum royalty provision81 and, therefore, petitioners are not entitled to a deduction for that year for advanced royalties. Petitioners have not established that there is a genuine issue as to any material fact. Accordingly, respondent's motion for summary judgment will be granted. The remaining issue to be decided in whether petitioners are liable for damages under section 6673. As applicable herein, section 6673 provides that damages up to $5,000 shall be awarded to the United States whenever it appears that proceedings before the Tax Court have been instituted or maintained primarily for delay or that the taxpayer's position in such proceedings is frivolous or groundless. After considering the entire record in this case and in particular petitioners' oral arguments in opposition to respondent's motion, we do not find that petitioners are liable for damages under section 6673. We note that this Court has considered a number of factual situations and arguments concerning minimum annual royalty payments which were "paid," in large part, by means of a nonrecourse note and that this Court does not hesitate to award damages in the maximum allowable amount whenever it finds that a taxpayer's position is frivolous82 or groundless or that a proceeding was filed or maintained primarily for delay. See Oneal v. Commissioner,supra.On the particular facts presented in the instant case, however, we do not find that the imposition of damages is warranted. To reflect the foregoing, An appropriate order will be issued.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623182/	PETER MALLORY and JEAN MALLORY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMallory v. CommissionerDocket No. 21978-81.United States Tax CourtT.C. Memo 1983-257; 1983 Tax Ct. Memo LEXIS 532; 46 T.C.M. (CCH) 99; T.C.M. (RIA) 83257; May 9, 1983. 532 Peter Mallory, for the petitioners. Patrick C. McGovern, for the respondent. WILESMEMORANDUM OPINION WILES, Judge: This case is before us on respondent's motion for summary judgment filed on March 2, 1982, pursuant to Rule 121, 1 and heard on February 14, 1983. Petitioners Peter Mallory and Jean Mallory, husband and wife, resided in Fallbrook, California, when they filed their petition and amended petition in this case. On December 4, 1980, respondent notified petitioners by letter that their 1979 Federal income tax return had been selected for examination. This letter requested that petitioners provide respondent with certain records and make an appointment to discuss certain items on their 1979 return with respondent's representative. On December 10, 1980, petitioners sent a letter to respondent in which they enclosed three forms entitled "Demand for Immunity," "Grant of Immunity," and "Public Servant's Questionaire." These three documents had blank spaces and petitioners requested respondent to provide the requested information and return the completed forms within533 ten days. In the event respondent failed to do so, petitioners informed him that they "will assume that you did not want the meeting and/or audit * * ." By statutory notice dated July 31, 1981, respondent determined a deficiency in petitioners' 1979 Federal income tax in the amount of $7,040, and an addition to tax under section 6653(a) in the amount of $352. The issues raised in the notice of deficiency are whether petitioners are entitled to itemized deductions for charitable contributions, casualty losses, medical expenses, and business expenses. On August 24, 1981, petitioners timely filed a petition in which they gave the following statement of their position: I disagree with the I.R.S. entirely and I don't owe them anything. The assignments of error are: The Assessment is based upon whim and caprice, and not upon fact. The Assessment is just a wild guess, and fishing expedition by the I.R.S. and has no factual basis. I have incurred no tax liability for the years in question. On November 2, 1981, petitioners, pursuant to being granted leave to file by the Court, filed an amended petition. In this amended petition, petitioners made no reference to any specific534 adjustment of income made by respondent in determining a deficiency. Instead, the amended petition alleges, in pertinent part, as follows: B. The issuance and computation of statutory notice was done pursurant [sic] to and in accordance with unlawful procedures designed to deny the Petitioners their legal, civil, and Constitutional rights in the matter. C. The petitioners further know that the Respondent erred in arriving at the computed amount of $352.00 for the year of 1979, because this figuer [sic] does not take into consideration those deductions that Petitioners are entitled to, and which they rightfully claimed on their return, as daid [sic] deductions were arbitrarily denied and disallowed by the Respondent without just cause. * * * The facts upon which the Petitioners rely as a basis for their case are as follows: A. The Petitioners' income tax return for the year 1979 was filed, accepted as filed, and a check was issued to the U.S. Government, and accepted as evidence of the acceptance of said return. Sometime afterwards, the return was investigated by secret and unrevealed computer technology, which technology yealded [sic] a computerrized [sic] 535 accusation against the Petitioner, which accusation was never made known to the the generalised [sic] term "audit." B. The Petitioners were denied their legal rights, civil and Constitutional rights by the usage of Rev. Proc. 68-12 which Rev. Proc. has the effect of suspending the Constitution of the United States in any discussions with either the IRS District or Appellate [sic] conferees. On July 26, 1982, a hearing was held on respondent's motion for summary judgment and the petitioners' motion for a continuance. At this hearing, petitioners made no reference to any constitutional arguments but they informed the Court that, if granted a continuance, they would file another amended petition setting forth the facts to support the deductions in controversy. The Court granted petitioners' motion for a continuance and informed them that unless they filed an amended petition setting forth facts to support the claimed deductions then respondent's motion for summary judgment would come up for hearing again on the very next calendar. On August 9, 1982, petitioners filed a document entitled "Request for Amended Petition." In such document, petitioners failed to536 set forth facts, as instructed by the Court at the previous hearing of this case, and instead alleged that they were unable to bear the cost of obtaining substantiation for any of their claimed deductions. Rule 121(b) provides that a motion for summary judgment shall be granted if the "pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Petitioners' petition, amended petition, and their document entitled "Request for Amended Petition" do not satisfy the pleading rules of this Court. Rule 34(b) provides, in pertinent part, that the petition in a deficiency action shall contain: (4) Clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability. * * * (5) Clear and concise lettered statements of the facts on which petitioner bases the assignments of error * * . Petitioners' petitions allege no justiciable error with respect to respondent's determination of the537 deficiency or addition to tax and fail to state facts which would indicate that there is a genuine issue of material fact. 3 Consequently, respondent's motion for summary judgment is granted. 4To reflect the foregoing, An appropriate order will be issued.Footnotes1. All rule references are to the Tax Court Rules of Practice and Procedure.↩3. See Sidle v. Commissioner,T.C. Memo. 1982-124↩. 4. We wish to add that, on the record before us, a motion to dismiss for failure to state a claim upon which relief can be granted would have been entirely appropriate. See Rule 40. While we could raise such a motion, see Rule 53, we see no need to do so as summary judgment is also an appropriate motion for respondent in the instant case.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623187/	CARMEL M. BRONSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBronson v. CommissionerDocket No. 5211-91United States Tax CourtT.C. Memo 1993-233; 1993 Tax Ct. Memo LEXIS 235; 65 T.C.M. (CCH) 2791; May 25, 1993, Filed 235 Decision will be entered under Rule 155. Carmel M. Bronson, pro se. For respondent: William S. Garofalo, Brendan G. King, and James Gehres. JACOBSJACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined the following deficiencies in and additions to petitioner's Federal income tax: Additions to Tax under SectionsYearDeficiency6651 6653(a)6653(a)(1) 1978$ 18,830$ 4,708$ 942 -- 198024,2696,0671,213-- 198134,9548,244-- $ 1,748198234,5078,089-- 1,72519832,675237-- 134Additions to Tax under SectionsYear6654 66596653(a)(2) 6621(c)1978$ 787 -- --219801,546-- --219812,489$ 10,4861 219823,09810,3521 21983318031 2236 All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. After concessions, the issues remaining for decision are: (1) Whether petitioner is entitled to depreciation and other deductions and investment tax credits relating to art masters purchased from Jackie Fine Arts, Inc.; (2) whether, and if so, to what extent, petitioner is entitled to deductions of losses claimed from either or both Resort Timeshare Marketing Associates, Ltd. or Resortimeshare Development Associates, Ltd. II; (3) whether petitioner is liable for an addition to tax under section 6651(a)(1) for failing to timely file a Federal income tax return for each of the years in issue; (4) whether petitioner is liable for an addition to tax for negligence or intentional disregard of rules and regulations under section 6653(a) for 1979 and 1980, and under section 6653(a)(1) and (2) for 1981 through 1983; (5) whether petitioner is liable for an addition to tax under section 6654 for underpayment of estimated tax for each of the years in issue; and (6) whether petitioner is relieved of liability as an innocent237 spouse under section 6013(e). Each of these issues except the last was decided as to petitioner's husband (Mr. Bronson) in Bronson v. Commissioner, T.C. Memo. 1992-122 (Bronson I). FINDINGS OF FACT To a substantial extent, the stipulations of facts incorporate the testimony and exhibits (including respondent's expert witness reports, stipulations of facts, and the statement regarding the stipulated settlement of issues) in the record in Bronson I. The stipulations of facts and attached exhibits are incorporated herein by this reference. Inasmuch as the Court in Bronson I made detailed findings of fact relating to the background of the transactions in issue, we here set forth only the salient facts. Petitioner resided in Morrison, Colorado, on the date the petition was filed in this case. Art MastersJackie Fine Arts, Inc. (Jackie) is a corporation that sold art masters. An art master consists of a metal plate or plates, mylars, or other tangible property from which prints can be made. The painting or other original work of the artist from which the plate is modeled was not included by Jackie as part of the art master. Jackie would arrange238 for the printing of a limited edition from the plate for an additional fee, or alternatively, an investor could arrange to contract out the printing. The limited edition prints were signed by the artist. Jackie sold the copyright and other marketing and production rights for the image produced from the art master, which entitled the investor to produce posters and other ancillary products, such as note cards. From 1977 through 1980 or 1981, Jackie sold approximately 2,500 art masters. In 1977 and 1978, Jackie sold its art masters for cash, short-term promissory notes secured by letters of credit, and long-term nonrecourse notes. In 1979 and 1980, the long-term notes were partially recourse. Some contracts contained a provision which allowed investors to return inventory or ancillary products produced by them in payment of their recourse liabilities. From 1978 through 1981, Mr. Bronson promoted sales of Jackie art masters through presentations to tax professionals. The sales presentations included an information memorandum and an illustration of the purported tax consequences to investors. Both the information memorandum and illustration of tax consequences focused on purported239 tax benefits; for the year of purchase such benefits averaged $ 4 of tax writeoffs for each dollar invested. The commissions paid to Mr. Bronson by Jackie were based on the amount of cash and secured short-term notes required under the contracts sold, without regard to the total purchase price or the amount of the long-term notes (whether recourse or nonrecourse). As a promoter, Mr. Bronson received a discount on the initial cash payment if he purchased an art master, with a corresponding increase in the long-term note, resulting in the same total purchase price. Mr. Bronson and a partnership, High Country Images, Ltd. (High Country), in which he was a 75-percent partner, purchased three art masters (Dead Giveaway, Rocky Mountain Freighter, and Dreams of Eldorado I and II) from Jackie, on December 30, 1978, December 22, 1979, and December 28, 1980, respectively. (These art masters are herein referred to individually as Dead Giveaway, Freighter, and Dreams of Eldorado.) The prints for Dead Giveaway were from a serigraph by William Schwedler, known to some extent in New York and San Francisco, but almost unknown in the West. The prints for Freighter and Dreams of Eldorado were 240 from etchings by Roy Purcell, who did not have a national reputation, but was known in certain western locations, such as Denver. Mr. Purcell received $ 3,000 in cash, and a $ 165,000 nonrecourse note, for each art master he sold to Jackie. He was also paid $ 4,500 for the printing of each. He eventually sold Jackie 16 art masters, each with 250 limited edition prints; he received no payments on the nonrecourse notes. The record is silent as to the amount received by Mr. Schwedler. For each art master purchased from Jackie, Mr. Bronson and High Country made an initial $ 5,000 or less cash payment and gave a long-term note, on which principal and interest was not due until maturity. The purchase price for the three art masters, including the nonrecourse portion of the long-term note, was: Art MasterPurchase priceNonrecourse portionDead Giveaway$ 280,000$ 275,000Freighter315,000282,247Dreams of Eldorado265,000169,000The agreement for Freighter provided for the return to Jackie of items produced using the art master image (inventory), the value of which would first reduce the recourse liability and then the nonrecourse liability. The agreement for241 Dreams of Eldorado had a similar provision regarding inventory return. Under the purchase agreement, 50 percent of the net receipts from the sale of prints and ancillary products was to be paid on the long-term notes until such debts were satisfied. Jackie routinely forgave the recourse liabilities relating to art master purchases if investors returned the art master and limited edition prints. No attempt was made to verify whether the fair market value of the art masters and related prints was equal to the amount outstanding on the notes. Mr. Bronson received an offer to return art masters and prints in exchange for Jackie's forgiveness of recourse liabilities. Mr. Bronson or High Country received appraisals for each of the three art masters in excess of $ 300,000. The record does not reflect when these appraisals were prepared, but each is dated after the sale of the art master being appraised. In 1980, the recourse portions of the notes for the purchase of Dead Giveaway and Freighter were increased; the term of the note for Dead Giveaway was extended. Edward Koplin, Mr. Bronson's partner in High Country, owned a retail gallery in Denver. Mr. Koplin also owned a marketing242 and distribution company named Authenticated Graphic Editions Internationale, Ltd. (AGE) which was primarily an art wholesaler. AGE was made the exclusive distributor of Dead Giveaway, Freighter, and Dreams of Eldorado. The AGE agreements required a $ 500 initial payment and a $ 2,500 payment due after the plates or limited editions were received; both payments were to be used to market the products from the art master. AGE was to receive a nonrefundable commission of 40 percent of gross receipts from all sales, and an additional 10 percent of gross receipts, which was refundable if not actually spent on marketing or retained as "reasonable compensation" for AGE. AGE sold nine Freighter prints from 1980 through 1982 and three Dreams of Eldorado prints in 1982 for total sales proceeds of $ 1,430 and $ 480, respectively; from 1983 through 1989, there was at most one sale of the art master prints for $ 300. A few of the Jackie art master prints were sold by Chatfield Frameworks and Gallery, a custom framing shop and gallery in which Mr. Bronson and petitioner were partners. Mr. Bronson and petitioner filed joint Federal income tax returns for 1980 through 1982 claiming depreciation243 deductions for Jackie art masters as follows: Depreciation claimedArt MasterBasis198019811982Dead Giveaway$ 65,000$ 10,543$ 8,200 $ 7,222 Freighter86,14718,11315,09412,578Dreams of Eldorado72,0008,00014,33311,944Investment tax credits were also claimed on the returns for these years; however, the source for the credits was not clearly identified. 1An unsigned Form 1040 for 1979 sent by Mr. Bronson and petitioner to the Internal Revenue Service claims a $ 140,000 basis in an "ART MASTER" acquired in "12/78", $ 27,259 in related depreciation, $ 14,340.50 of loss from High Country, and $ 3,090 of investment tax credit based on $ 157,500 of property of High Country. The 1979 tax return filed by Mr. Bronson and petitioner 244 (in 1989) does not show depreciable basis for any Jackie art masters, but claims an $ 11,863 investment tax credit based in part on High Country property in the amount of $ 23,102. 2In Bronson I, respondent presented expert testimony by Karen Carolan and Larom Munson. Ms. Carolan projected that optimistically only between 10 to 25 percent of each Jackie art master limited edition would be sold, and that even if the entire limited edition was sold, the net sales proceeds would be less than $ 46,000 for each. Her estimates and projections were based in part on the huge volume of prints by these artists which were placed on the market by Jackie. Mr. Munson projected that a good marketing effort would result in limited edition sales of 5 percent for Dead Giveaway, 15 to 17 percent for Freighter, and 20 percent for Dreams of Eldorado. He estimated the total value of these limited editions as $ 500, $ 3,000, and $ 3,250, respectively. His estimates were245 also based on the fact that the market was "flooded" with Jackie prints. Ms. Carolan and Mr. Munson each testified that there was little chance that either posters or other ancillary products from these art masters would be marketed successfully. Timeshare PartnershipsMr. Bronson was the sole shareholder and president of Resort Timeshare Management Company, Inc. (Management). Management was a subchapter S corporation formed under the laws of the State of Delaware. Resort Timeshare Marketing Associates, Ltd. (Marketing) was an accrual method, calendar year, limited partnership formed under the laws of the State of Colorado on December 4, 1980. Management was the sole general partner of Marketing. Mr. Bronson was the initial limited partner of Marketing, but agreed to withdraw upon the admission of additional limited partners. Mr. Bronson was not issued Schedules K-1 relating to Marketing for 1980, 1981, or 1982. International Vacation Resorts, Inc. (IVR) was organized in November 1980 under the laws of the State of Colorado for the purpose of creating and marketing timeshare intervals. Mr. Bronson owned one-third of the stock in IVR, and was on its board of directors. 246 On December 4, 1980, Marketing and IVR entered into an agreement providing for IVR to be the exclusive agent in certain countries to market timeshare intervals in the United States and Bermuda (the Marketing/IVR agreement). 3 Marketing agreed to pay IVR a nonrefundable "minimum annual marketing fee" in an amount equal to 125 percent of the limited partners' total initial capital contributions to Marketing. IVR was to be paid a commission of 50 percent of the gross retail sales price of the timeshare intervals sold to which the cumulative fees paid would be credited. Payment of the fee could be deferred by Management if the limited partners assumed personal liability for payment. The Marketing/IVR agreement was amended on March 30, 1981, to require a minimum annual fee of $ 712,500, plus an amount equal to two times the initial capital247 contributions of the limited partners admitted in 1981. As of December 31, 1980, Marketing had not acquired any asset from which timeshare intervals could be marketed. At the end of 1981, Marketing had acquired an option to purchase from IVR the Old Adobe Resort in Tucson, Arizona. The partnership returns for Marketing reflect the following deductions for marketing fees: Taxable period Amount Dec. 30 to 31, 1980$ 712,500 Jan. 1 to Dec. 31, 19811,612,500Jan. 1 to Dec. 31, 19821,612,500$ 3,937,500These returns show deductions for management fees in the amounts of $ 36,000 for 1981 and $ 39,000 for 1982. Marketing did not file partnership returns for tax years after 1982. Resortimeshare Development Associates, Ltd. II (Development) was an accrual method, calendar year, limited partnership formed in 1981 under the laws of the State of Colorado. Management was the sole general partner of Development. Mr. Bronson was a limited partner in Development. Attached to the private placement memorandum for Development is an unsigned agreement dated December 30, 1981, between Development and IVR, which is similar to the Marketing/IVR agreement. As of December248 31, 1981, Development had not acquired any assets which could be marketed as timeshare intervals. At the end of 1982, Development had acquired an option on a boat named White Peppa for $ 17,090, a creditor interest of $ 1,005,000 in a boat named Romance, and made a $ 120,623 downpayment on a boat to be built named Skipperliner. The partnership returns for Development reflect the following deductions for marketing fees: Taxable period Amount Dec. 30 to 31, 1981$ 1,025,000Jan. 1 to Dec. 31, 19821,025,000$ 2,050,000The 1982 return shows a deduction for a management fee of $ 27,000. No partnership returns were filed for Development for tax years after 1982. Additions to TaxNeither Mr. Bronson nor petitioner timely filed a Federal income tax return for any of the years 1979 through 1983. By letter dated November 27, 1981, the IRS advised Mr. Bronson and petitioner that available records indicated that "you" had income of about $ 103,000 from Financial Strategy Company for 1979. A series of letters, ending with one dated April 28, 1983, from Mr. Bronson to the IRS in response to IRS correspondence, indicates that the IRS requested that he249 file a return for 1979. In 1982, Mr. Bronson submitted an unsigned Form 1040 for 1979 to the IRS, showing taxable income of $ 54,899.36, the tax on which was eliminated by claimed investment tax credit. On December 28, 1987, Mr. Bronson and petitioner filed a joint income tax return for 1983. In April 1989, Mr. Bronson and petitioner filed joint income tax returns for each of the years 1979, 1980, 1981, and 1982. On the unsigned Form 1040 for 1979 and the returns for 1980, 1981, and 1982, there are claimed deductions relating to the Jackie art masters. The returns for 1980 through 1983 report losses relating to Management, and the returns for 1981 and 1982 report losses relating to Development. In the notice of deficiency mailed to petitioner on December 20, 1990, respondent determined taxable income on the basis of bank records and other financial information. Innocent SpousePetitioner claims entitlement to innocent spouse relief under section 6013(e). In this regard, she testified that she asked Mr. Bronson if they had to file returns for the years in issue, to which he responded no because they did not "owe any money". She further testified that she signed the 250 returns prepared by Mr. Bronson because "he handled financial matters, and [she] trusted him". She was aware that they were undergoing an IRS audit for 7 or 8 years. In 1982, Mr. Bronson, petitioner, and their children spent about 2 weeks in Europe. Part of the trip was spent at the Riviera where Mr. Bronson allegedly examined a boat for investment for development of timeshare intervals. Procedural MattersPursuant to petitioner's request, the Court instructed the parties to file seriatim briefs, with petitioner filing the first brief by July 20, 1992. Petitioner failed to file a brief. Consequently, respondent did not file a brief. OPINION Petitioner presented little, if any, testimony or other evidence to supplement the record in Bronson I. As a result of her failure to file a brief, and based on the limited allegations in her petition, we can only guess at her positions with respect to each of the issues involved. 4251 Art MastersIn Rose v. Commissioner, 88 T.C. 386">88 T.C. 386 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989), we concluded that the investment in Jackie art masters was a "generic tax shelter", devoid of economic substance, and disallowed related depreciation and other deductions, and investment tax credit. In reaching this conclusion, we emphasized the following factors: (1) Tax benefits were the focus of promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued in relation to tangible property included as part of the package; (4) the tangible assets were acquired or created at relatively small cost shortly prior to the transactions in question; and (5) the bulk of the consideration was deferred by promissory notes, nonrecourse in form and substance. * * [Id. at 412.]In affirming Rose, the Court of Appeals for the Sixth Circuit stated that it was not necessary to label the transaction a "generic tax shelter" because252 the record fully supported the Tax Court's finding that it was devoid of economic substance. Rose v. Commissioner, 868 F.2d at 853-854. The record here is not sufficiently distinguishable from that in Rose and in other cases involving taxpayers participating in the Jackie art masters program 5 for us to reach a different conclusion. The Jackie promotional materials are replete with illustrations of the tax benefits associated with the Jackie art masters investments. As a promoter for Jackie, Mr. Bronson marketed the art masters and was particularly familiar with the promised tax benefits and their importance to the investment. As in Bronson I, 253 here we conclude that petitioner failed to prove that Mr. Bronson or High Country negotiated price terms with Jackie. Indeed, the total purchase price of the art master remained the same after Mr. Bronson's "discount" as a promoter for Jackie; only the cash paid was affected. Further, petitioner failed to rebut respondent's determination that the art masters were substantially overvalued compared to the underlying tangible property. Respondent's evidence regarding valuation was far more convincing than the evidence presented by Mr. Bronson in Bronson I. We see no purpose in reiterating the full analysis in Bronson I regarding the valuation evidence. We agree with the analysis and incorporate it here. The evidence indicates that Mr. Purcell received $ 3,000 cash and a $ 165,000 nonrecourse note for each art master from Jackie. There were no payments on the nonrecourse notes. In comparison, High Country purchased the Purcell art masters, Freighter and Dreams of Eldorado, from Jackie at prices of $ 315,000 and $ 265,000, respectively. There was no evidence in the record of the cost to Jackie of Dead Giveaway. To the extent established, the cost of the art masters to Jackie was254 considerably below the resale price. Finally, the bulk of the consideration from Mr. Bronson or High Country to Jackie was in the form of nonrecourse long-term notes. Mr. Bronson testified that this was "essentially a form of equity more than it was debt". He acknowledged that it was not expected to be paid. He also testified that even if all of the prints in the limited edition were sold, after marketing fees, this would not cover the amount of the recourse portion of the notes. Additionally, Jackie routinely offered to forgive the "recourse" liabilities if the investor returned unsold art masters and limited edition prints. And Mr. Bronson received such an offer from Jackie. Petitioner's testimony regarding this issue did more harm to her case than good. She characterized Mr. Bronson's purchase of Dead Giveaway as a "tax shelter". She acknowledged that the net profit which could be realized from the sale of all of the limited edition prints of each art master was less than $ 30,000. In summary, we are satisfied that the investments in Jackie art masters lacked economic substance and do not entitle Mr. Bronson and petitioner, either directly or through High Country, to 255 related depreciation or other deductions, or investment tax credits. Timeshare PartnershipsPetitioner did not present here any evidence additional to that presented in Bronson I or make any arguments with regard to Management, Marketing, or Development. We agree with and thus here incorporate the analysis and conclusions reached in Bronson I. As to the losses relating to Management and Marketing reported on Mr. Bronson's and petitioner's joint returns for 1980 through 1983, we concluded in Bronson I that (1) Mr. Bronson failed to show that he had any adjusted basis in his Management stock or indebtedness of Management to him and was not entitled to deduct losses passed through from Management under section 1374(c)(2) for 1980, 1981, and 1982 and section 1366(d)(1) for 1983, and (2) he failed to show that he was an individual limited partner in Marketing entitled to a distributive share of its losses from IVR or Management fees. As to losses relating to Development reported on Mr. Bronson's and petitioner's joint returns for 1981 and 1982, we concluded that he was not entitled to deduct losses as a limited partner in Development because to the extent that the underlying 256 marketing fees and other expenses were incurred for the tax years 1981 and 1982, Development was not yet in the trade or business of developing and selling timeshare intervals under section 162, but was in a preoperational phase. 6 We agree with and thus here incorporate the full analysis supporting these conclusions as set forth in Bronson I; the analysis and conclusions are equally applicable to petitioner. Additions to TaxApart from the deficiency notice mailed to her, petitioner submitted no evidence in addition to that introduced by Mr. Bronson in Bronson I, and made no arguments with respect to the additions to tax determined by respondent. Section 6651(a)(1) imposes an addition to tax for failure to timely file a return, unless the taxpayer establishes that the257 failure was due to reasonable cause and not willful neglect. The addition equals 5 percent of the tax required to be shown on the return for the first month, with an additional 5 percent for each additional month or fraction of a month during which the failure to file the return continues, not to exceed a maximum of 25 percent. The burden of showing reasonable cause rests with petitioner. Rule 142(a). In Bronson I, we concluded that Mr. Bronson was liable for the addition to tax under section 6651(a)(1), rejecting his contention that he had reasonable cause because "someone" in the IRS told him that he did not have to file a return if he did not have income. We agree with and thus here incorporate the analysis and conclusion in Bronson I. Accordingly, we sustain respondent's determination that petitioner is liable for the addition to tax under section 6651(a)(1). Section 6653(a) for 1979 and 1980, and section 6653(a)(1) for 1981 through 1983, provide for an addition to tax of 5 percent of the underpayment of tax if any part of the underpayment is due to negligence or intentional disregard of the rules and regulations. Section 6653(a)(2) imposes a further addition to tax equal258 to 50 percent of the interest due on the portion of the underpayment attributable to the negligence for taxes due after December 31, 1981. Negligence is the lack of due care, or the failure to do what a prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioner bears the burden of establishing that the negligence addition to tax does not apply. We concluded in Bronson I that Mr. Bronson failed to show that any part of the underpayment was not due to negligence or intentional disregard of the rules and regulations. We agree with and reach the same conclusion as to petitioner. Thus, respondent's determination that petitioner is liable for the additions to tax under section 6653(a) for 1979 and 1980, and under section 6653(a)(1) and (2) for 1981 through 1983, is sustained. Section 6654 provides for an addition to tax for underpayment of estimated tax by a taxpayer. Mr. Bronson and petitioner had tax liabilities for each of the years 1979 through 1983. Respondent determined that no estimated tax payments were made for any of the years in issue, and the record does not include any evidence of such 259 payments. In Bronson I, we concluded that Mr. Bronson failed to show that he met any of the exceptions to the addition to tax set forth in section 6654(d). Reaver v. Commissioner, 42 T.C. 72">42 T.C. 72, 83 (1964). Likewise, here we reach a similar conclusion with respect to petitioner. Accordingly, respondent's determination that petitioner is liable for additions to tax under section 6654(a) for each of the years in issue is sustained. Innocent SpouseUnder section 6013(d)(3), if a husband and wife file a joint tax return for a year, then "the tax shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several". Section 6013(e)7 relieves a spouse of all or part of the joint return liability if certain requirements are met. 260 In order to qualify for relief for the years in issue, petitioner must show that: (1) Mr. Bronson and she filed joint tax returns; (2) on the returns there is a substantial understatement of tax; (3) the substantial understatement of tax is attributable to "grossly erroneous items"; (4) the "grossly erroneous items" are items of Mr. Bronson; (5) in signing the returns, she did not know, and had no reason to know, of the substantial understatement; and (6) considering all the facts and circumstances, it is inequitable to hold her liable for the deficiency attributable to the substantial understatement. See Estate of Simmons v. Commissioner, 94 T.C. 682">94 T.C. 682, 683 (1990); Purcell v. Commissioner, 86 T.C. 228">86 T.C. 228, 234-235 (1986), affd. 826 F.2d 470">826 F.2d 470 (6th Cir. 1987). If the "grossly erroneous items" are claims for deductions, credits, or basis, they must have "no basis in fact or law" and exceed a certain percentage of the adjusted gross income for the "preadjustment year" (her most recent taxable year ending before the date the deficiency notice was mailed). Sec. 6013(e)(2)(B), (4). In deciding whether261 it is equitable to hold petitioner liable for the deficiency, an important consideration is whether she benefited significantly from the understatement of tax; "normal" support is not a significant benefit. See sec. 1.6013-5(b), Income Tax Regs.Petitioner bears the burden of showing that she satisfied each of the statutory requirements to be relieved of liability. Bokum v. Commissioner, 94 T.C. 126">94 T.C. 126, 138 (1990). The record does not provide the adjusted gross income for 1989, the preadjustment year. Additionally, petitioner traveled to Europe, including the Riviera, for 2 weeks in 1982, which appears to be a benefit beyond "normal" support. On this record, we conclude that petitioner failed to show that (1) the underpayment attributable to the "grossly erroneous items" ("deductions, credits, or basis") exceeded the required percentage of her preadjustment year adjusted gross income, and (2) it would be inequitable to hold her liable for such underpayment. Thus, we conclude that she is not entitled to be relieved of liability for any of the years in issue under section 6013(e). To reflect the concessions by respondent, Decision will be entered*262 under Rule 155. Footnotes2. Interest on the underpayment attributable to tax-motivated transactions, accruing after Dec. 31, 1984, at 120 percent of the normal underpayment rate.↩1. 50 percent of the interest due on the portion of the underpayment attributable to negligence.↩1. The 1980 return contains an unclear notation as follows: ↩80610Rocky Mt Freighter (increased recourse note)91000Dreams of Eldorado I & II recourse notes5000cash176,610x .75132,458+4050 = 136508computer 2. A footnote to the $ 23,102 amount states: ".75 of $ 30802."↩3. The Marketing/IVR agreement was signed on behalf of Marketing by Mr. Bronson as president of Resort Timeshare, Inc. which was characterized as the general partner of Marketing.↩4. In the petition, petitioner alleged that respondent should be estopped from joining her as a party in Bronson I based on several procedural arguments. However, she was not joined as a party.↩5. Bronson I; Mandelbaum v. Commissioner, T.C. Memo. 1990-223; Ballard v. Commissioner, T.C. Memo. 1988-436; Estate of Murray v. Commissioner, T.C. Memo. 1987-602; cf. Gangel v. Commissioner, T.C. Memo. 1991-358↩.6. In Bronson I, we also concluded that Mr. Bronson's capital contribution to Development was $ 10,000 and his distributive share of allowable losses, if any, from Development would be limited to $ 10,000 under secs. 465(a) and (b) and 704(d).↩7. The applicable statute for the years in issue is sec. 6013(e)↩ as amended retroactively to all open years to which the Internal Revenue Code of 1954 applies by the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 242(a) and (c), 98 Stat. 494, 801-802, 803.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623190/	Union Telephone Company v. Commissioner.Union Tel. Co. v. CommissionerDocket No. 10564.United States Tax Court1948 Tax Ct. Memo LEXIS 263; 7 T.C.M. (CCH) 42; T.C.M. (RIA) 48007; January 28, 1948263 Held, that the transactions here involved between petitioner and the holder of all its outstanding old bonds did not constitute purchase and sale transactions but an exchange or substitution of new bonds for old as evidence of a continuing indebtedness between the same parties. Further, held, that the amount paid for premium and unamortized discount and expense upon retirement of the old bonds in 1941 is not deductible in full in that year, but should be amortized over the life of the new bonds issued in exchange for the old. South Carolina Continental Telephone Company, 10 T.C. 164">10 T.C. 164. (Promulgated January 28, 1948), followed. Milton E. Carter, Esq., 1 N. La Salle St., Chicago 2, Ill., for the petitioner. Gene W. Reardon, Esq., for the respondent. TYSON Memorandum Opinion TYSON, Judge: This proceeding involves an income tax deficiency of $20,521.09 for the calendar year 1941, determined by respondent against petitioner, a Michigan corporation which has its principal place of business at Owosso, Michigan, and which owns and operates telephone exchanges, properties, and systems within that state. Petitioner kept its books on the accrual basis and264 made its tax return for the period involved on that basis. The return was filed with the collector of internal revenue for the district of Michigan. The only issue herein involves the respondent's disallowance for the year 1941 of a deduction of $66,197.08, claimed as premium paid and unamortized discount and expense upon the retirement, in that year, of petitioner's first mortgage Series A bonds in the principal amount of $1,300,000. The proceeding was submitted upon the pleadings and a stipulation of facts including exhibits attached thereto. The stipulation is adopted as our findings of fact and included herein by reference. Except as to such matters as the taxpayer involved, the dates of issuance and principal amounts of and rates of interest on its old Series A bonds and its refunding new Series B bonds, and the amount of the claimed deduction on account of premium paid and unamortized discount and expense upon retirement of the old Series A bonds, etc., the parties are agreed that the facts herein are in all essential respects similar to those involved in the proceeding South Carolina Continental Telephone Company, Docket No. 10212, which was heard on the same date as this265 proceeding and which involves a similar issue. We conclude, and so find, that the transactions carried out on March 12, 1941 pursuant to agreement between petitioner and the John Hancock Mutual Life Insurance Company, whereby petitioner issued $1,300,000 principal amount of its new Series B bonds, under Article Four of the indenture of mortgage, for the purpose of refunding, and the simultaneous cancellation and retirement of an equal principal amount of old Series A bonds, constituted essentially an exchange or substitution of petitioner's new bonds or obligations for its old one, principal amount for principal amount, as evidence of a continuing indebtedness between the same parties. (Promulgated January 28, 1948), followed. On authority of the above cited case the respondent is sustained in his determination that the amount paid for premium and unamortized discount and expense upon retirement of the old bonds in 1941 is not deductible in full in that year, but should be amortized over the life of the new bonds issued in exchange for the old. As agreed by the parties. Decision will be entered under Rule266 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623191/	JOHN G. LONSDALE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lonsdale v. CommissionerDocket No. 19741.United States Board of Tax Appeals11 B.T.A. 659; 1928 BTA LEXIS 3747; April 18, 1928, Promulgated 3747 A national bank desiring to form a trust company to perform certain functions which were prohibited by its charter, secured agreements from a majority of its stockholders that in the event of the declaration of a cash dividend, such stockholders would allow the dividend to be used in payment for stock in the trust company to be formed. The dividend was declared and the amount thereof, in so far as assented to by a majority of the stockholders, was used in payment for stock in the trust company. Held, that the dividend constituted taxable income to the stockholders. Abraham Lowenhaupt, Esq., and Stanley S. Waite, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. LITTLETON659 The Commissioner determined a deficiency in income tax of $3,766.91 for the year 1924. The issue is whether the petitioner received a taxable dividend in 1924 when a dividend was declared by the National Bank of Commerce in connection with a proposed plan for the formation of a trust company, which plan had previously been approved by a majority of the stockholders of the bank 660 in their individual capacities and under which plan those3748 accepting it obligated themselves to allow the dividends to which they were entitled to be used in payment for stock in the trust company. The facts are stipulated. FINDINGS OF FACT. At all the times hereinafter mentioned, the National Bank of Commerce of St. Louis, Mo., was a corporation organized under the National Banking Act and operating a national bank in the City of St. Louis, Mo. It had outstanding $10,000,000 in par value of capital stock, divided into 100,000 shares of the par value of $100 each. Petitioner was president of said bank, owning 1,410 shares. Said National Bank of Commerce was advised that as a national bank it could not engage in various financial endeavors advantageous for banks to undertake and in which state banks and trust companies may freely engage and, feeling that the National Banking Act so restricted its endeavors that it was handicapped in competing with said banks and trust companies, said National Bank of Commerce in the year 1923 concluded that it would be advantageous to its business to organize a Missouri corporation to engage in the business in which it was restricted or handicapped by the National Banking Act and the rules and regulations3749 promulgated thereunder. Thereupon the National Bank of Commerce, through its president and acting under authority of its board of directors, under date of June 18, 1923, addressed the following circular letter to all of its stockholders advising them of its purpose to organize and setting forth its plan for the organization of a new company. As you know, we have established a Savings Department which now has nearly 50,000 depositors, with total deposits of over eight millions. We have also put in a Bond Department which is doing a very satisfactory business By special permission of the Federal Reserve Board, the bank qualified to act in a fiduciary capacity, and our Trust Department is now handling a large volume of trust matters. We have also taken over and are now operating our Safe Deposit Vaults. There are, however, some financial matters that cannot be transacted through a National Bank, and yet are allied with commercial banking so closely that we have realized for some time the necessity of having a way to take care of this business. And so, at a recent meeting of the Board of Directors, the officers of the bank were directed to formulate a plan for creating a company3750 to be called Commerce Company or some other suitable name which will have the power of dealing in all kinds of securities, including first mortgage on real estate, real estate, and other matters of like character, it being the purpose that the charter of this company shall be broad enough to enable the company to supplement the service now performed by the bank. The new company is to be owned by the stockholders of the bank in proportion to their holdings of stock in the bank. We have examined a number of different plans that have been adopted by national banks throughout the 661 country, and have concluded that the best is that known as the Chicago plan. Under this plan, the directors of this bank will declare a 10% cash dividend, amounting to a million dollars, and the stockholders will be asked to subscribe for stock in the new company in an amount equal to this dividend and authorize the committee to apply the proceeds in payment of their stock in the new company. In this way, each subscribing shareholder in the bank will have one-tenth of a share of fully paid stock in the new company for each share of stock in the bank. Believing that the interests of the stockholders3751 of this bank will best be served if their interests in the bank and the new company are kept identical, the plan of organization provides that the stock in the new company shall be held by the trustees named in the agreement for the benefit of the subscribers, except a few shares that may be necessary for the directors to qualify. While such trust continues, the beneficial interest in the stock of the new company deposited with the trustees will pass with the transfer of the stock in this bank. Each stockholder, therefore, is requested to sign the enclosed acceptance and power of attorney so that the new company may be promptly organized and put in operation. The gentlemen named in the power of attorney are directors and large stockholders in the bank. Inclosed with the letter was a form of acceptance of the plan addressed to the president of the bank and power of attorney, which form of acceptance follows: Replying to your circular letter of June 18th, 1923, in which you refer to a proposition and plan to form a new company to be called "Commerce Company" or some other suitable name the undersigned hereby accepts and approves such proposition and plan. The undersigned3752 hereby designates and appoints W. Frank Carter, Chas. Rebstock and John Strauch, jointly and severally, a Committee, and hereby vests in said Committee jointly and severally full right, power and authority for and on behalf and in the name of the undersigned, to do anything they or either of them deem proper and desirable to consummate and carry into effect the above or any similar proposition and plan, and to deposit the shares of stock and certificates representing the same, of said new company in trust with Trustees, all the terms and provisions of the agreement creating said trust and of the charter of the new company, to be such as said committee jointly or severally shall determine. And said committee shall for me have the authority and power to receive the ten per cent (10%) dividend when declared by the National Bank of Commerce in St. Louis, and to use the same to pay my interest in full in the company to be organized and called Commerce Company, or some other suitable name. And said committee jointly or severally is hereby given full right, power and authority to do everything in the premises that said committee jointly or severally shall deem fit or proper, hereby ratifying, 3753 confirming and approving everything that said committee jointly or severally shall do under or by virtue hereof. Prior to January 2, 1924, stockholders, including petitioner, owning in excess of 80 per centum of the stock of the National Bank of Commerce, to wit, 93,820 shares of its stock, out of a total of 100,000 shares outstanding on that date, had signed acceptance and power of attorney and filed it with the National Bank of Commerce. 662 January 2, 1924, the board of directors of the National Bank of Commerce adopted a resolution in the following words, to wit: WHEREAS, response to the June 18th, 1923 circular letter of the President to the stockholders indicates that the formation of the new "COMMERCE COMPANY" (The name of which has been determined to be "NATIONAL COMMERCE COMPANY") is generally favored, and WHEREAS, the capital of this bank is $10,000,000.00, its surplus $2,000,000 and its undivided profits in excess of $3,000,000, and said $2,000,000 surplus was accumulated in the years and in the amounts following: 1889$100,000.00Original$100,000.001890500,000.00Added making600,000.001899400,000.00Added making1,000,000.001902400,000.00Added making1,400,000.001907600,000.00Added making2,000,000.003754 and no part of said surplus has ever been reduced, and WHEREAS, it is desired to declare a special $1,000,000 ten per cent, dividend from a "Special $1,000,000 Dividend Account" of undivided profits to be drawn from surplus, and it is desired in drawing said $1,000,000 from the present 20% surplus of $2,000,000 that the surplus be not reduced below the required $2,000,000 and the only way that result can be had is by increasing surplus $1,000,000 from undivided profits before, rather than after, the $1,000,000 is withdrawn from said $2,000,000 surplus to said "Special $1,000,000 Dividend Account," and WHEREAS, the purpose of said special dividend is that each stockholder so minded may, with said dividend, cause the payment in full of his interest in said "NATIONAL COMMERCE COMPANY," NOW, THEREFORE, IT IS RESOLVED, That $1,000,000 of undivided profits be transferred to surplus, making total surplus $3,000,000, so that when said 10% dividend is transferred from the said surplus of $2,000,000 to said "Special $1,000,000 Dividend Account," the surplus may not be reduced below the required 20% or $2,000,000, and that a "Special $1,000,000 Dividend Account" of undivided profits be3755 and is hereby established to receive $1,000,000 from the said $2,000,000 of surplus for said special dividend for said "NATIONAL COMMERCE COMPANY." AND IT IS FURTHER RESOLVED, That a special $1,000,000 10% dividend as of this date be and is hereby declared from said "Special $1,000,000 Dividend Account" of undivided profits drawn as above from said surplus in order that each stockholder so minded may with such dividend cause the payment in full of his interest in said "NATIONAL COMMERCE COMPANY." Eventually stockholders of the National Bank of Commerce owning 98,178 shares of the stock of the bank, out of a total of 100,000 shares outstanding, signed the acceptance and power of attorney and thereby agreed that the dividend payable upon their stock might be used to pay up the stock of the new company. The new company, contemplated by the above-described plan and called the National Commerce Co. in the resolution of the board of directors of the National Bank of Commerce, dated January 2, 1924, was incorporated under the laws of Missouri as the Federal Commerce Trust Co., with an authorized capital stock of $800,000 and a 663 paid-in surplus of $181,780. The 10 per cent3756 dividend declared by the National Bank of Commerce upon all its stock held by persons who signed said power of attorney (including petitioner's stock) was paid by it to W. Frank Carter, Charles Rebstock, and John Strauch, the committee named in the acceptance and power of attorney, and was used by them to pay for the stock of the Federal Commerce Trust Co. January 9, 1924, attorneys for the stockholders of the National Bank of Commerce, who subscribed to the acceptance and power of attorney, entered into a trust agreement with John G. Lonsdale, W. L. Hemingway, W. B. Cowen, David Sommers, and L. N. Moffitt, as trustees, and there was deposited with these trustees all of the stock of the Federal Commerce Trust Co., including the stock paid for with the dividend upon petitioner's stock in the National Bank of Commerce, to hold the same during the continuance of said trust and in the manner provided therein. The trust agreement has been in full force and effect since the execution thereof. The trust agreement follows: AGREEMENT, Made at St. Louis, Missouri, dated as of the ninth day of January, 1924, between John G. Lonsdale, W. L. Hemingway, W. B. Cowen, David Sommers, and N. 3757 L. Moffitt, hereinafter called the Trustees, and W. Frank Carter, Charles Rebstock and John B. Strauch, as a committee representing certain stockholders of National Bank of Commerce in St. Louis, hereinafter called the Bank. WHEREAS, the Bank has heretofore declared a ten per cent (10%) dividend of $1,000,000.00, upon its capital stock issued and outstanding; and, WHEREAS, the great majority of its stockholders have through said Committee caused the same to be devoted to the payment of the capital and surplus of the Federal Commerce Trust Company, a corporation organized under the laws of Missouri, hereinafter called Trust Company; and, WHEREAS, it is desired that the beneficial ownership of said shares of the Trust Company should be evidenced by and transferred only as appurtenant to the shares of stock of those shareholders of the Bank who have contributed thereto; and, WHEREAS, it is believed that the interest of all said stockholders will be greatly benefited by entering into said agreement; and WHEREAS, said Committee have been fully authorized to represent the said stockholders who have contributed their respective shares in said dividend toward the payment of said capital3758 stock of the Trust Company; Now, THEREFORE, the parties agree as follows: The said John G. Lonsdale, W. L. Hemingway, W. B. Cowen, David Sommers and N. L. Moffitt, all of whom are now directors of the said Bank, are hereby appointed Trustees hereunder. There are hereby vested in and imposed on the Trustees each and all the rights, powers, privileges and duties in this agreement specified. Any three or more of the Trustees acting at any time and from time to time shall have all the powers, rights and privileges hereby created in and may discharge all the duties imposed upon all trustees collectively, and the act of any three or more 664 shall constitute and be the act of the Trustees. The Trustees are given power and authority at any time and from time to time to remove any of their number and to fill any vacancy in membership caused by removal, death, resignation, absence, sickness, inability or refusal to act or otherwise. The Trustees may select and remove from time to time a Chairman (who shall be a Trustee) and a Secretary (who need not be a Trustee) of the Trustees and may, from time to time, adopt and change such rules, regulations and procedure of every kind3759 and nature for the government of the Trustees, as the Trustees may deem proper. No person who is not at the time a director of the Bank or its successor, shall ever act as or be appointed a Trustee hereunder. When any Trustee ceases to be a Director of said Bank or its successor, he shall immediately without further action cease to be a Trustee hereunder. There shall be deposited with the Trustees, and there shall remain on deposit with them as long as the trust hereby created continues the certificates (except as otherwise herein stated) representing all the shares of the present or future capital stock of the Trust Company. Such certificates (except as otherwise herein stated) shall all be transferred on the books of the Trust Company into the names of the Trustees or of such person or persons acting for the Trustees as the Trustees may from time to time designate for the benefit of said trust. The Trustees may, however, from time to time, sell, transfer and assign to each person who becomes a Director of the Trust Company sufficient shares to qualify each such Director, and take back from each such person an appropriate agreement that when he ceased to be a Director of3760 the said Trust Company, his said shares of capital stock of that Company shall and will be forthwith sold and transferred by him or his legal representatives, to the Trustees for the same price such person paid therefor. The Trustees may at any time and from time to time increase or decrease the capital stock of the Trust Company, or change its name, or amend, extend or renew its charter or effect a consolidation or merger of any other companies lawfully entitled to consolidate or merge with it. The Trustees shall, in case of such increase of the capital stock arrange that the total amount of such increase, including that which would otherwise be allotted to the Directors of the Trust Company by reason of their ownership of shares of stock in that company, shall be issued to and held by the Trustees in the same manner and subject to the same rights, powers, privileges and duties under which the Trustees hold the original stock of the Trust Company hereunder. All the stock held by the Trustees of the Trust Company hereunder, shall be held by them for the benefit of such person as from time to time shall be the owners of those shares of the Bank of which the ten per cent (10%) dividend3761 declared by the Board of Directors of said Bank on the 2nd day of January, 1924, has been devoted to the payment of the capital stock and surplus of said Trust Company and for the benefit of any person or future holder of any share of the capital stock of said Bank, the owner of which has not heretofore made such contribution to such stock of the Trust Company at any time after any owner of such share of stock shall have paid to said Trust Company for its surplus fund an amount equal to the said Ten per cent (10%) dividend on such share or shares of the capital stock of the Bank, together with interest thereon at not to exceed five per cent (5%) from the date of the organization of the Trust Company to the date of such payment but such payment shall not entitle the owner of such share or shares to the benefit of any dividends declared on capital stock of the Trust Company prior to the date of making such payment. All the stock of the Trust Company held by the Trustees hereunder shall be held by them as herein provided and the Trustees may exercise during the life 665 of the trust hereby created, all of the rights, powers and privileges of absolute owners of said stock except3762 as otherwise herein provided and except also to the extent and in so far as they may receive express directions, in writing, signed by a majority of at least two-thirds in interest of the persons beneficially interested in said stock and subject to distribution of dividends upon said stock as hereinafter provided. All dividends received by the Trustees on said stock shall be immediately distributed by the Trustees either through the Trustees or through the said Bank if turned over to it by the Trustees among the persons beneficially interested as aforesaid in the capital stock of said Trust Company pro rata according to their ownership of record of shares of stock of said Bank, or its successors for the time being that is to say each stockholder of the bank or its successors who shall be the owners of stock, the dividend of which shall have been applied to the payment of the capital stock of surplus of the Trust Company as hereinbefore provided, shall participate in any dividend so distributed in proportion to his holdings of record of such stock of the Bank or its successor on the day of payment of the dividend by the Trust Company so to be distributed. The Trustees may, upon the3763 receipt of such dividend from the Trust Company turn same over to the Bank or its successor for immediate distribution by the Bank or its successor among the persons beneficially interested as aforesaid. The turning over of said dividend by the Trustees to the Bank for distribution as aforesaid, shall be a complete and absolute release and discharge of the Trustees to the extent of the dividends that may from time to time be turned over to the Bank for distribution, as aforesaid. The trust hereby created shall continue so long as the Bank or its successor or successors shall continue to do a banking business unless the said trust shall be sooner terminated, and it may be so terminated by the affirmative request in writing of a majority of at least two-thirds in interest of the holders of record of the entire capital stock at the time of the Bank or its successor for the time being and upon the termination of said trust the shares of stock of said Trust Company shall belong to and be distributed among the then stockholders of record of the Bank or its successor for the time being in proportion of their holdings of those shares of the Bank or its successor; the dividends upon which3764 shall have been paid to the Trust Company for its capital or surplus aforesaid. While the stock of the Trust Company shall be held by the Trustees as hereinbefore provided, no person beneficially interested therein shall have the right to transfer his interest therein, or any part thereof otherwise than by the transfer of the ownership of his stock in the Bank or its successor for the time being upon the books of the Bank or its successor, and no beneficial interest in the said stock of the Trust Company shall be capable of being severed from the ownership of said stock of the Bank or its successor and the only evidence of such beneficial interest of any person in the stock of the Trust Company shall be that given by an endorsement placed upon all certificates of stock of the Bank, the dividend of which shall have been applied as aforesaid, and a corresponding memorandum shall thereafter until the termination of the trust always be placed as aforesaid on the back of the certificate of stock of such Bank or its successor which shall be entitled to the benefit of said trust as hereinbefore set forth, and no person owning any beneficial interest in stock of the Trust Company shall3765 be entitled to share in the distribution of any dividends received by the Trustees until his certificate for his stock in the Bank shall be presented to the Trustees, and said endorsement shall have been placed thereon, but the Trustees may, at their election, cause such dividend to be paid to any stockholder of the Bank entitled thereto who from inadvertence 666 or for some valid reason has failed to present his certificate for such endorsement, although otherwise entitled to the benefit of this agreement. The capital stock of the bank may be increased or decreased from time to time as by law provided, and in case of any such increase or decrease a corresponding increase or decrease shall be made in the beneficial interest of present stockholders of the bank in the stock of the Trust Company so that the holders of all stock hereafter issued shall forthwith become and be beneficially interested in common with other stockholders of the Bank or its successor who have contributed to the capital or surplus of the Trust Company in a pro rata amount of the stock of said Trust Company under the trust hereby created. Each and all the provisions herein contained shall govern and3766 apply with the same force and effect to any successor or successors to either the Bank or Trust Company, and shall also govern and apply if the name of either the Bank or Trust Company shall be changed or if the charter of said Bank or said Trust Company shall be amended, extended or renewed, or if any other bank or banks shall be merged into or consolidated with the bank or its successors. WITNESS THE SIGNATURES of the parties on the date first above written. (signed) W. FRANK CARTER. CHARLES REBSTOCK. JOHN B. STRAUCH. (signed) DAVID SOMMERS, W. B. COWEN, N. L. MOFFITT, JOHN G. LONSDALE, W. L. HEMINGWAY, As Trustees.As a committee for the stockholders of the National Bank of Commerce in St. Louis who have contributed a certain ten per cent dividend declared upon its stock as a payment on the capital and surplus of the Trust Company. Pursuant to the terms of the trust agreement, all of the stock of the Federal Commerce Trust Co. was issued to the trustees and is held by them. The trustees were stockholders and directors of the National Bank of Commerce. No certificates of beneficial interest were issued by the trustees. Evidence of the beneficial3767 interest in the stock of the Federal Commerce Trust Co. of petitioner and the other stockholders of the National Bank of Commerce is an endorsement stamped upon the certificates of stock of the National Bank of Commerce. The amount of a dividend of 10 per cent upon the stock of the National Bank of Commerce held by petitioner at the time of the adoption of the Directors' resolution above written is $14,100, and the Commissioner held that petitioner received in the year 1924 a taxable dividend amounting to $14,100. The deficiency found by the Commissioner is based upon the addition of that amount to the petitioner's income for the taxable year. OPINION. LITTLETON: The issue is whether there was taxable income to the petitioner on account of the dividend declared by the National 667 Bank of Commerce and used under an agreement between the bank and the petitioner to pay for stock in the Federal Commerce Trust Co. The argument of the petitioner is that "as to those stockholders who accepted the proposal of the National Bank of Commerce for the organization of the Federal Commerce Trust Company, the dividend declared by the National Bank of Commerce was not payable in3768 cash, but was payable in a pro rata interest in the stock of the Federal Commerce Trust Company"; and that since the dividend in question was payable in stock, the transaction here involved constituted a reorganization of the National Bank of Commerce under section 203(c), Revenue Act of 1924, providing as follows: If there is distributed in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized. We do not understand that the petitioner is contending that the dividend in question should not be taxed for the reason that it is a stock dividend and, therefore, exempt from tax under the principle laid down in . Nor do we understand it to be contended that even though it should be found that the dividend was not a cash dividend, but a dividend payable in stock of the trust company, this would of itself exempt3769 the dividend from tax as a stock dividend, since a dividend of one corporation payable in stock of another corporation may be taxable in the same manner as a cash dividend. ; . Was the dividend paid in stock of the trust company? At the time the dividend was declared, the trust company had not yet been formed and, of course, the bank did not have any stock in the trust company which it could use in liquidating the liability to its stockholders arising on the declaration of the dividend. Nor did the bank ever come into ownership of any of the stock of the trust company. What the bank had when the dividend was declared was a cash surplus sufficient to pay the dividend, and agreements from 93.82 per cent of its stockholders that the amounts to which they were entitled under the dividend declaration would be used to pay for stock in the trust company. The persons entitled to receive the dividend were the stockholders of the bank, and a majority agreed that they would allow it to be used in payment for stock in the trust company. We think it would not be possible, 3770 even disregarding form and considering only substance, to say that the dividend was paid in stock which the bank neither then, nor subsequently, owned. It may be true that 668 the bank would not have declared the dividend at this time had it not had agreements with the stockholders that cash would not be demanded, but that the liability of the bank to the stockholders would be met through the transfer of the bank's cash surplus appropriated for the purpose to the trust company and the issuance of stock of the trust company to trustees. It is also true that the stock of the trust company did not come into the hands of the stockholders of the trust company, and that no certificates of beneficial interest in such stock were issued to the stockholders, but the stock was issued to trustees who held the stock under a trust agreement by means of which the purpose in forming the trust could be accomplished, and evidence of the beneficial interest of the stockholders in such stock was shown only by an indorsement on the stock certificates. These facts, however, would not make the payment of the dividend a payment by the bank in stock of the trust company, which it did not then or3771 subsequently own, and which stock was essentially different in character from the stock of the bank. That which took place in this instance is clearly distinguishable from the cases of , and , on which petitioner places much emphasis. Those cases involved an issuance of stock dividends by the Gulf Oil Corporation. The facts in those cases and the reasons for holding the dividends exempt from tax are briefly stated in the syllabus accompanying the Mellon case, as follows: Where a corporation, which was using its earnings in extending its business and was not in a financial position to declare or pay a cash dividend, in order to secure funds with which to pay existing indebtedness and to conduct its business, adopted a plan providing for the sale at par of an amount of stock equal to the outstanding stock to existing stockholders pro rata, and for the issuance to each purchaser, in addition to the stock purchased at par, 100 per cent. of extra stock, and where large stockholders, to insure the success of the plan, agreed to take and pay for shares declined3772 by other stockholders, the extra stock issued to such a heavy stockholder, who had purchased stock other than his proportionate share, on other stockholders' refusal to subscribe therefor, held not subject to income tax, since the receipt of such stock did not increase his income; "income" being something coming to a man. Plainly, the foregoing is far from being analogous to the situation before us. Likewise, ; ; ; and , all involved instances where no second corporation consideration for this reason as well as for others unnecessary to be mentioned. Consistent with the argument that the dividend was paid in stock of the trust company, the petitioner contends that the dividend is 669 exempt from tax under the provisions of section 203(c), supra, since the transaction in question constituted a reorganization within the meaning of section 203(h)(1)(B), which reads as follows: (h) As used in this section and sections 201 and 204 - (1) The term "reorganization" means * * (B) a transfer3773 by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, * * But was there a transfer of assets by the bank to the trust company in the sense contemplated by the foregoing provisions? Of course, if we look only at the fact that bank had certain cash which found its way to the trust company, and disregard the steps by which this was accomplished, it might be said that there had been a transfer of assets from the bank, and that after the transfer, such assets are in another corporation which is now controlled by the stockholders of the corporation from which the assets came. But apparently, the very purpose of the plan followed was to avoid the transfer or exchange of a part of the bank's assets in such a way that it would appear that the bank was forming a branch bank which the bank was prohibited from operating. Section 11737(1), Revised Statutes of Missouri (1919) and 3774 . What the bank desired was a corporation to carry on certain activities which were prohibited under its charter, and there is no evidence that the desired results were accomplished in any way that placed the bank in a position where it could not defend its action as having been carried out in a manner which conformed to the legal requirements under its charter and the Missouri statutes. The assets that passed to the trust company were assets legally owing by the bank to the stockholders after the dividend declaration, but which the stockholders had voluntarily agreed should be used by a committee representing them in payment for stock in the trust company. Under such circumstances, the assets that came to the trust company would in reality represent assets belonging to the individual stockholders and paid in by them for stock in the trust company. The Board is, therefore, of opinion that the transaction here in question does not constitute a reorganization such as would exempt the dividend from tax under the statute. Finally, the petitioner says that he did not receive anything that he did not have before, and3775 that, therefore, it can not be said that income has come to him which would be taxable. Even conceding that this was, in effect, a dividend payable in stock of the trust company, we think the petitioner's contention is unsound. That stock in the bank prior to the issuance of the dividend was not the same as stock in the bank plus stock in the trust company, after assets from 670 the bank had found their way to the trust company, is readily apparent. In the case of , in which a situation arose involving a trust company which was formed in connection with a national bank similar to the plan followed in the case under consideration, the court said: Because the bank and the loan company were distinct legal organizations, operating under separate charters derived from different sources, and possessing independent powers and privileges, we are constrained to hold that, notwithstanding the identity of stock ownership and their close affiliation in management, for some purposes they must be regarded as separate corporations, for instance, as being capable in law of contracting with each other. 3776 The very fact that it was necessary to form the trust company because the bank could not perform the functions which it was desired to have the trust company perform, shows that stock of an entirely different nature was issued by the trust company from that issued by the bank. In , in which the assets and liabilities of one corporation were transferred to a new corporation formed under the laws of another State, the stockholders remaining practically the same, the court, in holding that taxable gain resulted through the exchange said: In the case at bar, the new corporation is essentially different from the old. A corporation organized under the laws of Delaware does not have the same rights and powers as one organized under the laws of New Jersey. Because of these inherent differences in rights and powers, both the preferred and the common stock of the old corporation is an essentially different thing from stock of the same general kind in the new. The difference between the stock in the trust company and the stock in the bank was even more marked than in the foregoing case, for the reason that the trust company was formed*3777 in order to have done things which the bank could not do. The fact that the stock of the trust company could not be sold separate and apart from the stock of the bank does not alter the fact that such stock is something of value even though inseparably attached to the stock of the bank, and carries with it rights and powers that did not exist in the stockholders of the bank before the formation of the trust company. In view of the foregoing, the Board is of the opinion that the action of the respondent in holding that the dividend in question constituted taxable income to the petitioner should be sustained. Reviewed by the Board. Judgment will be entered for the respondent.TRUSSELL dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623192/	FRANK BOYER AND THE ESTATE OF NANCY BOYER, DECEASED, FRANK BOYER AND EDWARD HABERERN, CO-EXECUTORS, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent BoyerDocket Nos. 6728-89, 6765-89, 6476-90, 12620-90United States Tax CourtT.C. Memo 1992-724; 1992 Tax Ct. Memo LEXIS 762; 64 T.C.M. (CCH) 1570; December 22, 1992, Filed Decisions will be entered under Rule 155. For Petitioners: William R. Cousins, III and Lauren C. LaRue. For Respondent: Marikay Lee-Martinez and Rachael J. Zepeda. DAWSONDAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: These cases were assigned to Special Trial Judge D. Irvin Couvillion pursuant to the provisions of section 7443A(b)(4) 2 and Rules 180, 181, and 183. The Court agrees with and adopts the opinion of the Special Trial Judge which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE COUVILLION, Special Trial Judge: In these consolidated cases, respondent determined deficiencies in petitioners' Federal income taxes, additions to tax, and increased interest, as follows: Frank and Nancy Boyer, docket No. 6728-89: Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1) & (2)665966611981$ 45,77812$ 13,733.40--198212,040123,612.003applies 198316,559124,967.703applies 198446,0981213,829.403applies 19853,928121,178.40--763 R. Dale Jost, docket No. 6765-89: Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1) & (2)665966611985$ 98,769.1012$ 29,630.733applies 764 Billy G. and Doris A. Nix, docket No. 6476-90: Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1) & (2)665966611981$ 14,172.0012$4,251.60 --198215,891.00124,767.303applies 19837,892.00122,367.603applies 198410,968.00123,290.403applies 198555,629.441211,768.44applies198645,384.86128,727.32appliesCharles W. and Deborah J. Godwin, docket No. 12620-90: Increased Interest and Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6621(c)6653(a)(1) & (2)665966611981$ 45,31012$ 13,593--198211,013123,3044applies 198475,5701212,171applies198510,108123,0324applies 198733,4771210,0434applies 765 These cases are part of a larger group of cases which respondent has identified as a national litigation project known as William Max Young (Alberta Livestock Transplant) -- PO. The subject cases were selected as test cases to determine the deductibility of certain losses and investment credits in connection with transactions involving registered cattle known as: (1) The 1984 William Max Young & Associates Donor Cow Program (the donor cow program); (2) the 1984 William Max Young & Associates Embryo Program (the 1984 embryo program); and (3) the 1985-MJ or 1986 Global Capital Management Embryo Program766 3767 (the 1986 embryo program). The issues for decision are: (1) Whether petitioners' purchases of donor cows or embryos under the programs had economic substance, business purpose, and profit motive so that the losses and investment credits attributable thereto should be recognized for Federal income tax purposes; 4 (2) if so, the proper amount of income, deductions, and investment credit to be taken into account by each petitioner; (3) if so, whether section 465 limits the losses deductible by petitioners; (4) whether petitioners are subject to the various additions to tax; and (5) whether petitioners' participation in the programs constituted tax-motivated transactions within the meaning of section 6621(c). FINDINGS OF FACT Some of the facts were stipulated and are so found. The stipulation of facts and the annexed exhibits are incorporated herein by reference. PetitionersPetitioners Frank and Nancy Boyer were residents of Pennsylvania at the time their petition was filed. Petitioner R. Dale Jost was a resident of California when his petition was filed. 768 Petitioners Billy G. and Doris A. Nix were residents of Kansas at the time their petition was filed. Petitioners Charles W. and Deborah J. Godwin were residents of Tennessee when their petition was filed. Petitioners Frank Boyer (petitioner Boyer), R. Dale Jost, and Charles W. Godwin (petitioner Godwin) are medical doctors. Nancy Boyer, who was deceased at the time of trial, was also a medical doctor and, like her husband, specialized in cardiology. Prior to his retirement in 1986, Dr. Jost specialized in anesthesiology. Dr. Godwin's medical specialty is gynecology and obstetrics. Each of the physicians initially became aware of the cattle programs at issue through seminars sponsored by an individual named Gene Balliett, who was a former editor of a publication called Medical Economics. Petitioner Billy G. Nix (petitioner Nix) learned of the donor cow program through his son, Billy Chris Nix, who is a medical doctor and who also became aware of the programs through one of the Balliett seminars. Petitioner Nix retired from the United States Air Force in January 1980 and was employed in the aircraft industry during the years at issue. Petitioners had no expertise in cattle769 at the time they made their investments, although petitioner Nix grew up on a farm with dairy cows, and petitioner Godwin also lived on a small farm during his childhood. Each of the physician-petitioners had knowledge of genetics through his medical school training, and Dr. Godwin was also familiar with some of the theories underlying the embryo program through his medical practice, which included care of patients with fertility problems. The Entities Involved With the ProgramsWorldwide Capital Management was based in Dallas, Texas, and provided tax advice to clients. It promoted the donor cow and 1984 embryo programs at issue in these cases. Global Capital Management promoted the 1986 embryo program. William Max Young & Associates was a cattle advisory company in Phoenix, Arizona, and was the original manager of petitioners' cattle in the donor cow program. Leonard Bestgen was an employee of William Max Young & Associates and, in November 1985, assumed management of petitioners' cattle through his own company, Greatwestern Trading Co. Alberta Livestock Transplants, Ltd. (Alberta Livestock Transplants, or ALT), was a Canadian corporation engaged in embryo transplantation770 in registered cattle and was the seller of the donor cows in the donor cow program and the source of the embryos involved in the embryo programs. All embryos sold by petitioners in the donor cow program and all calves sold by them in the embryo programs were to Alberta Livestock Transplants. Dr. David D. Dyrholm was an owner and president of Alberta Livestock Transplants in 1984 and 1986 when petitioners invested in the programs. Dr. Dyrholm, with his wife, Joey Dyrholm, also owned Jo Resources Ltd., a Canadian corporation. Terrence Mitenko was an owner (through Terrejo Enterprises Ltd., a corporation he owned with his wife, Josephine Mitenko) and a director of Alberta Livestock Transplants. Rivergold Farms Ltd. (Rivergold) was a Canadian corporation which was owned in 1985 by Terrejo Enterprises Ltd. and Jo Resources Ltd. Rivergold became the lessee of petitioners' donor cows during 1985. The North American Association was a cooperative organized to sell calves of investors in the embryo programs. All of petitioners' sales of embryo progeny were conducted through the North American Association, and all such sales, as noted earlier, were to Alberta Livestock Transplants. 771 The 1984 William Max Young Donor Cow Program (the donor cow program)All petitioners in these cases invested in the donor cow program through Worldwide Capital Management. Under the terms of this program, petitioners purchased registered cows 5 from Alberta Livestock Transplants during 1984 as follows: PetitionerNumber of CowsPrice Per CowTotal InvestmentBoyer8$ 26,0001928,500$ 749,500Jost2128,500598,500Nix1526,000390,000Godwin926,0001228,500576,000At trial, Dr. Boyer produced registration certificates for 25 Simmental cows and 1 Brahman cow. Of the Simmental cows, the registration certificates reflect772 that six were born in the first quarter of 1984. Dr. Jost produced 26 Simmental certificates and 1 Brahman certificate. Some of Dr. Jost's certificates indicate that the cows were obtained through foreclosure from another investor, Mr. Tolbert. Dr. Jost acquired nine additional cows through a transaction with Mr. Tolbert. The Jost registration certificates show that nine of the donor cows acquired from Alberta Livestock Transplants in the donor cow program were born in 1984, and one was born in 1985. Petitioner Godwin produced 20 Simmental and 1 Brahman registration certificates. His Simmental cows were all born between 1981 and September 1983. Petitioner Nix produced 15 certificates for Simmental cows, 6 of which were born in March 1984. The program required cash down payments of $ 1,820 per cow for animals purchased for $ 26,000, and $ 1,995 for the $ 28,500 cows, together with execution of unsecured promissory notes payable to the seller, Alberta Livestock Transplants, for the balance of the purchase amounts. The notes were due in 5 years and required no principal payments prior to the due date. The donor cow program provided that Alberta Livestock Transplants would breed773 petitioners' cows using embryo transplant technology. This technology involved hormonally inducing "superovulation" in a cow with desirable genetic traits (the donor cow) and fertilization of the ovum through artificial insemination using semen of genetically desirable bulls, followed by removal of the resulting embryos through a process known as "flushing" and implantation of the embryos in lesser quality recipient cows for completion of the pregnancy and birth of the calves (referred to as progeny). Embryos could be frozen for implantation at a later date. It was represented to investors that a donor cow could be flushed three or four times during a year, ordinarily resulting in recovery of multiple embryos in each procedure. The purpose of the technique was to increase the progeny of a genetically superior cow. Ordinarily a cow will produce only 8 to 12 calves during her lifetime. The donor cow program offering memorandum provided that Alberta Livestock Transplants would receive one-half of all embryos produced by petitioners' donor cows for the services of ALT in breeding and flushing the cows. The offering memorandum projected sufficient revenue from sales of the remaining774 embryos to retire the investor's promissory note, pay the cost of care and feeding of the cows, and generate a profit for the investor. The projections assumed that each cow would produce 24 embryos each year for 5 years at a price of at least $ 750 per embryo. Pursuant to a management contract with William Max Young & Associates, petitioners were charged separate fees, on a per-head basis, for care and feeding of the donor cows. Sales of embryos from petitioners' cows were to be made through Alberta Livestock Transplants, and ALT would retain sufficient portions of the sale proceeds to pay principal and interest on petitioners' promissory notes, as well as the expenses associated with caring for the donor cows. In 1985, Leonard Bestgen presented petitioners with the option of leasing their donor cows to Rivergold Farms. The prospect of leasing the cows had not been contemplated at the time petitioners entered the program and was not part of the original donor cow program. Under the Rivergold lease agreements, Rivergold would have unlimited use of the donor cows for at least 7 quarters (21 months) and could extend the lease for an additional 21 months to allow for natural breeding775 of any cow that was unsuitable as an embryo transplant donor. The lease specified that Rivergold would flush each cow once per quarter and retain all embryos for its own purposes. Petitioners would be paid $ 2,900 per flushing and could elect to receive the entire amount due under the lease ($ 20,300 for seven flushings) in the first year of the lease. Rivergold was required to pay all expenses of maintaining the cows during the lease and agreed to carry liability insurance on the animals. All petitioners entered into leases with Rivergold and control of the cows was relinquished to Rivergold for the duration of the lease. It appears that the cows remained situated during the Rivergold lease at the same ranches where they had been previously maintained by Alberta Livestock Transplants. Some of petitioners' cows were held over past the initial lease term for natural breeding by Rivergold under the provision extending the lease for cows that had proved unsuitable for use as embryo transplant donors. Lease payments due petitioners under the agreement with Rivergold were credited to principal and interest on petitioners' notes to Alberta Livestock Transplants by interaccount transfers776 between Rivergold and ALT through a Canadian bank. As a result of these credits, petitioners' purchase money notes to Alberta Livestock Transplants were marked "paid" and returned to petitioners. All of petitioners' donor cows were sold at auction in 1989 for $ 700 per head. 1984 William Max Young Embryo Program (the 1984 embryo program)Petitioners Boyer, Godwin, and Jost invested in the 1984 William Max Young Embryo program. This program provided for the sale of an embryo unit (defined as 20 embryos that were expected to yield 10 viable pregnancies) for $ 36,000 or $ 39,000 per unit. Cash payments of $ 9,000 and $ 12,000 were required for the $ 36,000 and $ 39,000 units, respectively, together with an unsecured note for the balance of the purchase price. The notes were payable in 30 months and bore interest at the rates of 12 percent (for the $ 36,000 unit) and 11 percent (for the $ 39,000 unit). Petitioner Godwin purchased two units at $ 36,000 per unit; petitioners Boyer and Jost each purchased one unit for $ 39,000. Although the program was structured as a sale of 20 embryos per unit, petitioners expected to receive 10 calves from the program, regardless of whether777 implantation of their 20 embryos resulted in more or less than 10 live births. As projected in the program's promotional materials, sales of 8 of the 10 calves to be born from the embryos would pay the costs of the program, including the purchase money note, leaving two calves to be retained or sold by the investor for a profit. Petitioners deducted the full purchase price of the embryo units as an expense in the year purchased. 6778 Petitioners were each provided what was referred to at trial as "embryo assignment" sheets consisting of lists of 20 matings per unit, each entry consisting of a donor cow dam identified by ear tag or tattoo number and breed and a sire identified only by name, without breed designation, tattoo numbers, registration numbers, or other identifying information. A recipient cow, identified by a number and location, was also listed. No information was provided concerning dates of flushing of the donor cow or implantation of the embryos. Dr. Boyer provided two registration certificates for calves he claimed were born of embryos acquired in this program. Dr. Godwin provided four registration certificates, and Dr. Jost provided one certificate for claimed embryo progeny from this program. None of the animals identified in petitioners' registration certificates match the information on the embryo assignment sheets in that either the dam, the sire, or both, as reflected on the certificates, differ from the dam and sire information shown on the assignment sheets. Genetically, the animals represented by petitioners' seven registration certificates could not be the result of any of the breedings779 shown on the embryo assignment sheets produced by petitioners. Greatwestern Trading Co., owned by Leonard Bestgen, invoiced petitioners Godwin and Jost in 1986, and North American Association, the cooperative, invoiced Alberta Livestock Transplants in 1987 for the following amounts pertaining to Dr. Jost's one unit and Dr. Godwin's two units in the 1984 embryo program: June 13, 1986GodwinJostFeed and care$ 25,200$ 12,600.00Interest10,3955,197.50Principal payment3,5861,793.00Total $ 39,181$ 19,590.50March 31, 1987GodwinJostFeed and care$ 7,200 $ 3,600 Feed and care1,440720Interest4,6202,310Principal payment50,41425,207Management fees326163Total $ 64,000$ 32,000The Godwin invoices were paid by Alberta Livestock Transplants, crediting $ 39,181 to Dr. Godwin's account to reflect proceeds from the sale of eight calves for a total price of $ 39,181 on June 13, 1986, and the sale of an additional eight calves for a total price of $ 64,000 on March 31, 1987. The proceeds of both sales were payable through the North American Association; the purchaser in both instances was Alberta Livestock780 Transplants. Dr. Jost reported the sale of four calves to Alberta Livestock Transplants through the North American Association on June 13, 1986, for $ 19,590.50, and an additional four calves on March 31, 1987, for $ 32,000, with the proceeds of these sales being credited to Dr. Jost's account with ALT. Global Capital Management 1986 Embryo Program (the 1986 embryo program)The 1986 embryo program offered one unit (10 pregnancies from 20 embryos) for $ 38,000, payable $ 12,500 cash per unit and an unsecured promissory note for $ 25,500, bearing interest at 12 percent per annum and payable in 36 months. Dr. Jost purchased two units at a total cost of $ 76,000, executing a note for $ 51,000; Dr. Godwin purchased six units at a total cost of $ 228,000, executing a note for $ 153,000. The embryo assignment sheets provided to petitioners in this program were similar to the ones in the 1984 embryo program, differing only in the following respects: (1) No breed designation was listed for the donor dams; and (2) the lists contained only 10 entries per unit, with the notation that "A list of the ten (10) embryo transplants that failed to produce a pregnancy is on file at Greatwestern781 Trading Company." No registration certificates for progeny from this program were produced by Dr. Jost or Dr. Godwin. Neither Dr. Jost's nor petitioner Godwin's 1986 taxable years are before the Court in these cases; however, respondent disallowed maintenance fees in the amount of $ 20,400 deducted by petitioner Godwin on his 1987 income tax return with respect to this program. The ExpertsThe cows in the donor program were appraised by petitioners' expert, James C. Mitchell. Respondent's experts who appraised the cattle were Dr. C. K. Allen and Ron Daily. Additionally, Dr. Allen and Mr. Daily appraised the embryos in the two embryo programs. All of the appraisers qualified as expert witnesses under Rule 143(f) and testified at trial. Mr. Mitchell, petitioners' expert, received his B.S. degree in animal science from the University of Kentucky and was involved in beef cattle management since 1970. His experience with Simmental cattle over a period of more than 20 years included showing and selling the breed in several States and serving on the board of trustees for the American Simmental Association during 1980-86. Mr. Mitchell reviewed the registration certificates 782 of all the cows acquired by petitioners in the donor cow program and inspected or observed some, but not all, of the cows. Mr. Mitchell based his conclusions as to the value of the cows upon the pedigree and weaning weight information contained in the registration certificates and his observation of the donor cows. The average value of the donor cows reflected in Mr. Mitchell's report (using the values in his second report) is $ 3,311.36 per cow. Mr. Mitchell did not express an opinion as to the value of the embryos in either the 1984 or the 1986 programs. Respondent's first expert, C. K. Allen, is an associate professor of agriculture at Northwest Missouri State University with a B.S., M.S., and Ph.D. in animal husbandry. Dr. Allen has experience in animal breeding and genetics as well as cattle valuation and cattle management. Dr. Allen researched the value of Simmental cattle during 1984, the year of purchase, including Canadian as well as U. S. sales figures. He also inspected the donor cows and factored in individual merit, reviewing the pedigrees and weaning weights of each cow. The average value of the donor cows shown in Dr. Allen's report is $ 2,891.58 per cow. Dr. 783 Allen also appraised the embryo units in the 1984 and 1986 embryo programs, concluding that none of the units had any positive value, primarily because the information shown on the embryo assignment sheets was inadequate to identify the embryos for purposes of registering the resulting calves. Respondent's second expert, Ron Daily, received his B.S. degree in animal science in 1970 and has spent 15 years managing cattle operations, 7 years conducting agricultural appraisals, and 2 years as executive secretary of the Texas Angus Association. He is a member of several professional associations, including the International Society of Livestock Appraisers and the American Society of Farm Managers and Rural Appraisers. His appraisal was based on the market data approach, comparing the subject property with other Simmental, Brahman, Salers, Simbrah, and Romagnola cattle and embryos of like quality, size, and age that were sold in 1984 through 1986. Mr. Daily's opinion was that the value of the donor cows as of June 1, 1984, was $ 3,374 per cow. Using a cost approach, Mr. Daily determined values for the embryo units in the 1984 and 1986 embryo programs of between $ 6,647.60, assuming784 the donor cow had a value of $ 3,374, and $ 10,252.90, assuming the donor cow had a value of $ 25,000. He also expressed an opinion of the value of the programs on a "per pregnant recipient with embryo" basis, taking into consideration the limited individual sire and dam information shown on the embryo assignment sheets for each petitioner. His value under that method ranged from $ 6,650 to $ 10,100 per unit for the 1984 embryo program units and $ 12,500 for the 1986 embryo program units. Petitioners' Purchases and Involvement in the ProgramsPetitioners did not obtain appraisals of the donor cows or embryo units before investing in the programs and did not negotiate the purchase prices of any of the programs. They did not consult independent cattle experts to determine if the projections contained in the offering memoranda were reasonable, or whether they could realize a profit from the programs. Petitioners did not attempt to contact or consider competitors or other cattle producers involved in donor cow and embryo programs. While some petitioners made inquiries about the business reputation of World Wide Capital Management, none of them investigated the qualifications785 of the cattle manager, William Max Young. Similarly, petitioners made no inquiries about Rivergold Farms before entering into the lease agreement. Petitioners were unaware of common ownership between Rivergold and Alberta Livestock Transplants at the time of the lease. Information identifying the specific donor cows purchased by petitioners was not provided to them until several months after the purchase documents were executed. In several instances, the donor cows originally designated by the cattle managers in correspondence with petitioners were not the cattle for which petitioners eventually received registration certificates. Although it was represented in the offering materials that the donor cows were to have been capable of producing embryos in the year purchased (and therefore should have been at least 18 months to 2 years old), based on the registration certificates, a number of the cows were less than 6 months old at the time petitioners entered the program. Petitioners were generally not aware of the age of the cattle purchased until they commenced preparation for trial of these cases. Petitioners did not negotiate the terms of the lease with Rivergold and were 786 not provided any information concerning embryo production of their donor cows during the Rivergold lease. Even though petitioners had executed agreements for the care and maintenance of their cows with William Max Young & Associates, no documents were ever executed to rescind the prior agreements at the time Rivergold took over the cows as lessee. Petitioners participating in the two embryo programs produced a combined seven registration certificates they claim represented calves born from 12 embryo units; however, none of the progeny reflected in the certificates matched any of the designations on the embryo assignment lists, and two of the registration certificates were for cattle born of natural breeding, not embryo transfer. During the years in issue, petitioners claimed deductions for depreciation, cattle maintenance, and interest expenses, as well as investment credits for the donor cow program and embryo programs. ULTIMATE FINDINGS OF FACT The average fair market value of the donor cows purchased by petitioners on the date of purchase was $ 3,374 each pursuant to the opinion of Mr. Daily. The fair market value of the 1984 and 1986 embryo units on the dates of purchase 787 was $ 250 per unit. The transactions in which petitioners acquired the donor cows and embryo units and sold embryos and embryo calves were not arm's-length, negotiated transactions. The lease with Rivergold Farms was not an arm's-length, negotiated transaction. OPINION Respondent disallowed losses and investment credits claimed by petitioners with respect to the donor cow program and each of the two embryo programs. Respondent also determined that petitioners were liable for additions to tax under sections 6653(a)(1) and (2), 6659, and 6661, and increased interest under section 6621(c). Respondent maintains that petitioners' transactions as to each of these programs should be disregarded for tax purposes because the programs lacked economic substance. Respondent also argues that the programs constituted generic tax shelters pursuant to Rose v. Commissioner, 88 T.C. 386">88 T.C. 386 (1987), affd. 868 F.2d 851">868 F.2d 851 (6th Cir. 1989). It is well settled that transactions without business purpose or economic substance, apart from anticipated tax consequences, are to be disregarded for tax purposes. Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 365-370 (1960);788 Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 469-470 (1935); Hulter v. Commissioner, 91 T.C. 371">91 T.C. 371, 388 (1988). The economic realities, rather than the form or labels employed by the parties, control the tax consequences of a transaction. When taxpayers resort to the expedient of drawing up documents to characterize transactions contrary to objective economic realities and which have no economic significance beyond expected tax benefits, the particular form employed is disregarded for tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 573 (1978); Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332, 347 (1985). In evaluating the economic reality of a transaction, the typical focus is on the related factors of whether (1) the transaction had "economic substance", and (2) the taxpayer had a business purpose beyond the generation of tax benefits. Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 354 (9th Cir. 1988), affg. Brown v. Commissioner, 85 T.C. 968">85 T.C. 968 (1985). Business purpose is present where the investment "was not motivated789 or shaped solely by tax avoidance features that have meaningless labels attached". Hilton v. Commissioner, 74 T.C. 305">74 T.C. 305, 349-350 (1980), affd. per curiam 671 F.2d 316">671 F.2d 316 (9th Cir. 1982). In general, the test for business purpose involves an inquiry of the investor's subjective purposes for entering the transaction. Levy v. Commissioner, 91 T.C. 838">91 T.C. 838, 854 (1988). The inquiry into economic substance, as distinguished from business purpose, involves an analysis of the objective factors that indicate whether the transaction had a reasonable opportunity of producing a profit, exclusive of tax benefits. Levy v. Commissioner, supra.In Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 994-996 (1987), a case involving a purported sale of cattle, this Court looked at four factors in determining whether the transaction had economic substance: (1) Whether the stated price for the property was within reasonable range of its value; (2) whether there was any intent that the purchase price would ever be paid; (3) the extent of the taxpayer's control over 790 the property; and (4) whether the taxpayer would receive any benefit from the disposition of the property. Additional factors relevant here include the presence or absence of arm's-length negotiations; the structure of the financing; the degree of adherence to contractual terms; and the reasonableness of the income and residual value projections. Levy v. Commissioner, supra at 856. In the cases here, to allow petitioners the losses and investment credits claimed, the Court must find that: (1) The donor cow and embryo programs were bona fide; (2) the promissory notes executed by petitioners in connection with the transactions represented genuine indebtedness; and (3) petitioners intended to profit from their investments in the programs. The most important factor in determining whether the transactions were bona fide is the relationship of the price paid by petitioners for the donor cows and embryos and the respective fair market values of the cows and embryos. The normal attribute of a true arm's-length sale is a purchase price approximately equal to the fair market value of the thing sold; a totally disproportionate purchase price strongly militates791 against a conclusion that a true sale has taken place. Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221, 1240-1241 (1981). The parties presented experts who submitted reports and testified as to the value of the donor cows at the time petitioners entered into the programs. These experts, including petitioners' expert, valued the cows at amounts substantially less than what petitioners agreed to pay for the cows. The consensus of all experts was that the cows averaged in value from $ 2,891.58 to $ 3,374 per cow. However, petitioners' purchase prices were $ 26,000 and $ 28,500 per cow. Assuming each cow had a value of $ 4,000, a price of $ 26,000 per cow means that the buyer (investor) paid 6.5 times more than the cow was worth. Petitioners, however, argue that the cows were more valuable because they were purchased for use in an embryo transplant program and should, therefore, be valued on the basis of the potential income that could be derived from the embryo program. None of the expert witnesses subscribed to this view, and petitioners offered no evidence, other than their own opinions, to support this valuation theory. Dr. Allen stated792 that the "stream of income" approach is not used in the cattle industry to value donor cows, and Mr. Daily also noted that the use of an income approach is not used in the cattle industry to appraise beef cattle. Petitioners' expert witness, Mr. Mitchell, stated that he did not use the income method to value petitioners' cattle. Petitioners also argued that access to Alberta Livestock Transplants' technology and the expertise of the cattle manager, William Max Young & Associates, in selecting and caring for the donor cows added value to the cows; however, petitioners provided no evidence to support this proposition, and the testimony of the experts was to the contrary. Both of respondent's expert witnesses found the assumptions underlying the economic projections contained in the donor cow and embryo offering memoranda overly optimistic. Mr. Daily's report notes that the assumption in the offering memorandum that investors could expect 24 embryos per year per cow for each of 5 years of the program was an overestimation of the number of embryos that could realistically be expected from each donor cow over the course of the program. While this number of embryos conceivably could793 be expected the first year, Mr. Daily was of the opinion that it was not feasible to expect that number of embryos in the succeeding years because the continuous practice of flushing disrupts a cow's normal reproductive cycle. His opinion not only was based on his own experience but also was supported by articles of researchers in embryo transplant technology. In the opinion of Mr. Daily, the projected value of embryos from petitioners' cows, $ 750 per embryo, was too high. Dr. Allen was also of the opinion that the projected number of embryos from each cow was not likely to be attained, and that the projected value of $ 750 per embryo was not realistic given the quality of petitioners' donor cows and the high cost of producing embryo pregnancies. Dr. Allen also noted that the maintenance costs required under the programs exceeded the amounts that would normally be agreed to by knowledgeable cattle owners. Mr. Daily agreed with Dr. Allen that payment of one-half of the embryos for Alberta Livestock Transplants' services was excessive. Petitioners' arguments that the value of the cows increased because the cows were in an embryo transplant program is not supported by the evidence. 794 Nor is there any evidence that the purchase price petitioners agreed to pay for the program included any other tangible or intangible property or rights that would justify the price paid. Petitioners' donor cows were eventually sold at auction in 1989 for $ 700 per head as ordinary commercial beef cattle rather than premium registered cattle. Perhaps the most succinct characterization of the economic substance of the donor cow program was set forth by Dr. Allen, who, in his report, pragmatically observed: The Business Plan Outline stated that it was expected that each donor will produce 24 fertile embryos per year and half would belong to ALT for providing the ET labor, technology and marketing and the other half would belong to the investor. Further the Business Outline specified that the expectation was that sales of embryos and calves should fully retire the promissory note and pay interest as well as the high maintenance expenses and the donor cow would have a residual value of $ 5,000. They certainly were not talking about cows of the same caliber that I appraised. If you really get to the bottom line, why would anyone sell cows worth $ 26,000 or more for a down payment795 of $ 1,820 or $ 1,995 when that is apparently the only payment that the investor will have to make and the rest of his payments and cost will come from revenue and residual value. Why not just keep the cow and all the income. In addition many of the donor cows were not raised cows and had to be purchased by ALT before they were placed in the program. Few producers would sell cows with the ability to produce this much income for a price that would make this program feasible.On this record, the Court concludes that the donor cows were substantially overvalued. The Court accepts the values determined by Mr. Daily at $ 3,374 per cow. Petitioners presented no evidence as to the value of the embryos in the 1984 and 1986 embryo programs, for which they had agreed to pay between $ 36,000 and $ 39,000 per unit. Respondent's expert, Dr. Allen, concluded that the embryos had little or no value for the following reasons: (1) The embryo assignment sheets provided to petitioners as the only documentation to identify the embryos purchased did not contain pertinent information such as the registration numbers and complete names of the sire and dam, the implant date, the date due to calve, 796 and whether the embryo was fresh or frozen; (2) some of the embryos appeared to have resulted from crossbreeding Simmental and Salers cattle, a cross that would have had little value; (3) some of the embryos appeared to be Romagnola, a breed that was not well known in the United States in 1984 and would have little value; and (4) the programs required extremely high maintenance and management fees. As a result of the above, Dr. Allen concluded that registration of the progeny would not have been possible because of inadequate information on the embryo assignment sheets. In his report, Dr. Allen summarized his opinion of the value of the embryos as follows: "If these embryo units were sold on the open market they would have no value. In other words, under the conditions and financial obligations of these programs informed buyers would not take them even if they were offered free." Mr. Daily, respondent's other expert, used a cost method in determining a value for the embryos. He considered as cost the $ 3,374 value he found for each of the donor cows and apportioned this cost over the total number of embryos to be produced by the cow over the 5-year period projected in the promoter's797 offering memoranda, 24 embryos per cow per year for 5 years, and a conception rate of 50 percent. He then added to that the costs involved in preparing the cows for flushing and in implantation of the embryos in recipient cows. Under this cost method, Mr. Daily determined that each embryo unit (20 embryos) had a cost or value of $ 6,647 per unit. If the donor cows were valued at $ 25,000 each, the value of an embryo unit would be $ 10,251.90. Both values, as determined by Mr. Daily, are substantially less than the amounts paid by petitioners in the 1984 and 1986 programs. The Court disregards Mr. Daily's cost approach in determining the values of the embryos because his approach to value fails to take into account the demand for the product in the marketplace. It is recognized that, since the supply of a particular property may be greater or less than demand, the reproduction cost of such property may bear no relationship to its fair market value. Tracy v. Commissioner, 53 F.2d 575">53 F.2d 575 (6th Cir. 1931), affg. Huron Bldg. Co. v. Commissioner, 15 B.T.A. 1107">15 B.T.A. 1107 (1929). As a general proposition, replacement cost is not favored798 for tax purposes in arriving at fair market valuations. Ingram-Richardson, Inc. v. Commissioner, T.C. Memo. 1972-157. While reproduction cost may be a factor in determining fair market value, there must be a showing that there is a demand for the property. Lloyd A. Fry Roofing Co. v. Commissioner, T.C. Memo. 1970-298. Replacement cost is not a valid estimate of fair market value in a declining market. Milbrew, Inc. v. Commissioner, 710 F.2d 1302 (7th Cir. 1983), affg. T.C. Memo. 1981-610; Fox River Paper Corp. v. United States, 165 F.2d 639">165 F.2d 639 (7th Cir. 1948). Mr. Daily expressed no opinion that the embryos could have been sold for the cost he determined as the value of the embryos, or that there was a market for the embryos at these prices. Dr. Allen noted in his report that, in 1984, there were too few embryos sold to establish a market value, and that the conditions and guarantees among the few known sales were highly variable, none of which were similar or comparable to the 1984 and 1986 embryo programs involved in the cases799 here. Most sales of embryos involved pregnant recipients carrying embryos with known due dates in which the buyer purchased the recipient cow. Dr. Allen pointed out additional "down side" considerations in embryo breeding, such as abortion, calving difficulty, dead calves, high variability in type and performance even among siblings, inferior calves, and bull calves which usually had much lower values than female siblings. He also pointed out that embryos had little or no value unless a pregnancy rate was guaranteed and the sire and dam were among the very elite cattle of the breed. Mr. Daily stated explicitly in his report that the donor cows he appraised in these cases were not of the elite breeding stock that would command premium prices. The cost for production of the embryos, as determined by Mr. Daily, does not constitute an acceptable value for the embryos in these cases. The Court finds that the embryos had a value of $ 250 per unit in both the 1984 and 1986 programs. Petitioners argued that the purchase prices, while perhaps higher than fair market value, were paid in full by petitioners and should, therefore, be fully recognized for tax purposes. These payments were800 made or effected by the credits by Alberta Livestock Transplants for sales of embryos or calves and lease payments made by Rivergold Farms to ALT. This argument presupposes that the embryo and calf sales and the donor cow lease were bona fide transactions. The evidence does not support such a conclusion. The embryo sales petitioners cite as the source of payment of expenses, interest, and principal before inception of the Rivergold lease appear to have had little, if any, substance. All embryos reported as sold on petitioners' behalf were purchased by Alberta Livestock Transplants, who acted both as petitioners' selling agent and as purchaser. All sales were apparently at prices set unilaterally by ALT. No evidence of any attempt to market the embryos to unrelated third parties is in the record. The lease transaction with Rivergold is similarly without substance. No evidence was introduced to show why Alberta Livestock Transplants would, apparently without receiving any consideration, relinquish its rights to one-half of the embryos obtained from flushing petitioners' donor cows in order to permit Rivergold to assume that role and retain all embryos for itself. This action801 makes sense only when viewed in the context of the common ownership of majority interests in Rivergold and Alberta Livestock Transplants by Dr. Dyrholm and Mr. Mitenko, and the fact that the transactions essentially required only bookkeeping entries to effectuate the desired result. The Canadian revenue agent who investigated the transactions between Alberta Livestock Transplants and Rivergold described the series of credits and deductions as "a wash" insofar as the two Canadian companies were concerned for Canadian tax purposes -- virtually all amounts shown as income for one company were deductible as an expense by the other. No funds were exchanged except between the related companies, which essentially was a movement of money from one corporate pocket to another corporate pocket. Further, the lease did not effectuate any real change in the status of the cattle as between petitioners and Alberta Livestock Transplants. ALT, through Rivergold, continued its control over the cattle during the lease term as it had before, simply crediting the notes for their remaining balances through the device of lease payments rather than purchases of petitioners' one-half of the embryos. Finally, 802 it is illogical that Rivergold would be willing, in an arm's-length transaction, to pay $ 20,300 per head to lease cows which could have been purchased for less than $ 3,400 per head. The lease, and the credits to petitioners' notes and accrued accounts for maintenance of the cows, were nothing more than a means of showing petitioners' satisfaction of the notes representing the inflated purchase prices of the cattle without petitioners' being required to put forth any additional funds for that purpose. In the 1984 embryo program, petitioners point to Alberta Livestock Transplants' crediting of proceeds of sales of calves as the source of payment of their notes. However, there is no evidence that attempts were made to market any of the calves to unrelated third parties; all the sales were to Alberta Livestock Transplants, the original source of the embryos, for amounts set unilaterally by ALT. This permitted Alberta Livestock Transplants to merely credit petitioners' accounts receivable for maintenance costs and "pay off" petitioners' notes by means of bookkeeping entries, without requiring that the transactions yield any true proceeds payable to petitioners. Other than receipt803 of two unencumbered cows worth little more than the cash they had invested in them, petitioners received no true economic benefit from the program. Even petitioner Jost testified that the fact that the embryo calf sales were all to Alberta Livestock Transplants and at prices that matched exactly the accrued expenses and note payments seemed strange to him: Q: When you saw the matching numbers there, what was your reaction? A: Well, it was a little disturbing that these animals were going back and forth to ALT in the first place. When they came out the same, my interpretation was that there may have been some collusion between ALT and Great Western in controlling the price they sold these at. Q: Can you elaborate? What did you think that collusion might be? A: Well, price fixing. I thought that ALT and Great Western had arranged to simply sell the cows back to them for the balance of the expenses so we would be satisfied and have two cows.On this record, the Court concludes that the sales of embryos and calves to ALT and the lease with Rivergold were without economic substance. In addition to the wide discrepancy between the fair market value of the cows and804 embryos and the price to the investor in the offering memoranda, there are other factors supporting the conclusion that there was no economic substance to petitioners' transactions. In Houchins v. Commissioner, 79 T.C. 570">79 T.C. 570, 591 (1932), and Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. at 1237-1238, this Court identified six factors in determining whether a sale is bona fide. See also Cherin v. Commissioner, 89 T.C. at 997; Massengill v. Commissioner, T.C. Memo. 1988-427, affd. 876 F.2d 616">876 F.2d 616 (8th Cir. 1989). These factors are: (1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquires any equity in the property; (4) whether the purchaser has any control over the property and, if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser receives any benefits from the operation or disposition of the property. Under these criteria, petitioners' transactions in the donor cow and embryo805 programs were spurious. As to the first factor, petitioners produced registration certificates from the American Simmental Association and the American Brahman Breeders Association to establish legal title to the cows. Although the director of operations for the American Simmental Association testified that registration certificates do not show ownership and are not analogous to title documents, the fact that the cows were registered to petitioners, and that they eventually sold the cows at auction in 1989, with petitioners receiving the proceeds, indicates that this factor falls in favor of petitioners. The evidence of title in the embryo programs consisted of bills of sale that did not specifically identify the embryos. Lists or assignment sheets of purported embryos were produced at trial; however, the information contained on the lists was vague, at best, and, according to the expert witnesses, could not have been used to identify with certainty either the embryos or the calves that might have resulted from their implantation. Indeed, petitioners were unable to identify any calves that were born from embryos described on the embryo assignment sheets. The evidence is insufficient806 to conclude that petitioners acquired legal title to the embryos. As to the second factor, there is considerable evidence that the parties did not treat the transactions as sales in either the donor cow or embryo programs. At the time the investments were made, none of the cows or embryo units had been assigned, and petitioners received no information identifying their property for several months or, in at least one case, more than 1 year after investing in the donor cow program. Petitioners never received documentation sufficient to identify what they purchased in the embryo programs. The seven calves claimed by petitioners to be 1984 embryo progeny could not have resulted from the matings described on the embryo assignment sheets, and petitioners were unable to otherwise identify any calves born from the embryo programs. Possession of the donor cows or embryos was not transferred to petitioners and remained with Alberta Livestock Transplants, or its related corporation, Rivergold, until the cattle were eventually sold at auction in 1989. The facts and circumstances show that neither petitioners nor the sellers acted as though sales to petitioners ever had taken place. As 807 is evident from the preceding discussion of the fair market value of the donor cows and embryo units, petitioners never acquired any equity in the property, the third factor noted above. The balances due on the promissory notes always greatly exceeded the values of the property purportedly acquired. The fourth factor is whether petitioners had any control over the property. The documents petitioners presented show that petitioners had complete control, exercisable through the cattle managers they contracted with to oversee the donor cows and embryo progeny. Petitioners emphasized at trial their selection of cattle managers to care for their cattle -- first William Max Young & Associates, then Leonard Bestgen and his company, Greatwestern Trading Company, and, finally, Morris & Howland, the business consultants who arranged the auction sale of the cattle for $ 700 per head in 1989. However, the reality is that petitioners were content to leave management of the cattle to whomever was suggested to them, and they never investigated the qualifications of any of the managers before agreeing to their employment. Mr. Bestgen was a former William Max Young & Associates employee, and 808 petitioners merely acquiesced in his succession to William Max Young & Associates as the manager. Mr. Bestgen, in turn, recommended Mr. Morris as his successor. In fact, petitioners had little, if any, control over the property until Mr. Morris assumed responsibility for the cattle and then sold the cattle shortly thereafter. Petitioners generally were only vaguely aware of the various locations where the cattle were maintained during the programs and received minimal information about their condition. The fifth factor is whether the purchaser bears the risk of loss or damage to the property. Although the documents indicate that petitioners bore the risk of loss, as a practical matter, because petitioners never acquired any equity in the overvalued cows and embryos, the seller bore such risk. While not formally guaranteed, petitioners expected to receive no less than 10 calves from each unit of 20 embryos purchased in the two embryo programs, regardless of the actual success rate for producing viable pregnancies from their unit. Petitioners understood they would have rights to no more than 10 calves per unit even if more than 10 calves were born from their 20 embryos. These809 factors indicate that petitioners neither bore a significant risk of loss nor had the right to fully profit from the embryo unit production. The final factor is whether petitioners were likely to receive any benefits out of the production and disposition of their cows or embryo progeny. Since the donor cows and embryos were substantially overvalued, along with the other factors noted, there was little likelihood that petitioners would ever realize any benefits from the programs. On this record, the Court holds that there was no economic substance to the donor cow and embryo programs based upon the six factors set out in 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 a transaction is not conducted at arm's length by two financially self-interested parties, or where a transaction is based on "peculiar circumstances" which influence a purchaser to agree to a price in excess of the property's fair market value, the Court has disregarded indebtedness to the extent it exceeded fair market value of the purchased asset. See, e.g., Bryant v. Commissioner, 790 F.2d 1463">790 F.2d 1463, 1466 (9th Cir. 1986),810 affg. Webber v. Commissioner, T.C. Memo. 1983-633; Odend'hal v. Commissioner, 80 T.C. 588">80 T.C. 588, 604 (1983), affd. and remanded 748 F.2d 908">748 F.2d 908 (4th Cir. 1984); Lemmen v. Commissioner, 77 T.C. 1326">77 T.C. 1326, 1348 (1981); Roe v. Commissioner, T.C. Memo. 1986-510, affd. without published opinion sub nom. Young v. Commissioner, 855 F.2d 855">855 F.2d 855 (8th Cir. 1988), affd. without published opinion sub nom. Sincleair v. Commissioner, 841 F.2d 394">841 F.2d 394 (5th Cir. 1988). Petitioners argue that the Court should recognize their indebtedness to the sellers under each program on the following grounds: (1) The notes were recourse; (2) petitioners believed they would have to pay the notes with other resources if the sales of embryos, embryo progeny, or the donor cows did not cover the debt; and (3) the notes were in fact paid by credits from the Rivergold lease and sales of embryos and calves to Alberta Livestock Transplants. It is the substance of such debt and not its form that must be considered. Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 902 (1986),811 affd. per curiam 841 F.2d 264">841 F.2d 264 (9th Cir. 1988). The courts have refused to give effect to notes which, on face, are recourse notes but which are unlikely to be enforced because of the surrounding circumstances. See, e.g., Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1122-1124 (1987), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865">868 F.2d 865 (6th Cir. 1989); Helba v. Commissioner, 87 T.C. 983">87 T.C. 983, 1009-1011 (1986), affd. without published opinion 860 F.2d 1075">860 F.2d 1075 (3d Cir. 1988). An indication that a loan is genuine is the care with which a prospective lender scrutinizes a transaction prior to making the loan to ensure it will be repaid. There is no evidence in these cases that the lender in any of the programs requested even the most rudimentary812 financial information from the investors. The promissory notes in the donor cow and 1984 embryo program were unsecured, and, in all of the programs, the fair market value of the property for which notes were given in payment was significantly less than the principal amount of the notes. Each of these factors weighs against a finding that the notes represented bona fide indebtedness. As previously discussed, the claimed payment of the notes by means of bookkeeping entries reflecting non-arm's-length sales to Alberta Livestock Transplants of embryos or embryo calves and the equally non-arm's-length lease payments made to ALT by Rivergold are not credible. Under these circumstances, the Court concludes that the "indebtedness" represented by the notes in each program was not genuine; the notes did nothing more than create tax benefits by inflating the purchase prices of the property, thereby increasing petitioners' depreciation and investment credits in the case of the donor cows and also increasing the cost of the embryos deducted as current expenses in the embryo programs. Accordingly, petitioners' indebtedness cannot be recognized for Federal tax purposes. See Goldstein v. Commissioner, 364 F.2d 734">364 F.2d 734, 740 (2d Cir. 1966),813 affg. 44 T.C. 284">44 T.C. 284 (1965). In summary, the Court holds that none of the transactions at issue, including the sales to petitioners of the donor cows and embryos, the subsequent lease to Rivergold, and the sales of embryos and embryo progeny calves back to Alberta Livestock Transplants had economic substance. Having held that the transactions lacked economic substance, the Court addresses the question whether petitioners had a business purpose other than tax avoidance in entering the programs. Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360, 1363 (9th Cir. 1990), affg. T.C. Memo 1987-628">T.C. Memo. 1987-628, affg. in part and revg. in part Larsen v. Commissioner, 89 T.C. 1229 (1987), affg. Moore v. Commissioner, T.C. Memo. 1987-626, affg. Sturm v. Commissioner, T.C. Memo. 1987-625. The "business purpose" test involves an inquiry into whether the taxpayer had a legitimate profit objective apart from tax considerations. Shriver v. Commissioner, 899 F.2d 724">899 F.2d 724, 725-726 (8th Cir. 1990), affg. T.C. Memo. 1987-627.814 The mere assertion of a subjective profit objective will not require recognition of a transaction for tax purposes where the transaction lacks economic substance. Cherin v. Commissioner, 89 T.C. at 993. Petitioners testified they entered into the programs seeking profits which might arise from successful embryo transplant breeding operations, and they relied entirely upon the cattle managers and Alberta Livestock Transplants to carry on the ventures. Despite this testimony, the Court is not convinced that petitioners actually had the objective of realizing economic gain from their cattle activities. Many of the same factors that demonstrate lack of economic substance are also important in considering whether petitioners had an "actual and honest profit objective" in engaging in the transactions at issue. Rose v. Commissioner, 88 T.C. at 411; Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 321 (1976). Additionally, in determining whether a taxpayer intended to profit from an activity in which participation is passive, the Court pays particular attention to whether the taxpayer was prudent 815 in acquiring the property and assigning duties to third parties with respect to the property, and the extent to which the taxpayer supervised the performance of such duties as the enterprise progressed. Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 932 (1983). Specifically, the Court takes into account (in addition to the factors previously discussed in this opinion) such factors as: Whether the taxpayer was knowledgeable of the industry, Sutton v. Commissioner, 84 T.C. 210">84 T.C. 210, 224 (1985), affd. per curiam 788 F.2d 695">788 F.2d 695 (11th Cir. 1986), affd. sub nom. Knowlton v. Commissioner, 791 F.2d 1506">791 F.2d 1506 (11th Cir. 1986); whether the taxpayer attempted to obtain valid information about the industry or researched the feasibility of making a profit in a particular industry, Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 234-237 (1983); whether the taxpayer ultimately relied on the promoters of the program, Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 555-556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986); whether the816 purchase price was negotiated, Elliott v. Commissioner, 84 T.C. 227">84 T.C. 227, 238 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986); and whether any appreciable effort was spent monitoring the investment, Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 936 (1988). The record does not support a finding that petitioners entered into the donor cow and embryo programs with economic profits in mind. Petitioners made no meaningful independent investigation of the cattle industry or of the risks associated with the use of embryo transplant technology in breeding registered cattle. While petitioners, who are medical doctors, demonstrated interest and general knowledge of genetics and were familiar with the mechanics of the procedures used in cattle embryo transplantation, they made no investigations of market values of registered cattle or the feasibility of the projections in the offering memorandum either before or after investing in the donor cow or embryo programs. The "business" aspect of the programs was clearly not an area about which petitioners had any knowledge or experience, and they made 817 no efforts to educate themselves in the business aspects of their activity. The promoters overestimated the number of embryos which would be produced from the donor cows, as well as the sales prices of embryos and the calves expected from the embryo programs. There is no evidence to substantiate the validity of the projections in the offering memoranda for the various programs. Both Dr. Allen and Mr. Daily observed that an investigation into market values of registered Simmental cows and embryos would have revealed that the donor cow program, as outlined in the offering memorandum, was not likely to be profitable. Similarly, a review of average market prices for Simmental cattle would have revealed that the projected market for calves from the embryo programs was not likely to be as represented in the offering memoranda. Nevertheless, petitioners never questioned or verified the projections. Information on market prices for such cattle in prior years was readily available from a variety of sources, including the American Simmental Association. The projections in the offering memorandum were based, in the opinions of the experts, on best-case scenarios which were very unlikely818 to happen. Petitioners had the program materials and projections reviewed by accountants and lawyers but never consulted experts in the cattle industry to ascertain whether the economic projections were realistically achievable. Petitioners entrusted operation of the program entirely to managers about whom they knew little, if anything, other than the information set forth in the offering memoranda. Further, with the exception of Dr. Jost (who did travel to the offices of the manager in Arizona to obtain information on the identification and location of his donor cows and then went to see some of the cattle), petitioners appear to have been content with the little information provided by the cattle managers about the donor cow program. No information concerning the identity of the donor cows assigned to each petitioner was conveyed to petitioners until several months after their entrance into the programs, and certificates of registration reflecting their ownership on the American Simmental Association records were not received in some cases for more than a year. Moreover, the certificates, once received, often did not match the prior identifying information petitioners had been819 provided. The registration certificates reflect that some petitioners had been assigned calves born in 1984 rather than mature cows capable of reproduction as they expected. Despite these discrepancies, there is no evidence in the record to indicate that petitioners sought or received clarification or correction of these matters. With respect to the embryo programs, except for a few registration certificates for animals that could not have resulted from the breedings shown on the embryo assignment sheets they had been provided, petitioners received no information identifying calves born of their embryo units. Petitioners were unable to positively identify any progeny that was consistent with the information they received identifying their embryos. Petitioners purchased 20 embryos per unit and believed they received 10 live births from the embryos but did not know if additional calves might have been born from their embryo units. Although the invoices they received showing sales of unidentified embryo calves reflected Alberta Livestock Transplants as the purchaser of all the calves sold, petitioners never questioned the way the sales were arranged, how the prices were determined, 820 and why the sales proceeds credited to them equaled exactly the service and maintenance charges payable by them. No amounts in excess of the predetermined maintenance costs and note payments were received by petitioners from any of the programs prior to the final liquidation of the remaining cattle. Although petitioners reported income from sales of embryos and the Rivergold lease in the donor cow program and from sales of calves in the embryo programs, they received none of the proceeds from any of these transactions and appear to have been content to merely receive credits against their obligations and no more. This lack of interest in the economic performance of the programs beyond their abilities to pay for themselves, together with the other factors, confirms that petitioners did not anticipate profits. Petitioners, however, did expect and realized substantial tax benefits from the programs, including deductions for depreciation, cattle maintenance, and interest expenses, as well as the investment credit for the donor cow program. Petitioners' notes were ostensibly satisfied by credits from the various transactions detailed above, so petitioners were not called upon for 821 additional funds for that purpose, and the cash investments petitioners made in the programs were fully recovered through tax refunds or offsets of tax liabilities they would have incurred on income from other sources. On this record, the Court concludes that petitioners engaged in the transactions to obtain tax deductions and credits and thereby reduce the taxes they would otherwise have been required to pay on their substantial income from other sources. See Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 570-571 (1985); sec. 1.183-2(b)(8), Income Tax Regs.Since the transactions lacked economic substance and profit motive, the claimed depreciation and expense deductions and investment credits are not allowable. Accordingly, it is not necessary to address the alternative issues raised by respondent other than those involving petitioners' interest deductions and the additions to tax and increased interest. The deductibility of interest focuses on the character of the underlying indebtedness -- essentially, whether the debt is bona fide. As discussed previously, the Court examines the substance of the debt and is not guided solely by its form. Debt that, in822 fact or in substance, is unlikely to be paid lacks economic substance. Waddell v. Commissioner, 86 T.C. 848">86 T.C. 848, 902 (1986), affd. per curiam 841 F.2d 264">841 F.2d 264 (9th Cir. 1988); Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 555-556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986). Due to the inflated purchase prices, the notes petitioners executed represented amounts far in excess of the fair market values of the property which they purportedly purchased. Although "recourse" on face, the notes were so commercially unreasonable the Court does not believe they were ever intended to be repaid and, therefore, holds the notes did not represent bona fide indebtedness sufficient to support interest deductions. The payment of the notes through bookkeeping credits generated by the Rivergold lease and sales of embryos and calves to Alberta Livestock Transplants is not determinative, since the Court has found that such transactions were not arm's-length and were sham transactions. On this record, the Court holds that petitioners have not established their entitlement to interest deductions. 823 Respondent is sustained in the disallowance of the losses, deductions, and credits claimed by petitioners in all these cases. As a result of the conclusion that the transactions lacked economic substance, petitioners are allowed an appropriate adjustment to eliminate any income they reported from these transactions. See supra note 4. The remaining issues are the additions to tax and increased interest. Respondent determined that petitioners were negligent in claiming their losses and investment credits and, therefore, determined that they were liable for the additions to tax under section 6653(a)(1) and (2). 7 Section 6653(a)(1) provides that, if any portion of an underpayment is due to negligence or intentional disregard of rules or regulations, an amount equal to 5 percent of the underpayment is added to the tax. Section 6653(a)(2) provides for an addition to tax equal to 50 percent of the interest on the portion of the underpayment attributable to negligence. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985).824 Petitioners deducted depreciation and claimed investment credits on the donor cows based upon prices which significantly exceeded fair market values. Similarly, petitioners in the embryo programs claimed deductions on prices far in excess of the fair market value of the property purportedly purchased. Petitioners made no significant attempts to consult with any independent person having the appropriate expertise to evaluate the validity of the factual representations in the offering materials before relying upon them in claiming tax benefits. Some petitioners testified they consulted with their accountants about the tax benefits represented in the offering memoranda. The Courts have absolved taxpayers from additions to tax for negligence where the taxpayer: (1) Consulted a fully qualified, independent accountant; (2) fully disclosed the facts825 to the accountant; and (3) then relied upon the accountant's advice in good faith. See, e.g., Betson v. Commissioner, 802 F.2d 365">802 F.2d 365, 372 (9th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984-264; Leonhart v. Commissioner, 414 F.2d 749">414 F.2d 749 (4th Cir. 1969), affg. per curiam T.C. Memo. 1968-98. However, petitioners did not call their accountants as witnesses, and the record does not disclose the extent and substance of the facts petitioners disclosed to their accountants or the essence of the advice given as a result. See Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93, 96 (9th Cir. 1989), affg. Patin v. Commissioner, 88 T.C. 1086 (1987). Moreover, the Court is skeptical that the accountants or tax advisers possessed the necessary knowledge about donor cows and embryos to intelligently correlate such knowledge with the tax aspects of the transactions. In summary, petitioners' conduct does not evidence the due care and prudence required by the statute. Therefore, respondent's determination that petitioners are 826 liable for the additions to tax under section 6653(a)(1) and (2) is sustained. Respondent also determined, as to all petitioners, the section 6659 addition to tax for underpayments attributable to a valuation overstatement. 8829 Section 6659 imposes a graduated addition to tax where an underpayment of $ 1,000 or more is attributable to a valuation overstatement. Section 6659(c) provides that there is a "valuation overstatement" if the value of any property, or the adjusted basis of any property, claimed on a return is 150 percent or more of the correct value or correct adjusted basis. When a transaction lacks economic substance, section 6659 will apply because the correct basis is zero and any basis claimed in excess of that is a valuation overstatement. Gilman v. Commissioner, 933 F.2d 143 (2d Cir. 1991), affg. T.C. Memo. 1990-205; Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 566-567 (1988); Donahue v. Commissioner, T.C. Memo. 1991-181, affd. without published opinion 959 F.2d 234">959 F.2d 234 (6th Cir. 1992). This Court and others have found section 6659827 applicable when credits and deductions are disallowed in their entirety due to a lack of economic substance, lack of profit objective, or lack of bona fide sale of the property, when valuation is an integral factor in such determinations. Gilman v. Commissioner, supra at 151; Massengill v. Commissioner, 876 F.2d 616">876 F.2d 616, 619-620 (8th Cir. 1989), affg. T.C. Memo. 1988-427; Harness v. Commissioner, T.C. Memo. 1991-321; Diego Investors -- IV v. Commissioner, T.C. Memo. 1990-102. In situations where there are arguably two grounds to support a deficiency and one supports a section 6659 addition to the tax and the other does not, the taxpayer may still be liable for the addition to tax. Harness v. Commissioner, supra (citing Gainer v. Commissioner, 893 F.2d 225">893 F.2d 225, 228 (9th Cir. 1990), affg. T.C. Memo. 1988-416, and Irom v. Commissioner, 866 F.2d 545">866 F.2d 545, 547 (2d Cir. 1989), vacating and remanding T.C. Memo. 1988-211).828 The Court has held that the transactions in these consolidated cases lacked economic substance, and the donor cows and embryos were overvalued. The deficiencies, therefore, are attributable to overstatements of value and are subject to the section 6659 addition to tax. Gilman v. Commissioner, supra; Massengill v. Commissioner, supra; Harness v. Commissioner, supra; Donahue v. Commissioner, supra.Accordingly, respondent is sustained on this issue as to all petitioners. 9830 Respondent determined that petitioners are liable for the addition to tax under section 6661 for all post-1981 taxable years except the 1985 year for petitioner Boyer. With respect to Dr. Godwin's 1984 tax year and the 1985 and 1986 tax years of petitioner Nix, the section 6661 addition to tax was determined in the notices of deficiency. Therefore, these petitioners, for these years, bear the burden of proof. However, as to all other years, the section 6661 addition to tax was first asserted by respondent in answers or amended answers. Consequently, respondent bears the burden of proof for those years in which this addition to tax was raised in the answer. 10 Rule 142(a). 831 Section 6661(a) imposes an addition to tax if there is a substantial understatement of income tax. A "substantial understatement" is defined as an understatement which exceeds the greater of $ 5,000 or 10 percent of the amount of tax required to be shown on the return. Sec. 6661(b)(1). Any portion of the understatement that is also subject to the addition to tax under section 6659 for a valuation understatement is not taken into account in determining the substantial understatement of tax for purposes of section 6661. Sec. 6661(b)(3). In calculating understatements under section 6661(a), items for which there is substantial authority or with respect to which all relevant facts were adequately disclosed in the tax return, or in a statement attached to the tax return, are not to be considered. Sec. 6661(b)(2)(B). However, in the case of a "tax shelter", even full disclosure in the tax return does not reduce this addition to tax. Sec. 6661(b)(2)(C)(i). For this purpose, section 6661(b)(2)(C)(ii) defines a tax shelter as any partnership, entity or other plan or arrangement, the principal purpose of which is the avoidance or evasion of Federal income tax. Except as noted herein, 832 the understatements in tax are "substantial" within the definition of section 6661(b)(1). The Court holds that the transactions in these cases lacked economic substance and business purpose; the principal purpose for the transactions was to reduce petitioners' income tax liabilities. Accordingly, the additions to tax under section 6661(a) are sustained except as to understatements that are reduced below the threshold amounts by adjustments to income consistent with the Court's holding or by application of section 6659. Finally, respondent determined that the increased rate of interest under section 6621(c), formerly section 6621(d), for substantial understatements attributable to tax-motivated transactions applies to petitioners' donor cow and embryo activities. Tax-motivated transactions under section 6621(c) include valuation overstatements as defined by section 6659 and any sham or fraudulent transaction. Sec. 6621(c)(3)(A)(i), (v). This Court has interpreted "any sham or fraudulent transaction" to include transactions that lack economic substance. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 857 (1989). Accordingly, respondent is sustained on this*833 issue as to all petitioners. To reflect the foregoing, Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: R. Dale Jost, docket No. 6765-89; Billy G. and Doris A. Nix, docket No. 6476-90; and Charles W. and Deborah J. Godwin, docket No. 12620-90.↩2. All section references are to the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩1. 120 percent of the interest due on the deficiency.↩2. 5 percent of the deficiency and 50 percent of the accrued interest on the deficiency attributable to negligence. For 1986 and subsequent years, the additions to tax are determined under sec. 6653(a)(1)(A) and (B).↩3. Sec. 6661 addition to tax asserted by respondent by amendment to answer.↩1. 120 percent of the interest due on the deficiency.↩2. 5 percent of the deficiency and 50 percent of the accrued interest on the deficiency attributable to negligence. For 1986 and subsequent years, the additions to tax are determined under sec. 6653(a)(1)(A) and (B).↩3. Sec. 6661 addition to tax asserted by respondent by amendment to answer.↩1. 120 percent of the interest due on the deficiency.↩2. 5 percent of the deficiency and 50 percent of the accrued interest on the deficiency attributable to negligence. For 1986 and subsequent years, the additions to tax are determined under sec. 6653(a)(1)(A) and (B).↩3. Sec. 6661 addition to tax asserted by respondent by amendment to answer.↩1. 120 percent of the interest due on the deficiency.↩2. 5 percent of the deficiency and 50 percent of the accrued interest on the deficiency attributable to negligence. For 1986 and subsequent years, the additions to tax are determined under sec. 6653(a)(1)(A) and (B).↩4. Sec. 6661 addition to tax asserted by respondent by answer.↩3. Petitioners Jost and Godwin are the only petitioners in these cases who participated in the 1986 embryo program; however, the year 1986 in which they invested is not before the Court as to either of these petitioners. Petitioner Godwin's 1987 tax year is before the Court and certain deductions claimed by him for 1987 relate to the 1986 embryo program. As to petitioner Jost, the only year before the Court in these cases is 1985, a year prior to his participation in the 1986 embryo program.↩4. In amended petitions, petitioners allege that they should be allowed theft loss deductions under sec. 165 for their actual cash expenditures if the losses and credits claimed on their returns are disallowed on the grounds that the transactions did not occur or should not be recognized for tax purposes; however, petitioners presented no evidence to that effect and did not address this contention in their briefs. Accordingly, the issue is deemed waived. In answers to amended petitions, respondent acknowledged that, if the transactions are found not to have been of economic substance, any income reported by petitioners from the transactions in question should not be recognized except to the extent of cash or cash equivalents received.↩5. The majority of the cows purchased by petitioners were registered through the American Simmental Association as "purebreds", a designation requiring that each cow be at least seven-eighths Simmental. Petitioners Boyer, Jost, and Godwin each purchased one registered Brahman cow, which were registered through the American Brahman Breeders Association.↩6. With respect to the 1984 embryo program, respondent agreed that, if the program had economic substance and business purpose, the embryo costs were currently deductible under Rev. Ruls. 87-105, 2 C.B. 46">1987-2 C.B. 46, and 86-24, 1 C.B. 80">1986-1 C.B. 80. However, for any embryo investments after Feb. 24, 1986, which would include the 1986 embryo program, respondent's position is that embryo costs are not currently deductible even if the program had economic substance and business purpose, and that such costs are capital expenditures under Rev. Ruls. 87-105, 2 C.B. 46">1987-2 C.B. 46, and 86-24, 1 C.B. 80">1986-1 C.B. 80↩.7. Sec. 6653(a)(1) and (2) was redesignated as sec. 6653(a)(1)(A) and (B), effective for years after 1985. The discussion above encompasses both versions of the statute.↩8. Respondent concedes that the addition to tax under sec. 6659 is not applicable in the case of petitioners Boyer for taxable year 1983 because the deficiency determined by respondent for that year is not attributable to the cattle investments involved in these cases. Further, respondent concedes that adjustments to remove income reported by petitioners Nix in 1986, consistent with the Court's holding that the transactions at issue lacked economic substance, will reduce the underpayment of tax below the $ 1,000 threshold for sec. 6659 purposes.↩9. In Gainer v. Commissioner, 893 F.2d 225 (9th Cir. 1990), affg. T.C. Memo. 1988-416, the taxpayer was held not liable for the sec. 6659 addition to tax even though the taxpayer claimed deductions and credits on an overvalued asset. The deductions and credits related to that asset were disallowed on the ground that the asset had not been placed in service in the year in which the deductions and credits were claimed; therefore, the deficiency in tax was not "attributable to" a valuation overstatement within the meaning of sec. 6659. See Todd v. Commissioner, 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912">89 T.C. 912 (1987); see also Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo 1988-408">T.C. Memo. 1988-408. None of the cases of the petitioners here is appealable to the Fifth Circuit. The case of Dr. Jost, here, is appealable to the Ninth Circuit and this Court, under Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), follows the law of the circuit to which an appeal lies. However, the facts of Dr. Jost's case are distinguishable from Gainer v. Commissioner, supra, in that the disallowed deductions and credits are not based upon the year or years the overvalued assets were placed in service; therefore, the deficiencies in tax in the case of Dr. Jost are "attributable to" a valuation overstatement. Also, respondent concedes that, of the $ 36,000 or $ 39,000 per unit deducted by petitioners Jost, Godwin, and Boyer for their investment in the 1984 embryo program, only $ 29,500, representing the cost of the ova and semen implanted, is subject to the sec. 6659 addition to tax pursuant to Soriano v. Commissioner, 90 T.C. 44↩ (1988). Similarly, respondent concedes that the sec. 6659 addition is applicable to only the $ 31,500 cost of the implanted ova and semen of the total $ 38,000 per unit invested in the 1986 embryo program.10. Respondent concedes that the sec. 6661 addition to tax is not applicable to the Boyer's 1983 taxable year because the deficiency is not attributable to the cattle investments at issue in these cases. Respondent concedes that adjustments to "phantom" income consistent with the Court's holding that the transactions lacked economic substance will render the sec. 6661 addition inapplicable to petitioner Jost's 1985 taxable year and petitioners Nix's 1985 and 1986 taxable years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623195/	GUILIO J. AND EDITH CONTI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentConti v. CommissionerDocket No. 15131-90United States Tax CourtT.C. Memo 1992-616; 1992 Tax Ct. Memo LEXIS 645; 64 T.C.M. (CCH) 1093; October 19, 1992, Filed 645 Decision will be entered under Rule 155. R determined deficiencies in income tax and additions to tax for 1986 and 1987 using the net worth plus expenditures method. Ps claim that the increase in net worth determined by respondent was due to withdrawals from an $ 800,000 cash hoard and $ 550,000 in loans from their son. Held: R's determination of deficiencies as amended is sustained. Held further: Additions to tax under secs. 6653(b) and 6661 as amended are sustained. For Petitioners: Mark C. Pierce, Robert B. Pierce, and Paul T. Mengel. For Respondent: Dennis C. Driscoll. COLVINCOLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: Respondent determined deficiencies in income tax of $ 116,410.57 for 1986 and $ 390,227.28 for 1987, and additions to tax for fraud under section 6653(b) and substantial understatement of income tax under section 6661. In the answer respondent alternatively asserted the addition to tax for negligence under section 6653(a). By amended answer, respondent asserted that petitioners' deficiency was $ 217,237 for 1986 and $ 339,021 for 1987. On brief respondent concedes that petitioners' deficiencies do not exceed $ 206,702 for 1986646 and $ 322,343 for 1987. After concessions, the issues for decision are: 1. Whether respondent's determination, including that petitioners had a $ 150,000 cash hoard on December 31, 1985, was arbitrary. We hold that it was not. 2. Whether petitioners had an $ 800,000 cash hoard on December 31, 1985, or received $ 550,000 in loans from their son during 1986 and 1987. We hold that they did not. 3. Whether petitioners are entitled to a $ 5,047 deduction for sales tax for 1986, and a $ 410 deduction for tax return preparation fees for 1987. We hold that they are not. 4. Whether petitioners have additional income of $ 893 for 1986 from the sale of their residence. We hold that they do. 5. Whether petitioners are liable for additions to tax for fraud under section 6653(b). We hold that they are. 6. Whether petitioners are liable for additions to tax for substantial understatement of tax under section 6661. We hold that they are. 7. Whether petitioners are liable for additions to tax for negligence under section 6653(a). We need not reach this issue in light of our holding on fraud. Petitioners offered into evidence the results of polygraph tests to corroborate their647 cash hoard claim. We previously ruled that the results of these tests are not admissible. Conti v. Commissioner, 99 T.C. (1992). Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated and are so found. References to petitioners are to Mr. and Mrs. Conti. 1. Petitioners and Their FamilyPetitioners are husband and wife who resided in Birmingham, Michigan, when the petition was filed. They were married in 1949 and had three sons, Chris, Gary, and Mark (the oldest). Petitioners' sons were in their late twenties to late thirties and petitioners were in their late sixties during the years at issue. a. Mr. ContiMr. Conti was born in 1921. He has a fifth grade education, and began work at age 14. Mr. Conti worked for Ford Motor Co. (Ford) beginning in 1937, and retired in 1985. From 1971 through 1985 he received $ 679,206 in wages from Ford. He was in reasonably good health during the years at issue. Mr. Conti served in the United States Army from 1942 648 through 1945. He fought in World War II in North Africa and Europe. He was paid $ 60 per month by the Army. Mr. Conti inherited $ 10,000 from his father in 1970, and $ 12,637 from his brother in 1984. Mr. Conti never made bank deposits. He gave all of the cash he acquired to Mrs. Conti. Mr. Conti purchased a deferred annuity for $ 150,000 on November 27, 1981. He withdrew $ 152,020.51 from the annuity account in July 1984, and received a final distribution of $ 38,610.33 on February 9, 1988. b. Mrs. ContiMrs. Conti is a high school graduate with varied work experience before her marriage. She handled the family finances. In 1986 and 1987 she made more than 300 deposits in at least three banks totaling over $ 950,000. At least 130 of the deposits were cash, totaling over $ 375,000. Also in those years petitioners bought and sold at least 12 real properties. These activities are discussed below. Mrs. Conti is a little hard of hearing and has high blood pressure. c. Mark ContiMark Conti, petitioners' son, is a college graduate. In the 1980s, he syndicated video games, financed and developed racket clubs, and rehabilitated real estate. In 1986 and 1987 he649 worked from 80 to 90 hours per week in his parents' real estate activity and in other business activities. His parents paid him about $ 30,000 in 1986 and $ 20,000 in 1987 for his services. During those years he also worked for Kathy Wilson Management Co. and Kathy Wilson individually. His total reported adjusted gross income was $ 43,000 for 1986 and $ 29,000 for 1987. d. The D'AnnunziosDavid D'Annunzio, Mrs. Conti's father, was born in 1881 and died in 1960. Rosa D'Annunzio, Mrs. Conti's mother, was born in 1881 and died in 1973. From about 1953 to 1966, petitioners and Mrs. Conti's mother lived together in Detroit, Michigan. Alfred D'Annunzio, Mrs. Conti's brother, died in 1981 following an extended illness. He had $ 2,907 in Federal and State income tax refunds for 1981, all of which Mrs. Conti received. Alfred D'Annunzio bequeathed all of his property to Mrs. Conti. His property, except for cash and other personal property, was held jointly by himself and Mrs. Conti. e. LifestylePetitioners had personal living expenses including Federal income tax payments of $ 38,487.69 for 1986 and $ 22,658.29 for 1987. They received Social Security payments of $ 12,313650 in 1986 and $ 13,459 in 1987. Their lifestyle was not lavish. 2. Petitioners' Bank and Brokerage AccountsPetitioners maintained several bank and brokerage accounts. The bank accounts were at Bloomfield Savings & Loan Association, Standard Federal Bank, Sterling Federal Bank, Sterling Federal Savings & Loan Association, Comerica Bank, First America Bank, Manufacturers National Bank, National Bank of Detroit, and Michigan National Bank. The brokerage accounts were with Merrill Lynch and E.F. Hutton. Petitioners also had individual retirement accounts at Comerica Bank. Mrs. Conti made at least the following deposits to their bank accounts in 1986 and 1987 (see appendix A): All DepositsCash DepositsCoin DepositsNumberTotalAverageNumberTotalAverageNumberTotalBloomfield Savings & Loan, 198626$ 137,772.81$ 5,298.9525$ 47,550.00$ 1,902.009$ 2,170Standard Federal Bank, 19861478,023.965,573.141430,100.002,150.0061,882Sterling Federal Savings, 198649,800.002,450.0049,800.002,450.0000Bloomfield Savings & Loan, 198737124,919.783,376.212067,650.003,382.5000Standard Federal Bank, 198738201,286.955,297.033385,125.002,579.5582,200Sterling-Federal Savings, 1987133399,403.693,003.0435138,083.903,945.0000651 Mrs. Conti and her brother had joint bank accounts with a $ 160,894.42 total balance when closed in 1981. As of June 27, 1980, Mrs. Conti and her brother jointly owned common stock which cost $ 72,391. Petitioners had the following account balances in banks at the end of the years indicated: Bank198519861987Bloomfield Savings$ 78,400.39 $ 22,457.43 $ 40,454.90 Comerica34,590.5033,160.2762,583.22Standard Federal1 13,690.6632,069.51Manufacturers19,493.3126,863.8270,154.94National BankFirst America21,621.641 59,584.61Michigan National8,354.9122,181.611 BankNational Bank40,664.3526,078.6246,888.83of DetroitSterling Federal1 3,722.742,387.02SavingsTotals $ 203,125.10$ 148,155.15$ 314,123.03Petitioners sold 1,734 shares of stock from 10 companies in 1982 for a $ 7,635 profit. Petitioners sold 406 shares of stock from two corporations in 1985 for a $ 10,900 profit. Petitioners invested $ 77,979 in652 12 companies in 1985 and $ 26,047 in 7 companies in 1986. 3. Petitioners' Real Estate BusinessPetitioners began investing in real property in the early 1980s at the suggestion of their son Mark. They bought, sold, rented, and renovated real estate. Mrs. Conti handled the banking activity for the business. Petitioners had an office suite on Adams Street with two rooms. The sign on the door said, "Edith J. Conti". They had four employees. Petitioners had business assets with cost of acquisition values on the last day of 1986 and 1987 as follows: Business Assets19861987Phone$ 640$ 640Furniture25,22125,221Dump truck15,547Truck8,135Petitioners' real estate purchases and sales included the following: DateAddressActivityCommentsOct. 31, 198331491 Bellvinepurchase$ 51,315.52Birmingham, MIoutstandingmortgageOct. 26, 1984552 Hannahpurchaseassumed $ 64,000Birmingham, MImortgageJuly 10, 1985552 Hannahsale$ 8,123 gainBirmingham, MIAug. 26, 1985399 BaldwinpurchaseBirmingham, MIFeb. 7, 1986399 BaldwinsaleBirmingham, MIN/A745 AbbeypurchaseBirmingham, MIAug. 13, 1986745 AbbeysaleBirmingham, MIJune 12, 1986887 Wimbletonpurchase$ 96,250 mortgageBirmingham, MIN/A1231 Emmonspurchase$ 29,500 mortgageBirmingham, MIJuly 31, 1986963 Woodwardpurchase$ 46,000 mortgageBirmingham, MIAug. 8, 19864891 Yorkshiresalepetitioners'Detroit, MIresidenceOct. 16, 1986480 YarmouthpurchaseBirmingham, MIOct. 31, 1986319 Henleypurchase$ 317,500 mortgageBirmingham, MINov. 14, 1986Henleypurchaseunimproved lotBirmingham, MIMarch 27,31660 Glencoesale1987May 22, 19872655 E. MaplepurchasecondominiumBirmingham, MIJune 30, 1987423 Totting Lanepurchasedemolished house andBirmingham, MIsubdivided lotsOct. 15, 1987423 Totting Lanesalesubdivided lotsBirmingham, MIN/A600-602 LincolnpurchaseBirmingham, MI653 N/A = no date available. The total cost of petitioners' real estate held on December 31, 1985, was $ 255,630; $ 1,177,704 on December 31, 1986, and $ 1,279,704 on December 31, 1987. The total cost of real estate improvements made by petitioners was $ 65,712 on December 31, 1985, $ 186,927 on December 31, 1986, and $ 394,252 on December 31, 1987. Petitioners' total mortgages payable were $ 48,872.17 on December 31, 1985, $ 461,330.34 on December 31, 1986, and $ 137,070.61 on December 31, 1987. Mrs. Conti received $ 39,900 from the sale of a home at 13958 Parkgrove, Detroit, Michigan, that she held jointly with her mother and brother. 4. Petitioners' Net Worth as of December 31, 1985The parties stipulated to the items in the net worth analysis, except for cash on hand. We find that petitioners' cash on hand as of December 31, 1985, was $ 150,000 (as determined by respondent), and that they received no loans from Mark in 1986 and 1987. Petitioners' contentions to the contrary are discussed below. Adding cash on hand of $ 150,000 (as determined by respondent) to the stipulation results in the following: ASSETS198519861987Cash on hand$ 150,000.00$ 150,000.00$ 150,000.00 Cash in bank223,125.10148,155.04314,123.03 IRA's9,000.002,250.00 Merrill Lynch:Cash 590.151.32CMA funds 74,306.5055,105.0014,475.00 CD Phila. Savings Fund 20,000.00CD Northwest Svgs. 50,000.00 Investments77,979.0026,047.00Real estate225,630.001,177,704.001,279,704.00 Real estate improvements65,712.00186,927.00394,252.00 Business assets25,861.0049,543.00 TOTAL ASSETS $ 846,342.75$ 1,769,800.36$ 2,254,347.03 LIABILITIES Mortgages payable$ 48,872.17$ 461,330.34$ 137,070.61 Accumulated depreciation18,111.0043,368.00126,049.00 TOTAL LIABILITIES $ 66,983.17$ 504,698.34$ 263,119.61 NET WORTH$ 779,359.58$ 1,265,102.02$ 1,991,227.42 Less: prior year779,359.581,265,102.02 Net worth increase485,742.44726,125.40 Additions to net worth38,487.69151,419.29 Total net worth increase524,230.13877,544.69 Less: deductions40,074.0019,982.00 Corrected adjusted gross income484,156.13857,562.69 Adjusted gross income per return48,401.00(94,316.00)Unidentified income$ 435,755.13$ 951,878.69 654 On December 31, 1985, petitioners had cash of $ 100,000 in their home and $ 20,000 in a safety deposit box. 5. Petitioners' Income Tax ReturnsThe C.P.A. firm of Grey, Trepeck and Cohen, P.C., prepared petitioners' Federal income tax returns from 1981 through the years at issue. Their return for 1984 was prepared by Theodore Cohen, C.P.A. Their returns for 1985, 1986, and 1987 were prepared by Leonard A. Grey, C.P.A. (Mr. Grey). Petitioners gave some schedules of income and expenses, closing documents for real estate transactions, check stubs, Forms W-2 and 1099, and brokerage statements to Mr. Grey to prepare petitioners' returns. Sales, income, rents, and gain from the real estate transactions were included in petitioners' income tax returns by Mr. Grey and accounted for in the years in issue. Mrs. Conti wrote a $ 410 check to Grey & Trepeck, P.C., on May 13, 1987, with the memo, "taxes for 1986". Petitioners reported that they received $ 166,786 in interest and $ 38,335 in dividends on their income tax returns from 1971 through 1985. They received taxable refunds from 1971 through 1985 totaling $ 16,109 and other income of $ 1,938. Petitioners had a $ 12,000 nonbusiness655 bad debt in 1984. 6. The AuditRevenue Agent Pamela Keysor conducted the audit in this case. She obtained a bachelor's degree in accounting in 1985 from Ferris State University, and she prepared corporate tax returns for a C.P.A. firm for 2 years. She was hired by the Internal Revenue Service (IRS) in September 1987 and underwent training for about 3 months. The Contis' case was one of her first auditing assignments. It was her first net worth case. Ms. Keysor was not a certified public accountant as of the date of trial. She has taken the C.P.A. exam five times and has passed the practice and law portions, but has not passed the auditing and theory parts of the exam. Ms. Keysor began to audit petitioners for 1986 and 1987 around March 1988. Mark Conti dealt with Mr. Grey, petitioners' representative, on behalf of petitioners during the audit. Mark Conti provided documentation to Mr. Grey. As a part of the audit, Ms. Keysor met with Mrs. Conti, Mark Conti, and Mr. Grey on April 18, 1988. Except for Mrs. Conti's attendance of the April 18, 1988, meeting, petitioners had no contact with Mr. Grey during their audit. Ms. Keysor interviewed Mrs. Conti during the April656 18 meeting. In that interview Mrs. Conti told Ms. Keysor that petitioners had about $ 100,000 cash at their residence and over $ 20,000 in a safe deposit box. Mrs. Conti stated that the cash was partly from a $ 200,000 to $ 250,000 gift from her mother and partly from a $ 300,000 inheritance from her brother. Ms. Keysor's handwritten notes state, "Taxpayer keeps large sum of cash on hand, ($ 150,000)." Mrs. Conti did not say that the source of the cash was Mr. Conti's earnings from Ford and his military service, or loans from Mark Conti. After meeting with Ms. Keysor on April 27, 1988, Mr. Grey met with Mark Conti to prepare petitioners' response to Ms. Keysor's questions. Mr. Grey told Mark Conti the amount of cash on hand that would be required to account for the net worth increase. On May 23, 1988, Mr. Grey sent a letter to Ms. Keysor which stated that petitioners had the following cash on hand: Safety DepositTotal CashBoxesHouseon HandBeginning of 1986$ 300,000 +$ 150,000 +$ 450,000 +End of 1986100,000 +175,000 +275,000 +Mark Conti, not petitioners, gave all of this information to Mr. Grey. OPINION 1. Respondent's Determination657 Using the Net Worth MethodRespondent used the net worth method to determine petitioners' income for the years in issue. Under the net worth method, income is computed by determining a taxpayer's net worth (excess of assets at cost over liabilities) at the beginning and end of a year. The difference between the two figures is the increase in net worth. This difference is increased by adding nondeductible expenditures, including living expenses, and by subtracting gifts, inheritances, loans, and the like. Holland v. United States, 348 U.S. 121">348 U.S. 121, 125 (1954); United States v. Giacalone, 574 F.2d 328">574 F.2d 328, 330-331 (6th Cir. 1978). An increase in a taxpayer's net worth, plus his nondeductible expenditures, less nontaxable receipts, may be considered taxable income. Holland v. United States, supra.In a net worth case, respondent must: (1) Establish, with reasonable certainty, an opening net worth, and (2) either (a) show a likely income source, or (b) negate possible nontaxable income sources. Holland v. United States, supra at 132-138; Smith v. Commissioner, 91 T.C. 1049">91 T.C. 1049, 1059 (1988),658 affd. 926 F.2d 1470">926 F.2d 1470 (6th Cir. 1991); Brooks v. Commissioner, 82 T.C. 413">82 T.C. 413, 431-432 (1984), affd. without published opinion 772 F.2d 910">772 F.2d 910 (9th Cir. 1985). Petitioners argue that the determination is arbitrary because none of the Holland requirements have been met. We disagree. a. Opening Net WorthThe taxpayer's net worth at the beginning of the taxable year is a key element in a net worth case. Fuller v. Commissioner, 313 F.2d 73">313 F.2d 73, 77 (6th Cir. 1963), modifying T.C. Memo 1961-262">T.C. Memo. 1961-262; Brodella v. United States, 184 F.2d 823">184 F.2d 823, 825 (6th Cir. 1950). Petitioners contend that respondent's determination is arbitrary because of respondent's opening net worth figure. We disagree. With the exception of cash on hand and loans from Mark, the parties agree as to the opening net worth for each of the years in issue. Cash on hand is a part of the opening net worth. See Estate of Phillips v. Commissioner, 246 F.2d 209">246 F.2d 209, 213 (5th Cir. 1957), revg. and remanding T.C. Memo. 1955-139.659 Petitioners allege they had about an $ 800,000 cash hoard at the beginning of 1986, and about $ 550,000 in loans from Mark in 1986 and 1987. As discussed next, we conclude that these claims are implausible, inconsistent in significant ways with their previous statements to IRS agents and their own advisers, and uncorroborated by records. b. Petitioners' Cash Hoard ClaimRespondent determined petitioners' opening net worth to be $ 150,000 based on an interview of Mrs. Conti by respondent's revenue agent. Petitioners argue that this determination is arbitrary and that respondent's revenue agent was unqualified and inexperienced. Respondent's revenue agent testified that Mrs. Conti told her that petitioners had $ 100,000 cash at home and $ 20,000 in a safety deposit box. Respondent's agent rounded up and approximated $ 150,000 as the amount of cash on hand. In essence, respondent's agent gave petitioners a $ 30,000 benefit of the doubt. We do not find that that makes the determination arbitrary, and we see no reason to respond separately to petitioners' attack on respondent's agent's qualifications. At trial, petitioners and their son Mark testified that petitioners accumulated660 an $ 800,000 cash hoard over about 50 years. Petitioners allege that they had about $ 800,000 in cash as of December 31, 1985, composed of personal savings, gifts, and inheritances. There is no documentation for these assertions. Petitioners offer no corroboration for their testimony on these points. The objective evidence shows that Mrs. Conti made large cash deposits during the years in issue. She testified that she was very cautious and believed in depositing a small amount in a lot of banks. However, the objective evidence indicates the opposite is true. Petitioners had extensive investment activity from 1980 through 1985. This indicates that they were not as financially unsophisticated as they wish to appear. Petitioners give no persuasive reason why they would forgo earning interest on the massive claimed cash hoard, and then suddenly invest it. Petitioners' frequent bank deposit activity of several thousand dollars during the years at issue is also inconsistent with their claimed cash hoard; regular weekly deposits are more likely to be from a regular source of income than from a withdrawal of a cash hoard of currency savings accumulated over a lifetime. Mrs. Conti's661 explanation that she deposited cash on a weekly basis because it was as the business needed it is not supported by the documentary evidence. Petitioners placed mortgages on real property they owned while they allegedly had their cash hoard. They also allege borrowing money from Mark. Evidence of borrowing supports an inference that they had no cash hoard because a cash hoard negates the necessity to borrow. Thomas v. Commissioner, 223 F.2d 83">223 F.2d 83, 88 (6th Cir. 1955), revg. and remanding a Memorandum Opinion of this Court dated Oct. 30, 1953; see Holland v. United States, 348 U.S. 121">348 U.S. 121, 133 (1954) (taxpayers would not have lost possession of their cafe and furniture and accumulated unpaid debts if they had a cash hoard of $ 104,000). Petitioners have increased the amount of their claimed cash hoard throughout the life of this case. In the initial examination interview, Mrs. Conti stated that petitioners had $ 100,000 in cash at their home and $ 20,000 in a safe deposit box. After reviewing respondent's net worth analysis, petitioners' accountant sent respondent a letter stating that petitioners had $ 450,000 cash on hand662 at the beginning of 1986. When they filed their petition in this case, petitioners claimed that they had $ 800,000 in cash in the beginning of 1986. As to the source of their alleged cash hoard, petitioners suggest that about $ 800,000 came from personal savings, gifts from Mrs. Conti's mother, and an inheritance from Mrs. Conti's brother, and about $ 550,000 came from loans from Mark during 1986 and 1987. Petitioners assert that the sources of the cash hoard that they accumulated include: Mr. Conti's sale of Nazi weapons during World War II; gifts from Rosa D'Annunzio, who petitioners said accumulated cash from selling wine and beer during Prohibition; savings from 16 years with few or no expenses while living with Mrs. Conti's mother; and various gifts and inheritances from family members. Petitioners allege that they obtained two beige fireproof metal boxes from Alfred D'Annunzio in 1980, and that they hid cash in a green-colored metal box that they got from Mrs. Conti's mother. Petitioners testified to the dimensions of each of those containers. They claimed that Mrs. Conti's family accumulated large amounts of cash, from no substantiated source, and without any records. 663 We find petitioners' claims to be improbable and unbelievable. Other than petitioners' testimony, there is no evidence of their personal savings. Gifts from Mrs. Conti's mother are likewise uncorroborated. Moreover, it seems unlikely that either Mrs. Conti's mother or brother had the ability to provide funds as claimed. Most of the events alleged to be the source of the cash hoard occurred long ago. The events are not susceptible to being checked. Mrs. Conti's mother and brother and Mrs. Conti's father are deceased. Mrs. Conti's mother allegedly dealt largely in cash and allegedly purchased a house with cash. Presumably the sale of beer and wine during Prohibition was in cash. There is no documentary evidence of these nontaxable funds, inheritances, or gifts. As discussed below, we believe that the claimed loans from Mark are a fabricated defense. Overall, we have found petitioners' and Mark's testimony to be unbelievable, improbable, and unreasonable. Petitioners offered no credible, independent support for any of their claims. Petitioners did not offer to respondent any evidence which respondent may have failed to investigate as leads. A taxpayer cannot complain about664 the sufficiency of an investigation where he has offered no leads. United States v. Penosi, 452 F.2d 217">452 F.2d 217, 220 (5th Cir. 1971); Blackwell v. United States, 244 F.2d 423">244 F.2d 423, 429 (8th Cir. 1957). Petitioners argue that this case is like Goodman v. Commissioner, T.C. Memo 1961-201">T.C. Memo. 1961-201. We disagree. In that case we found that the Commissioner's opening net worth for the taxpayers was not sound because the Commissioner failed to include a substantial amount of undeposited cash which the taxpayer had. In the present case, respondent included undeposited cash of $ 150,000, and we have found that petitioners have not proven that they had any more undeposited cash. Thus, Goodman does not assist petitioners. c. Loans From MarkPetitioners claim that their son Mark Conti lent them $ 124,947.50 in 1986 and $ 450,077.58 in 1987. At trial Mark Conti produced a schedule that he prepared shortly before trial showing loans to his parents of $ 124,947.50 in 1986 and $ 457,077.58 in 1987 for a total of $ 582,025.80. He testified that he obtained the money from his savings of about $ 75,000, a divorce665 settlement of $ 170,000, and loans he received from others from 1981 through 1984. He also testified that only a small part of the loan to his parents came from his earnings. He stated that the loans to his parents had no interest rate and no due date. He said that he lent currency and checks to his parents but primarily currency. Mark Conti testified that from 1980 through 1985 people lent him approximately $ 600,000 or $ 700,000. He stated that Oakdale Racquet Club lent him $ 10,000 to $ 15,000 from 1981 to 1984. Mark Conti testified that he received a loan in 1983 from Hybernia Bank (2 percent over prime payable on demand) and successive loans from 1981 through 1983 from the Bank of the Commonwealth (3 percent over prime payable in 2 or 3 years). He testified that both Hybernia Bank and the Bank of the Commonwealth took a personal guarantee from him; thus there was no collateral for those loans. He testified that he was earning between $ 20,000 and $ 30,000 per year at that time. He stated that he made some installment payments, but the loans had not been repaid. Mark Conti testified that he invested the money lent to him, and that he removed money from the investments666 beginning in 1983. He invested in tennis clubs which were not successful. Mark Conti explained that his investment was not lost because he recovered cash from the sale of assets. Mark Conti testified that he made one small loan to his parents in the 1970s. Mark Conti's testimony about his purported loans to petitioners is implausible and incredible. Petitioners did not mention any loans from Mark Conti during the audit; they first claimed the existence of the loans at trial. We are not convinced that petitioners received loans from Mark Conti. There are no supporting documents, interest, or due dates for the purported loans. Petitioners argue that it is normal not to have such formalities for intrafamily loans. We disagree. The amounts of these purported loans make it unlikely that the loans would be undocumented. d. Petitioners' ExpertsPetitioners called two expert witnesses. Petitioners' expert Chauncy Tuttle investigated petitioners' financial affairs on their behalf before trial. His report simply assumes that petitioners' cash hoard claim is true. He testified that petitioners had not told him about any loans from Mark. This undermines petitioners' claim667 that they received loans from Mark. It is at best unlikely that petitioners would not inform their own expert of such a significant part of their financial situation. Petitioners' expert William Bangela prepared a schedule showing a source and application of petitioners' funds from January 1, 1937, to December 31, 1985. His report does not assist us in deciding the extent of cash on hand on December 31, 1985, because he simply assumed that the cash hoard figures given to him by petitioners were true. For example, based simply on petitioners' claims, the analysis assumes cash on hand as of December 31, 1965, of $ 273,500, cash from Alfred D'Annunzio of $ 300,000, and various cash gifts from Mrs. Conti's mother. His analysis was based primarily on total assets such as cash in banks, stock, life insurance, and real property over the entire lifetime of both petitioners. Mr. Bangela admitted that his analysis/report only shows potential rather than actual cash on hand. He also admitted that petitioners' income was relatively high but he used the Bureau of Labor Statistics low budget for estimating expenses, thus increasing potential cash on hand. e. Opening Net Worth -- Conclusion668 A taxpayer's unimpeached, competent, and relevant testimony "may not be arbitrarily discredited and disregarded" by the Court. Loesch & Green Construction Co. v. Commissioner, 211 F.2d 210">211 F.2d 210, 212 (6th Cir. 1954), revg. a Memorandum Opinion of this Court dated Dec. 11, 1952. However, we are not required to accept implausible testimony, particularly in the absence of persuasive corroborating evidence. See Estate of DeNiro v. Commissioner, 746 F.2d 327">746 F.2d 327, 330-331 (6th Cir. 1984), affg. in part and remanding in part T.C. Memo. 1982-497; Lovell & Hart, Inc. v. Commissioner, 456 F.2d 145">456 F.2d 145, 148 (6th Cir. 1972), affg. T.C. Memo. 1970-335; Geiger v. Commissioner, 440 F.2d 688">440 F.2d 688, 689 (9th Cir. 1971), affg. per curiam T.C. Memo. 1969-159; Urban Redevelopment Corp. v. Commissioner, 294 F.2d 328">294 F.2d 328, 332 (4th Cir. 1961), affg. 34 T.C. 845">34 T.C. 845 (1960). The Court may consider circumstantial evidence when deciding the amount of the taxpayer's funds 669 from nontaxable sources. Estate of Mercure v. Commissioner, 448 F.2d 922">448 F.2d 922, 924 (6th Cir. 1971), affg. T.C. Memo 1969-206">T.C. Memo. 1969-206; Friedman v. Commissioner, 421 F.2d 658">421 F.2d 658, 659 (6th Cir. 1970), affg. T.C. Memo 1968-145">T.C. Memo. 1968-145. We are cognizant of the line of cases in the Sixth Circuit holding that where the taxpayer is confronted with proving nonreceipt of income determined by respondent to be attributable to him, the court should apply a lesser burden to the taxpayer than is normally applied in tax cases. United States v. Walton, 909 F.2d 915">909 F.2d 915, 918-919 (6th Cir. 1990); Weir v. Commissioner, 283 F.2d 675">283 F.2d 675, 679 (6th Cir. 1960), revg. T.C. Memo. 1958-158; Harp v. Commissioner, 263 F.2d 139">263 F.2d 139, 141 (6th Cir. 1959), affg. in part and revg. in part T.C. Memo. 1957-105. Even applying a lesser burden of proof, we do not believe petitioners. Mrs. Conti's testimony was unconvincing. She was at times evasive, self-serving, inconsistent, and selectively670 forgetful. Mark Conti's testimony was also unconvincing. His testimony was contrived and implausible. The analysis of their experts did little or nothing to validate petitioners' cash hoard and loan claims. We conclude that as of December 31, 1985, petitioners did not have a cash hoard in excess of $ 150,000 or any loans from Mark. f. Leads and Likely Source of Unreported Taxable IncomeRespondent must also establish that a reasonable investigation of leads negating possible sources of nontaxable income has been conducted. Holland v. United States, 348 U.S. 121">348 U.S. 121, 135-138 (1954); Smith v. Commissioner, 91 T.C. 1049">91 T.C. 1049, 1059 (1988), affd. 926 F.2d 1470">926 F.2d 1470 (6th Cir. 1991); Brooks v. Commissioner, 82 T.C. 413">82 T.C. 413, 431-432 (1984), affd. without published opinion 772 F.2d 910">772 F.2d 910 (9th Cir. 1985). Respondent has met this burden because we have rejected petitioners' cash hoard and loan claims. Respondent has not shown a likely source of petitioners' unreported taxable income. However, proof of a likely source of income is not a prerequisite to 671 use of the net worth method when all possible sources of nontaxable income are negated. United States v. Massei, 355 U.S. 595 (1958); Foster v. Commissioner, 487 F.2d 902">487 F.2d 902, 903 (6th Cir. 1973), affg. T.C. Memo 1972-188">T.C. Memo. 1972-188. We note that respondent has the burden of establishing by a preponderance of the evidence the additional unreported income for 1986 asserted after the petition was filed in this case. Rule 142(a); Estate of Schneider v. Commissioner, 29 T.C. 940">29 T.C. 940, 956 (1958); Beck Chemical Equipment Corp. v. Commissioner, 27 T.C. 840">27 T.C. 840, 856 (1957). Since the parties stipulated petitioners' net worth, except for their cash hoard and loan claims which we have rejected, we are persuaded of the additional unreported income. 2. Deductions for Tax Return Preparation Fees and Sales TaxesRespondent disallowed petitioners' claimed $ 410 tax return preparation fee deduction for 1987 because of the 2-percent floor for miscellaneous deductions. Sec. 67. Petitioners' response to this argument is that the 2-percent floor is not a problem672 if they establish that they had an $ 800,000 cash hoard and $ 550,000 in loans from Mark. As is discussed above, we reject petitioners' position. Accordingly, petitioners may not deduct the $ 410 return preparation fee for 1987. Respondent disallowed $ 5,047 of petitioners' claimed sales tax deduction for lack of substantiation. At trial, Mr. Grey testified that either Mrs. Conti or Mark Conti gave him a lump-sum sales tax deduction figure without any underlying documentation. Petitioners do not contest this issue on brief. Accordingly, we treat this issue as conceded. 1 See Rule 151(e)(4) and (5); Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 683 (1989); Money v. Commissioner, 89 T.C. 46">89 T.C. 46, 48 (1987). 673 3. Income From Sales of ResidenceRespondent determined that petitioners had $ 893 in additional income in 1986 as gain from the sale of their residence. Petitioners do not argue this issue on brief. Consequently, we treat this issue as being conceded. See Rule 151(e)(4) and (5); Petzoldt v. Commissioner, supra; Money v. Commissioner, supra.4. Fraud Under Section 6653(b)Respondent determined that petitioners were liable for the fraud additions to tax under section 6653(b). Petitioners allege that respondent failed to prove fraud by clear and convincing evidence. We disagree. The existence of fraud is a question of fact to be resolved by consideration of the entire record. Parks v. Commissioner, 94 T.C. 654">94 T.C. 654, 660 (1990); Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). Respondent has the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Parks v. Commissioner, supra.674 First, respondent must prove the existence of an underpayment. Parks v. Commissioner, supra. For fraud purposes, respondent may not rely upon the taxpayer's failure to carry the burden of proof as to the underlying deficiency. Parks v. Commissioner, supra at 660-661; Petzoldt v. Commissioner, supra at 700; Estate of Beck v. Commissioner, 56 T.C. 297">56 T.C. 297, 363 (1971). Second, respondent must show that the taxpayer intended to evade taxes by conduct intended to conceal, mislead, or otherwise prevent tax collection. Stoltzfus v. United States, 398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968); Parks v. Commissioner, supra at 661; Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983). a. UnderpaymentRespondent may prove an underpayment by proving a likely source of the unreported income, Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954); Parks v. Commissioner, supra; Nicholas v. Commissioner, 70 T.C. 1057">70 T.C. 1057 (1978);675 or where the taxpayer alleges a nontaxable source, by disproving the specific nontaxable source so alleged, United States v. Massei, 355 U.S. 595">355 U.S. 595 (1958); Kramer v. Commissioner, 389 F.2d 236">389 F.2d 236, 239 (7th Cir. 1968), affg. T.C. Memo. 1966-234; Parks v. Commissioner, supra.Since no likely source of petitioners' unreported income has been shown, respondent must disprove petitioners' allegation of a cash hoard and loans. Respondent may disprove the alleged nontaxable source of income by showing that the reconstruction of income is accurate and that petitioners' allegation of a cash hoard and loans is inconsistent, implausible, and not supported by the objective evidence in the record. Parks v. Commissioner, supra.Petitioners contend that respondent's determination that petitioners had opening cash on hand of $ 150,000 is incorrect. We have rejected this view. Petitioners also argue that the initial income reconstruction was inaccurate as shown by respondent's changes to the initial determination in the amended answer and again676 on brief. The refinements to the initial income reconstruction are, in our opinion, the result of changes in information available to respondent, primarily from third parties. Additionally, there was a substantial increase in petitioners' net worth in 1986 and 1987. Petitioners' only explanation for this increase was the claimed cash hoard and loans from Mark. We rejected the cash hoard and loan theories. Accordingly, we conclude that respondent has proved an underpayment. United States v. Massei, supra; Kramer v. Commissioner, supra; Parks v. Commissioner, supra.b. Fraudulent IntentRespondent must also prove by clear and convincing evidence that petitioners had the requisite fraudulent intent. Parks v. Commissioner, supra at 664. For purposes of section 6653(b), fraud means "actual, intentional wrongdoing," Mitchell v. Commissioner, 118 F.2d 308">118 F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A. 424">40 B.T.A. 424 (1939); or the intentional commission of an act or acts for the specific purpose of677 evading a tax believed to be owing, Webb v. Commissioner, 394 F.2d 366">394 F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo 1966-81">T.C. Memo. 1966-81. The courts have developed a number of objective indicators or "badges" of fraud. Recklitis v. Commissioner, 91 T.C. 874">91 T.C. 874, 910 (1988). Examples of the "badges of fraud" present in this case are: (1) Large understatements of income, (2) inadequate records, (3) implausible or inconsistent explanations of behavior, (4) concealment of assets, and (5) dealings in cash. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo 1984-601">T.C. Memo. 1984-601. Petitioners' large underpayments are unexplained. We have rejected their theories of a large cash hoard and loans from Mark as incredible. We do not believe the purported sources of the cash hoard, including sales of Nazi weapons during World War II, bootlegging income, and savings from a purported 16 years of expense-free living with Mrs. Conti's mother. We do not believe that Mark made over $ 500,000 in interest-free loans to petitioners when he took out loans on678 which he had to pay interest. Large unexplained discrepancies between petitioners' actual net income and the net income reported on their tax returns are evidence of fraud. Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 214 (1971). Petitioners had unreported income in both of the years in issue. Fraud may be inferred from repeated understatements in successive years when coupled with other circumstances showing an intent to conceal or misstate taxable income. Patton v. Commissioner, 799 F.2d 166">799 F.2d 166, 171 (5th Cir. 1986), affg. T.C. Memo. 1985-148; Anderson v. Commissioner, 250 F.2d 242">250 F.2d 242, 250 (5th Cir. 1957), affg. on this issue T.C. Memo 1956-178">T.C. Memo. 1956-178. Petitioners did not maintain any records of their alleged cash hoard or loans from Mark. A taxpayer's failure to maintain accurate and complete records, when coupled with other indicia, supports a finding of fraud, as does a taxpayer's failure to supply his bookkeeper or accountant with all data necessary to maintain complete and accurate records. Merritt v. Commissioner, 301 F.2d 484">301 F.2d 484, 487 (5th Cir. 1962),679 affg. T.C. Memo 1959-172">T.C. Memo. 1959-172; Reaves v. Commissioner, 295 F.2d 336">295 F.2d 336, 338 (5th Cir. 1961), affg. 31 T.C. 690">31 T.C. 690 (1958). Taxpayer's failure to supply complete information about their income and expenses to their tax return preparer is further evidence of fraudulent intent:. Korecky v. Commissioner, 781 F.2d 1566">781 F.2d 1566, 1569 (11th Cir. 1986), affg. per curiam T.C. memo. 1985-63. Petitioners maintained several bank and brokerage accounts. In 1986 Mrs. Conti made at least 43 cash deposits totaling $ 87,450. Her average cash deposit in 1986 was over $ 2,000. Mrs. Conti made at least 15 coin deposits in 1986 totaling over $ 4,000. In 1987 Mrs. Conti made at least 88 cash deposits totaling over $ 290,000. Her average cash deposit in 1987 was over $ 3,300. Petitioners' explanation that the cash and coin deposits came from their $ 800,000 cash hoard or $ 550,000 of loans from Mark is not believable. We believe petitioners are concealing the source of the cash. The intent to conceal or mislead may be inferred from a pattern of conduct. See Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943).680 A pattern of consistent underreporting of income for a number of years, especially when accompanied by other circumstances showing intent to conceal, such as Mrs. Conti's banking pattern of conduct, is strong evidence of fraud. Holland v. United States, 348 U.S. 121">348 U.S. 121, 137-139 (1954); Estate of Mazzoni v. Commissioner, 451 F.2d 197">451 F.2d 197, 202 (3d Cir. 1971), affg. T.C. Memo. 1970-37: Foster v. Commissioner, 391 F.2d 727">391 F.2d 727, 733 (4th Cir. 1968), affg. on this issue T.C. Memo 1965-246">T.C. Memo. 1965-246; Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 700 (1989); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 106 (1969). Petitioners increased the amount that they claimed as their cash hoard as the IRS examination and this case progressed from $ 120,000 at the initial audit interview, to $ 450,000 in a letter from Mr. Grey, to $ 800,000 during this litigation. They also did not claim they received $ 550,000 in loans from Mark until trial. Thus, their oral and written claims as to cash on hand were false and inconsistent. 681 Fraud may be inferred where the taxpayer makes false and inconsistent statements to revenue agents, Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 20 (1980), or files false documents, Stephenson v. Commissioner, 79 T.C. 995">79 T.C. 995, 1007 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984). Finally, petitioners had extensive unexplained dealings in currency which indicate fraud. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo 1984-601">T.C. Memo. 1984-601. We conclude that respondent has proven fraud by clear and convincing evidence. Accordingly, we hold that petitioners are liable for the additions to tax for fraud under section 6653(b). 5. Substantial Understatement of Income Tax Under Section 6661Respondent determined that petitioners are liable for the addition to tax under section 6661. Section 6661(a) imposes an addition to tax of 25 percent of the amount of any underpayment attributable to a substantial understatement of income tax for a taxable year. A substantial understatement is one which exceeds the greater of 10 percent of682 the tax required to be shown on the return or $ 5,000. Sec. 6661(b). If petitioners' understatement of income is substantial within the meaning of section 6661(b)(1), they are liable for the section 6661 addition unless the understatement can be reduced under the exceptions contained in section 6661(b)(2)(B). By either test of section 6661(b), petitioners' understatement is a substantial understatement. Petitioners have no authority for their failure to report their cash income, nor did they disclose any facts pertaining to such income on their returns or in a statement attached to their returns. Therefore, the addition cannot be reduced through application of the provisions of section 6661(b)(2)(B). We hold that petitioners are liable for the additions to tax under section 6661. To reflect concessions and the foregoing, Decision will be entered under Rule 155. APPENDIX N/A = no date available. Bloomfield Savings & Loan # 450323-6, for 1986Deposit DateTotal DepositCash DepositCoin DepositJanuary 8$ 1,747.83 $ 550 $ 100 January 172,000.002,0000January 173,210.679000January 215,100.002,6000February 33,426.662,000200February N/A6,177.361,3000March 33,875.98600110April 42,558.0900April 117,210.751,500200April 222,000.002,0000May 72,517.941,500100May N/A9,661.861,6000June 112,000.002,0000June 1713,000.003,0000June 302,911.462,5000July 33,994.941,0000July 214,500.004,5000July 288,061.162,500360August 13,930.461,000200August 1129,457.113,0000August 132,000.002,0000August N/A2,629.442,0000August 214,000.001,6000August 256,083.162,0000August 22,717.941,400400September 223,000.002,500500Totals $ 137,772.81$ 47,550$ 2,170683 Standard Federal Savings #041-500-4457, for 1986Deposit DateTotal DepositCash DepositCoin DepositSeptember 10$ 3,027.94$ 2,000$ 0 September 162,620.001,000250September 242,500.002,000500September 265,000.002,0000September 297,000.002,0000October 89,082.092,000400October 92,199.421,000132October 237,886.122,0000October 284,651.923,0000November 45,015.093,0000November 10$ 5,350.00 $ 4,000$ 300November 112,613.372,6000December 43,877.001,500300December 2617,201.012,0000Totals $ 78,023.96$ 30,100$ 1,882Sterling Savings #0-02-60-150581, for 1986Deposit DateTotal DepositCash DepositCoin DepositOctober 27$ 4,000$ 4,000$ 0November 242,0002,0000December 121,5001,5000December 292,3002,3000Totals $ 9,800$ 9,800$ 0Bloomfield Savings & Loan #10-01-040074-7, for 1987Deposit DateTotal DepositCash DepositCoin DepositFebruary 4$ 850.00 $ 0 $ 0February 52,600.0000February 24425.0000February 244,674.0000February 272,526.0000March 2850.0000March 41,040.0000March 41,500.0000Unknown date50.0000March 192,000.0000March N/A3,450.0000April 151,040.0000April 232,033.0000April 293,450.0000May 111,040.0000May 264,000.004,0000May 286,100.003,5000June 14,425.003,5000June 35,000.003,0000June 43,000.003,0000June 84,540.003,5000June 113,500.003,5000June 184,500.004,5000June 243,500.003,5000June 255,000.005,0000June 294,600.002,0000June 29$ 5,040.00 $ 4,000 $ 0July 12,000.0000July 144,000.004,0000Totals $ 86,733.00 $ 47,000$ 038,186.7820,650$ 124,919.78$ 67,650684 Bloomfield Savings & Loan # 03-02-0590431-3, for 1987Deposit DateTotal DepositCash DepositCoin DepositJanuary 21$ 3,500.00 $ 3,500 $ 0February 102,750.002,7500March 132,400.002,4000May 133,600.003,6000May 182,500.002,5000September 233,500.003,5000October 304,900.002,4000November 2315,036.7800Totals $ 38,186.78$ 20,650$ 0Standard Federal Savings # 041-500-4457, for 1987Deposit DateTotal DepositCash DepositCoin DepositJanuary 5$ 4,189.00$ 2,000$ 300January 74,640.492,500200January 156,290.873,5000January 213,146.732,5000January 282,809.982,3000February 35,630.002,500130February 53,275.492,0000February 104,050.003,0000February 1313,383.783,8250February 2415,881.613,0000March 42 3,000.00 2,0000March 172,708.772,000200March 273,877.803,0000April 24,969.001,0000April 153,398.003,0000April 223,874.523,2000April 3013,151.003,0000May 43,967.002,0000May N/A2,597.302,0000May 13$ 2,538.70 $ 2,000 $ 0 May 153,772.003,400270May 212,350.002,0000May 2610,110.004,0000June 33,105.002,0000June 53,868.773,0000June 1115,123.004,0000June N/A1,926.431,4000July 85,265.933,0000July 133,500.003,000500July 172,965.362,000200July 245,223.462,000400August 145,530.904,0000September 515,361.7500September 142,984.551,0000September 236,154.0000September 304,162.7600October N/A2,500.0000October N/A3,000.0000Totals $ 204,283.95$ 85,125$ 2,200685 Sterling Savings # 0-02-60-150581, for 1987Deposit DateTotal DepositCash DepositCoin DepositJanuary 13$ 2,000.00$ 2,000 $ 0February 252,000.002,000 0April 252,000.002,000 0May 142,000.002,000 0July 11,900.001,900 0July 146,935.006,935 0July 27414.340 0July 306,757.950 0July 302,600.000 0July 30828.800 0July 30491.000 0August 6102.000 0August 62,000.000 0August 61,040.000 0August 611,524.920 0August 105,100.005,100 0August 101,128.950 0August 115,000.005,000 0August 126,000.006,000 0August 134,000.004,000 0August 131,530.901,530.900August 1410,000.000 0August 142,000.002,000 0August 173,000.003,000 0August 217,000.007,000 0August 2175.000 0August 21$ 18.00 $ 0 $ 0August 225,000.005,000 0August 24500.000 0August 246,000.006,000 0August 256,510.006,510 0August 265,000.005,000 0August 26950.000 0August 261,525.000 0August 2720.000 0August 27666.000 0August 271,462.500 0August 311,500.001,500 0August 312,600.000 0September 26,000.006,000 0September 36,000.006,000 0September 3625.000 0September 53,143.003,143 0September 52,000.000 0September 5317.660 0September 540.000 0September 95,000.005,000 0September 106,500.006,500 0September 113,000.003,000 0September 148.000 0September 1499.840 0September 1475.000 0September 1488.920 0September 164,525.004,525 0September 177,000.007,000 0September 171,782.540 0September 182,000.002,000 0September 18196.120 0September 21628.910 0September 21445.630 0September 3025.600 0September 302.000 0September 30625.000 0September 302,600.000 0September 3030.000 0October 22,000.000 0October 297.530 0October 650,774.650 0October 6589.810 0October 6950.000 0October 1330.000 0October 1345.000 0October 13203.500 0October 1326.320 0October 2171,933.510 0October 2211,000.000 0October 272,600.000 0October 27$ 7,000.00$ 7,000 $ 0October 2745.820 0October 2783.670 0October 29600.000 0October 2920,000.000 0October 302,000.000 0November 31,040.001,040 0November 3950.000 0November 320,000.000 0November 939.330 0November 950.000 0November 940.000 0November 980.000 0November 1281.000 0November 1275.880 0November 121,094.810 0November 1220.000 0November 161,200.000 0November 1665.750 0November 1624.000 0November 25800.00800 0November 25950.000 0November 2540.000 0November 252,000.000 0November 25325.000 0November 25500.000 0November 2533.730 0November 252,500.000 0November 308.810 0November 30250.000 0November 30303.750 0November 301,250.000 0November 3065.750 0December 31,040.000 0December 3300.000 0December 320.000 0December 81,600.001,600 0December 91,500.000 0December 92,600.000 0December 17300.000 0December 1712.000 0December 17116.250 0December 2110.000 0December 216.750 0December 215,000.005,000 0December 2147.180 0December 21674.350 0December 2185.000 0December 224,000.004,000 0December 22374.000 0December 22139.350 0December 29$ 1,500.00 $ 0 $ 0December 291,807.610 0December 29365.000 0December 301,000.001,000 0December 301,200.000 0Totals $ 399,403.69$ 138,083.90$ 0686 Footnotes1. Not in record.↩1. We note that in the opening brief respondent proposed an ultimate finding of fact that petitioners are entitled to additional rental depreciation of $ 5,047 for 1986. Petitioners did not object to this finding. However, we conclude that petitioners are entitled to $ 5,369 disallowed in the notice of deficiency as additional rental depreciation.↩2. This amount was illegible and may exceed $ 3,000.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623197/	HAROLD L. BRAZILE and LINDA A. BRAZILE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrazile v. CommissionerDocket No. 14306-80United States Tax CourtT.C. Memo 1983-105; 1983 Tax Ct. Memo LEXIS 684; 45 T.C.M. (CCH) 795; T.C.M. (RIA) 83105; February 17, 1983. Robert D. Forrester,Wendell L. Davies,Harold C. Rector and Stephen W. Spencer, for the petitioners. William P. Hardeman, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' 685 income tax for the calendar years 1970, 1971 and 1972 in the amounts of $20,864, $1,932.83 and $39,191, respectively, and additions to tax under section 6653(b) 1 in the respective amounts of $10,432, $966.42 and $19,596. 2 The issues for decision are (1) whether assessment or collection of the deficiencies determined by respondent is barred by the statute of limitations; 3 and (2) if respondent establishes that the return for each of the years 1970, 1971 and 1972 is false and fraudulent with intent to evade tax, what is the proper additional income subject to tax in each of the years here in issue, and are petitioners liable in each year for the addition to tax for fraud under section 6653(b). 686 FINDINGS OF FACT Petitioners are husband and wife who resided in Amarillo, Texas, at the date of the filing of their petition in this case. They filed a timely joint U.S. Individual Income Tax Return, Form 1040, for each of the calendar years 1970, 1971 and 1972 with the Internal Revenue Service Center at Austin, Texas. Prior to 1964, Harold L. Brazile (petitioner) had been employed for a number of years in various grocery stores and in the years immediately preceding 1964 had been employed as a butcher. Petitioner Linda A. Brazile never worked outside her home until 1964 when petitioner opened his own meat market and she worked there on a part-time basis. Petitioner was born in 1939 in Nashville, Arkansas, which is a rural community of approximately 2,500 people. He is the younger of two children. Petitioner was brought up on a farm and began working for his father on the farm at a very young age. As soon as he was old enough, he began working for other people around Nashville, Arkansas, and would earn a little money. He entered public school in 1946, but worked after school and on weekends. When petitioner was growing up, his grandparents lived on the farm with petitioner687 and his parents. When petitioner was approximately 12 years old, his family moved to Amarillo, Texas, and he began working, delivering newspapers and helping after school at a local grocery store. When he was 15, he moved back to Arkansas and lived for a few months with his sister and then returned to Amarillo. When he was in Arkansas, he worked for a grocery store. When he returned to Amarillo, he went back to work in a grocery store after school. He was in the ninth grade in school and was making very poor grades. Because of the failing grades he was making in school, he dropped out of school in the tenth grade and began working full-time. In 1957, when he was only 17, petitioner married his wife, Linda, who was also 17. At that time, Mrs. Brazile had completed the eleventh grade in high school. Petitioner continued working for various grocery stores in Amarillo. He later worked in a grocery store in DeQueen, Arkansas, and then returned to Amarillo to work in a gorcery store. Before he left Amarillo, petitioner had become a butcher and after returning to Amarillo from Arkansas, was the manager of the meat department of the store. In 1964, petitioner opened his own meat688 market. From the time petitioner first began working, he would take some of the money he earned and put it away at home and keep it in cash. His grandparents had an unfortunate experience with loss of money in a bank closing in 1930 and encouraged petitioner's parents and petitioner to save cash at home. By 1964, when petitioner opened the meat market in Amarillo, Texas, he had, in cash at home, between $14,000 and $15,000. Petitioner leased the building in which he opened his meat market and purchased his equipment on time so that he used only about $4,000 of the cash he had at home in the opening of his market. Soon after petitioner opened his meat market in Amarillo, Texas, he was approached by Charles McClure, who was working for a bookkeeping firm. Mr. McClure talked with petitioners about installing a bookkeeping system for them. He represented to petitioners that the firm by which he was employed would install a bookkeeping system for their specific business and would provide them with complete bookkeeping, tax and business management services.Mr. McClure had only completed high school and had gone to work for the bookkeeping company as a salesman. The instructions689 which Mr. McClure gave to petitioners as to what they should give him from which to keep their books was that each day they should read the total amount of sales that had been rung up on the cash register in their store and enter it on a sheet furnished to them by Mr. McClure. Mr. McClure gave them a folder and told them that they should place all invoices which had been paid into the folder and, when a payment was made in cash, a memorandum should be placed in the folder of the cash payment if there was not an invoice for the payment. Shortly after opening the meat market, petitioner employed one full-time employee and two high school boys who worked for him in the afternoon. The employees were paid in cash and petitioner made the notation of the payroll cash payment and placed it in the folder for Mr. McClure. Twice a month Mr. McClure or someone he sent would pick up the sheet showing the cash register reading and the folder with the invoices and memoranda of cash payments and take them to the bookkeeping office where someone would make a summary of the information. In 1968, Mr. McClure left the bookkeeping firm for which he was working and opened West Texas Bookkeeping690 Service for himself. He took petitioner's account with him. Thereafter, he had petitioner follow the same system for recording the reading from the cash register and placing of invoices or memoranda of cash payments in a folder. Either Mr. McClure or one of his employees would prepare the summary from the information furnished to him by petitioner. Someone at the bookkeeping firm prior to 1968 and Mr. McClure or an employee of his thereafter would prepare petitioner's payroll tax reports as well as his Federal income tax returns from the information on the summary sheets. In 1966, petitioner opened a second store in Amarillo. Although petitioner owned this store, it was run by petitioner's mother and father and three or four employees. This store operated until late 1970. However, in approximately April 1970 it was moved from its original location to another location in Amarillo. Petitioner had never had a bank account of any type until he opened his meat market in Amarillo, Texas. In 1964, at the time he opened the meat market, petitioner opened a bank account at Amarillo National Bank, Amarillo, Texas. In April 1970, when the second store was moved, petitioner opened691 a second account at Amarillo National Bank. Both of these accounts were checking accounts. Petitioner never maintained a savings account at any bank. Petitioner would go to work at about 5 o'clock in the morning and work until after 8 o'clock in the evening. When he had only one store, he would cut the meat and put it in the cases at that store and have it all prepared at the time the store opened to customers at 8 o'clock. When petitioner was operating the second store, he would go to the second store at 5 o'clock in the morning and cut the meat needed for the entire day at that store and put it in the cases, and then, at approximately 7 o'clock, go over to his original store and cut meat for that store to have available for sale. After the store closed at 8 o'clock, petitioner would read the figures shown on the cash register and enter the amount on the sheet furnished him by Mr. McClure in the space provided for that day's entry. He would then put the money and checks that had been received in a container and take them home for the evening instead of leaving them in the store. The following morning, he would bring the money and checks back to the store and Mrs. Brazile692 would come down at about 10 o'clock and count the cash and list it and the checks, which very often were numerous, on a bank deposit slip and, before the bank closed, take the money and checks to the bank for deposit. Petitioner never counted the money and checks he received in a day to compare the total with the total sales shown on the cash register. Mrs. Brazile never checked the sales as shown from the cash register and recorded on the sheet furnished by Mr. McClure against the deposit she made at the bank. Although the majority of the expenses of the meat market were paid for by checks drawn primarily by Mrs. Brazile on petitioners' checking account, some purchases were paid for in cash. Purchases of bread and milk and miscellaneous items were usually the ones paid for in cash. When purchases were made in cash, petitioner or Mrs. Brazile would take cash from the cash register to make the payment and would write a notation on one of the slips furnished to them by Mr. McClure and place it in the folder furnished to them by Mr. McClure. Also, at times Mr. Brazile would instruct Mrs. Brazile to take a certain amount of cash out of the daily receipts and add it to the cash they693 kept at home instead of depositing it in the bank. Generally this was done when Mr. Brazile believed the market had a very good day. Although most of petitioners' personal living expenses were paid by check, petitioners occasionally would take cash from the cash register for payment of these expenses. Soon after petitioners began operating their meat market, individuals would come in to purchase quarters or halves of beef. Petitioner had no charge system, but two different finance companies would finance purchases of the halves or quarters of beef for petitioner's customers. When a customer came in and ordered a half or a quarter of beef which was to be financed, Mrs. Brazile would fill out a contract form for the financing of the beef. When the beef had been delivered, she would take the financing contract to the finance company. The finance company would check it out and the next day would call Mrs. Brazile and tell her she could pick up the check for the beef. Mrs. Brazile would pick up the check and put it in her purse, and the next day, when she made her bank deposit, would deposit that check in the Amarillo National Bank. Mrs. Brazile did not ring the amount of the694 checks she received from the finance company into the cash register. Since Mr. McClure had not told Mrs. Brazile to ring these amounts into the cash register, it did not occur to her to do so. The following schedule shows the total amounts, by year, received by petitioners from the finance companies in payment for beef quarters and halves that were financed: YearAmount1965$4,399.3219663,481.7319673,328.9919683,695.1319697,438.7219706,729.5119715,276.7419723,485.57The following schedule shows the total amounts deposited by petitioners in their bank accounts at Amarillo National Bank for the years 1970, 1971 and 1972: 197019711972Amarillo National Bank(Original Account)$259,880.44$231,197.81$310,302.88Amarillo National Bank(Account Opened in 1970)154,761.9350,000.00Total$414,642.37$231,197.81$360,302.88Some of the amounts deposited were from loan proceeds and from property sales. The $50,000 deposit made to the account opened in 1970 was a cash deposit made in the fall of 1972. The lowest balance petitioners had in their bank accounts during each of the calendar years695 1970, 1971 and 1972 was $28,265, $40,932, and $32,078, respectively. In the fall of 1972, a customer came into petitioner's store and stated that she was the executor of an estate that needed to sell a farm and receive cash proceeds from the sale. Petitioner and his wife discussed buying this 60-acre farm. At the time, they lived on a small farm that petitioner initially bought jointly with his father and later bought his father's interest. They counted the money they had in cash at home and it was almost $50,000. They took a small amount of cash from the cash register at the store to bring the total cash to $50,000 and deposited the $50,000 in the bank to use in payment for the farm. Approximately $3,000 of this cash deposit was in $100 bills and the remainder was in $20 bills and bills of smaller denominations. Respondent, using as the beginning point the bank deposits as above-stated, arrived at taxable income for petitioners of $53,913.69 for 1970, $16,007.29 for 1971, and $94,609.16 for 1972. Respondent failed to make an adjustment for a $2,000 loan petitioner received from his parents in 1970. He failed to deduct all business expenses paid by check in each of the696 years here in issue, failed to make the proper adjustment for returned checks in each of the years here in issue, and failed to make the proper adjustment for personal cash expenditures in each of the years here in issue. For the year 1970, he failed to adjust for a refund petitioner received from a bakery organization to which he belonged and for cash used by petitioners to open the new bank account in 1970. Respondent failed to make proper adjustments for the itemized or standard deductions taken by petitioners in each of the years here in issue and failed to make proper capital gains deductions with respect to property sold by petitioners in 1970 and 1971. After making these adjustments, the taxable income computed by the method used by respondent is $29,914.34 for 1970, $3,297.58 for 1971, and $57,183.03 for 1972. The $57,183.03 includes the entire $50,000 cash deposited by petitioners in 1972 in their bank account at the Amarillo National Bank. Petitioners reported taxable income for 1970, 1971 and 1972 in the amounts of $3,656, $12,249 and $12,254, respectively. At the end of the year, Mr. McClure would take the information he had accumulated from the sales receipts697 entered by petitioner from his cash register and the invoices placed into the folder he furnished them and prepare petitioners' income tax return. Before preparing this return, he would give petitioners a form on which to enter information with respect to their medical expenses and personal deductions. Mr. McClure also prepared a capital investment sheet on which he showed equipment purchased by petitioner that had a useful life of more than a year and the depreciation with respect thereto. After Mr. McClure prepared petitioners' income tax returns, he would bring them by and give them to petitioners, mark where they were to sign them and tell them to sign them and mail them to the Internal Revenue Service. Neither petitioner reviewed the return before signing it, but signed the return as prepared by Mr. McClure and mailed it in accordance with his instructions. There were some addition mistakes in the returns for each year here in issue and certain other mistakes in these returns. The most outstanding mistake was that the cost of goods sold for the year 1971 was understated by $10,000. Mr. McClure never asked for petitioners' bank statements or canceled checks and in no way698 reconciled petitioners' bank accounts with the records he kept for petitioners or with petitioners' tax return. Petitioner Harold L. Brazile was indicted in a five count indictment in the Amarillo Division of the United States District Court for the Northern District of Texas on March 29, 1977. This indictment charged petitioner with willfully attempting to evade and defeat his income taxes for 1970 and 1972 in violation of section 7201. The indictment also charged petitioner with willfully making and subscribing income tax returns for 1970, 1971, and 1972 under penalties of perjury which he did not believe to be true and correct as to every material matter in violation of section 7206(1). Petitioner was found not guilty by a jury on all charges by order of acquittal dated June 15, 1977, in the Amarillo Division of the United States District Court for the Northern District of Texas. 4699 Respondent in his notice of deficiency computed petitioners' income for each of the years here in issue on the basis of bank deposits adjusted for certain nontaxable items reduced by his determination of deductible expenses. Respondent determined that there was an underpayment of tax in each of the years here in issue, a portion of which was due to fraud with intent to evade tax. OPINION As both parties recognize, assessment and collection of the deficiencies for each of the years here in issue are barred by the statute of limitations absent proof by respondent that the return for that year was false or fraudulent with intent to evade tax. It is incumbent on respondent to prove fraud by clear and convincing evidence. . Although it is not necessary for respondent to prove the precise amount of underpayment, it is necessary that he show that there was some underpayment in each year and that a part of the underpayment is due to fraud. . In this case, respondent has failed to show any underpayment of tax by petitioners in the year 1971. For this700 reason, any deficiency that might be due for 1971 is barred by the statute of limitations. In order to show that a return is false or fraudulent with intent to evade tax, respondent must show by clear and convincing evidence that there is some underpayment of tax for the year.For the year 1972, respondent has failed to show that there is any deficiency in petitioners' tax unless a substantial amount of the $50,000 cash deposit made by petitioners in the fall of that year is considered to be income for the year 1972. Petitioners admit their failure to report $3,485.57 of receipts from beef sales which were financed in 1972, but there is no showing that this failure was due to fraud.The checks for this beef were deposited in petitioners' bank account and the evidence as a whole shows merely a misunderstanding by petitioners of the instructions from their bookkeeper as the explanation for their failure to include this amount on the sales sheet they supplied to Mr. McClure. Respondent's computation as corrected of $57,183.03 from the bank deposit method includes the $50,000 cash deposited in the fall of 1972 as well as the $3,485.57 of checks petitioners received for financed beef.701 If the $50,000 cash deposit is deducted from the $57,183.03, the remaining $7,183.03 is less than the $12,254 taxable income reported by petitioners.The evidence shows that some amount, but only a relatively small amount of the $50,000 cash was accumulated from petitioners' 1972 receipts. The evidence also shows that some other amounts of cash used by petitioners for personal expenses were not deposited to petitioners' checking account. However, there is no evidence of the amount of personal expenses petitioners paid by cash except that the amount was small. Certainly, there is no clear and convincing evidence that the total of the cash accumulated by petitioners in 1972 and the cash that was used for personal expenses without being deposited totaled over $5,000. Not only did both petitioner and his parents testify as to petitioners' maintaining their savings which they accumulated over the years at home, the inference from the other evidence clearly is that the $50,000 cash was not for the most part from 1972 earnings. To accept the conclusion that the entire $50,000 was accumulated in 1972 would mean that petitioner's sales increased by $129,000 in 1972 over 1971, with total702 costs increasing only about $33,000. The evidence shows that petitioner's operations in 1971 and 1972 were approximately the same and clearly indicates that any such substantial increase in profit percentage did not occur. Also, clearly petitioners had some savings. They had money with which to open their store in 1964 and with which to buy a farm with petitioner's father during the 1960's. They never had a savings account, and until they opened the meat market in 1964 had no form of bank account.The evidence as a whole clearly indicates that petitioners saved cash at home through the years. The evidence clearly shows an underreporting of income by petitioners in 1970, which is not totally explained by the $6,729.51 in receipts from financed beef. From an analysis of the bank deposits, it appears that the underreporting in 1970 was approximately $19,000.Also, if, as we have concluded, the $50,000 cash deposited by petitioners in 1972 was accumulated over the years from 1964 through 1972, some amount of this cash was probably accumulated in 1970 and not deposited to petitioners' checking account. Therefore, the issue as to 1970 is whether respondent has shown by clear and convincing703 evidence that some part of the underpayment of tax resulting from the underreporting of income was due to fraud with intent to evade tax. Based on the evidence as a whole, we conclude he has not. In 1970, petitioner was operating two stores. One of these was managed by petitioner's parents. Petitioner testified in detail about his instructions to everyone who worked in the meat market to ring up all sales on the cash register and that he thought all sales were being rung up. However, even though both of petitioner's parents testified at the criminal trial and their testimony is stipulated into this record, and petitioner's father testified at the trial of this case, they were not questioned on the details of how the receipts at the store they operated were rung up on the cash register. In fact, the record is not clear as to when petitioner obtained the figures from this cash register to put on the sheet kept to be given to Mr. McClure. There was a separate bank account used in 1970 for receipts from the second store. Deposite to this account were $154,761.93 in 1970. Although the record is not clear, the indication is that Mrs. Brazile made these deposits and that petitioner704 had picked up the funds for her to deposit. For all this record shows, any amounts which failed to be rung into the cash register in 1970 could have been at the second store so that petitioner would have no way of having direct knowledge of any failure to ring up some receipts in that store. Respondent has the burden of proof of fraud. The imprecise evidence in this case falls far short of the clear and convincing evidence needed to show fraud for the year 1970. Respondent relies heavily on a computation which shows that petitioners' expenditures for the period 1964 through 1969 exceeded their reported income plus established sources of nontaxable receipts. During most of these years, petitioner was operating the second store. While respondent's computation does indicate that petitioners' income during some or all of the years 1964 through 1969 was underreported, it does not show any knowledge of this fact on the part of petitioners. Also, during the years 1966 through 1969, the second store was being operated and may well have been the source of the unreported income without petitioners' having any knowledge of the underreporting. The indication from the record is that most705 of the receipts from the second store were deposited in petitioner's bank account, even though they may not have been included in his reported income because of failure of his employees to properly ring all receipts into the cash register. Furthermore, there are no indications of fraud other than any inference that might be drawn from petitioner's understatement of income. Most of the receipts from petitioner's business were deposited in bank accounts, even though these bank accounts could not be reconciled with the records Mr. McClure was keeping of petitioner's business. Someone knowingly, fraudulently omitting income from his return would make more of an attempt to hide the omission than to make deposits to a bank account which would not reconcile with his other records. Also, when the agents began investigating petitioner's records, he supplied them with all the information he had and assisted them in analyzing the information. Respondent makes much of the fact that when two special agents first questioned petitioner, without prior notice to him of the fact that his returns were being investigated, he told them that he had deposited $60,000 cash in late 1972 which he got706 from his father. Right after his interview with the agents, he consulted a lawyer, and early the next morning that lawyer, in petitioner's presence, called the two special agents and told them that the amount of cash petitioner had deposited was $50,000 and that it was cash he had been accumulating over the years. We are not persuaded that the fact that petitioner incorrectly stated the amount of cash deposited and its source to the agents when first questioned by them without notice is clear and convincing evidence of fraud, particularly when, within less than 24 hours, petitioner corrected the statement. Certainly, this record shows negligence on the part of petitioner. He should have discussed in more detail with Mr. McClure the nature of his business and questioned the system of bookkeeping Mr. McClure set up for him. Certainly, it was negligent of petitioner not to count each day's receipts to compare with the cash register total or have Mrs. Brazile compare her deposit slip each day with that total. However, negligence is not fraud. Fraud requires a showing of knowingly understating taxable income with intent to evade tax. The negligence shown in this case is not a showing*707 of any knowing understatement of income by petitioners. Thee is no pattern of concealment of funds in this case. Considering the evidence as a whole, we conclude that respondent has failed to show by clear and convincing evidence that petitioners' return for any one of the years 1970, 1971 or 1972 was false or fraudulent with intent to evade tax. Therefore, the assessment or collection of any deficiency for any of the years here in issue is barred. Decision will be entered for the petitioners.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue. ↩2. At the trial, respondent conceded that the deficiencies as determined in the notice of deficiency were overstated to some extent and that the proper deficiencies should be $19,009.05, $271.36 and $36,752.65 for the calendar years 1970, 1971 and 1972, and the additions to tax under sec. 6653(b) should be 50 percent of the amount of these redetermined deficiencies. ↩3. Respondent concedes that absent a showing in accordance with the provisions of section 6501(c), that petitioners' return for each of the years 1970, 1971 and 1972 was false or fraudulent with intent to evade tax, the assessment or collection of any deficiency is barred since the notice of deficiency was mailed after the expiration of the statute of limitations for determining deficiencies provided for in section 6501(a).↩4. The parties stipulated into the record in this case the exhibits received at the criminal trial consisting, to a large extent, of canceled checks, summaries, invoices, contracts for sale of beef halves and the like, and also stipulated into this record the complete transcript of the criminal trial.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623198/	Estate of Hamilton C. Rickaby, Deceased, Marcy W. Rickaby, Executrix, and Marcy W. Rickaby, Petitioners, v. Commissioner of Internal Revenue, RespondentRickaby v. CommissionerDocket Nos. 55403, 56023United States Tax Court27 T.C. 886; 1957 U.S. Tax Ct. LEXIS 251; February 28, 1957, Filed 251 Decisions will be entered under Rule 50. Payments, on account of bonds purchased "flat" in 1942, made by the debtor in the tax years as interest applicable to periods before 1942 and resulting in recoveries in excess of petitioner's basis but less than the face of the bonds, held taxable as capital gains under section 117 (f), I. R. C. 1939. David G. Sacks, Esq., and Allan J. Parker, Esq., for the petitioners.Clarence P. Brazill, Esq., for the respondent. Opper, Judge. OPPER887 These consolidated proceedings involve deficiencies, only part of which is in issue, of $ 648.76, $ 1,330, and $ 1,080252 in income taxes for the calendar years 1950, 1951, and 1952, respectively. Hamilton C. Rickaby died on February 15, 1956, and his estate was substituted as a party herein. The sole question presented is whether amounts received by Marcy W. Rickaby, Hamilton's wife, in excess of her basis of certain bonds, purchased "flat," are taxable as capital gains attributable to the retirement of bonds under section 117 (f) or in full under section 22 (a).FINDINGS OF FACT.Some of the facts have been stipulated and are hereby found.Marcy W. Rickaby, herein called petitioner, filed joint income tax returns with her husband for each of the years involved with the collector (now director) of internal revenue for the second (now lower Manhattan) district of New York.In 1942 petitioner, at a cost of approximately $ 1,750, purchased $ 50,000 principal amount (with interest unpaid thereon) of series B debentures of Retail Properties, Inc., herein called Retail, formerly Schulte-United Properties, Inc., a corporation organized under the laws of Ohio. No allocation was made on the purchase between the claim representing the principal amount of the debentures and the unpaid interest, that is, they253 were purchased "flat." By January 1, 1950, petitioner had recovered her original cost of these debentures and by September 1950 there existed a reasonable expectancy that the principal of these debentures would ultimately be collected. She received $ 1,500 in 1950, $ 3,500 in 1951, and $ 3,000 in 1952 from Retail on account of her ownership of these debentures. She and her husband reported these receipts, on their tax returns for the respective years, as amounts received on account of partial retirement of such debentures under the provisions of section 117 (f) of the Internal Revenue Code of 1939.On March 1, 1929, Schulte-United Properties, Inc., had issued approximately $ 6,500,000 principal amount of sinking fund 5 1/2 per cent gold debentures. Retail was unable to meet the interest payment due September 1, 1931, on these gold debentures. A debenture holder's protective committee was formed and a plan of reorganization, dated 888 February 3, 1932, was submitted to the debenture holders. Under the terms of that plan of reorganization, each holder of $ 1,000 in principal amount of gold debentures had the option to receive in exchange therefor $ 500 in principal amount254 series A 5 per cent debentures and $ 600 of series B 6 per cent debentures to be issued under the provisions of a trust agreement between Retail and the Guardian Trust Company of Cleveland. The plan of reorganization also provided for a voting trust of the preferred and/or common stock of Retail, to terminate when the series A and series B debentures were discharged or upon such earlier date as a majority of the voting trustees in their discretion should determine. Approximately 95 per cent of the holders of the gold debentures accepted the exchange offer and received series A and series B debentures. The outstanding gold debentures which were not exchanged were redeemed on December 1, 1940, at 102 per cent of the principal amounts thereof plus interest accrued to the date of redemption.In 1940 tenders were requested of series A debentures to be purchased for retirement out of funds realized largely from the sale of certain property of Retail. In 1943 a notice of offer to purchase debentures was sent to all holders of both series A and series B debentures. Funds for this purpose were realized in part from the sale of one of Retail's properties at Pueblo, Colorado. Tenders were255 requested at prices not in excess of bid and asked prices, which at that time were 82 and 84 plus accrued interest for series A and 12 3/4 asked flat for series B. A substantial number of both series was purchased pursuant to that offer. On March 19, 1947, $ 400,000 principal amount of series A debentures were called following the sale of certain of Retail's properties.On April 26, 1950, a notice of offer to purchase series B debentures was sent to holders thereof. In 1951 payment of an intercompany note by Retail Properties, Ltd., the wholly owned Canadian subsidiary of Retail, was made possible by the mortgage of that subsidiary's properties. All series A debentures then outstanding were redeemed and a payment equal to 40 per cent of the principal amount of the outstanding series B debentures was made. The series B debentures presented for partial payment were endorsed as follows:Forty percent (40%) of the principal amount of this Debenture has been paid. No interest will accrue subsequently to August 31, 1951 on the amount so paid. Interest accrued on the amount so paid at the rate of six percent (6%) per annum from November 1, 1934 to August 31, 1951 remains an obligation256 of the Company evidenced by this Debenture.Retail paid holders of series B debentures, in the following years, amounts equal to the following percentages thereof and designated by Retail as interest for the periods specified as follows: 889 YearPercentageInterest period19473Mar.1, 1932, to Aug. 31, 1932 19483Sept. 1, 1932, to Feb. 28, 193319493Mar.1, 1933, to Aug. 31, 1933 19503Sept. 1, 1933, to Feb. 28, 193419514Mar.1, 1934, to Oct. 31, 1934 19513Nov.1, 1934, to Apr. 30, 1935 19523May1, 1935, to Oct. 31, 1935 19523Nov.1, 1935, to Apr. 30, 1936 19533May1, 1936, to Oct. 31, 1936 19533Nov.1, 1936, to Apr. 30, 1937 19543May1, 1937, to Feb. 28, 1938 19553Mar.1, 1938, to Oct. 31, 1938 Under the provisions of the trust agreement, interest on the series B debentures was payable currently only if Retail earned "surplus income," therein defined as gross income on an accrual basis for any given period minus all operating and nonoperating expenses (but excluding interest on series B debentures) and the net deficit, if any, accumulated from March 1, 1932, to the beginning of such period. These debentures257 contained an unequivocal promise to pay both principal and accumulated interest no later than maturity. They were subject to redemption in whole or in part at any time after all the series A debentures ceased to be outstanding. The series B debentures were in registered form.No surplus income was earned by Retail from 1932 through 1950. From 1951 through 1955 payments were made out of surplus income with the exception of 1954 and 1955 in which years there was sufficient surplus income to make payment of only two-thirds of the amount paid to holders of series B debentures.On January 28, 1955, a notice was sent to holders of series B debentures offering to purchase at prices not in excess of $ 140 per $ 100 of original face amount of debentures. On September 9, 1955, the outstanding series B debentures were redeemed by using funds provided by (a) loans from the Prudential Insurance Company of America secured by mortgages of certain of Retail's properties, (b) a short-term bank loan, and (c) the balance of cash on hand. This action terminated the voting trust and placed control of Retail in the hands of the holders of the preferred stock. The value of the preferred stock of Retail258 steadily increased during the period from 1947 through 1955, as indicated by the bid and asked quotations therefor.The series B debentures constituted capital assets in the hands of petitioner. The amounts received by petitioner during the years involved as payments on account of these debentures constituted payments in retirement thereof.890 OPINION.When bonds which are making current payments of undefaulted interest are bought and sold, it is frequently, if not ordinarily, the practice to make an adjustment for the interest earned to the date of sale. In that event, the portion of the interest already paid for, is, when subsequently received, not income of any kind to the purchaser. L.A. Thompson Scenic Railway Co., 9 B. T. A. 1203. See Charles T. Fisher, 19 T. C. 384, 387, affd. (C. A. 6) 209 F. 2d 513, certiorari denied 347 U.S. 1014">347 U.S. 1014.In the present situation, however, interest was in default 1 when petitioner bought the bonds. Although a substantial amount had accumulated and was unpaid at the time, no segregation of the purchase price between principal259 and interest was made by the parties. In other words, petitioner bought the bonds flat.By the time the present tax years commenced, sufficient payments had been made on the bonds so that petitioner had recovered her basis. But she had not yet received their face amount. Additional payments received in the tax years in excess of basis but still falling short of the principal due were reported by petitioner as capital gain. Respondent treated them as ordinary income, but not as "interest income." His statement on brief is: 260 Respondent agrees that the payments in question in the instant case are returns of capital as opposed to "interest income" but contends that unless petitioners can show that they are entitled to capital gains treatment under section 117, such payments are necessarily taxable as ordinary income under section 22 (a). See Corn Products Refining Company v. Commissioner (1955) 350 U.S. 46">350 U.S. 46, 1955 P-H par. 72,023, rehearing denied, 350 U.S. 943">350 U.S. 943. 2 [Emphasis added.]261 Apparently the argument being made is that while this could never be interest income because it represented payments already in default when petitioner bought the bonds, see William H. Noll, 43 B. T. A. 496, it was ordinary income under section 22 (a), Internal Revenue Code of 1939, because the provisions of section 117 (f) do not reach it. 3891 For this conclusion respondent relies on Rev. Rul. 55-433, 1955-2 C. B. 515, and this in turn on the contention that section 117 (f) does not apply because the obligation being paid was not "issued" by the corporation.262 We think this proposition cannot be maintained. In the first place, other obligations than that to pay principal are considered to have been "issued" notwithstanding that they may not arise until a bond has been in existence for some time. In District Bond Co., 1 T. C. 837, for example, the debtor was permitted to redeem the bonds in advance of maturity upon payment of principal and interest to date and an additional "premium." We said (at page 840):Upon the retirement of bonds at a price in excess of cost, the resulting profit is treated for Federal income tax purposes as capital gain. Section 117 (f) of the 1938 Act. * * With this exception [the interest], however, the proceeds are treated as receipts from the sale or exchange of the bonds, and there is nothing in the statute to remove premiums from this treatment. * * * [Emphasis added.]Again, while this petitioner had recovered her basis by the time the payments in controversy were made, she had by no means as yet collected the principal amount. There is hence no reason to assume that she would necessarily be receiving something over and above principal which might be characterized263 as interest or some other kind of ordinary income. Cf. Charles T. Fisher, supra.But see Clyde C. Pierce Corp. v. Commissioner, (C. A. 5) 120 F. 2d 206, affirming a B. T. A. Memorandium Opinion. Assuming the debtor had the right to characterize what these payments constituted, see Huntington-Redondo Co., 36 B. T. A. 116; G. C. M. 2861, VII-1 C. B. 255, they should be attributed to interest which had already been defaulted when the bonds were purchased. If this is so, the obligation being already in existence was bought by petitioner along with the bond itself. Erskine Hewitt, 30 B. T. A. 962; William H. Noll, supra.No reason appears why it should not have constituted a capital asset which, when disposed of, would result in capital gain.Purchase of the bonds in question included in the price paid not only the title to the securities, but the right to receive interest accrued and unpaid. As to the petitioner the whole constituted a capital acquisition and the subsequent payment of the defaulted264 interest was a return of a portion of his investment, regardless of the label attached by the payor. [R. O. Holton & Co., 44 B. T. A. 202, 205.]Finally, the purpose of section 117 (f) having been to assimilate amounts received on retirement to those resulting from sales or exchanges, we think it would do violence to the congressional purpose to hold that this payment was not capital gain. Respondent has conceded that the amount received was not "interest income" but was a "return of capital." We think he would be obliged to agree that 892 if this bond had been sold instead of being retired, amounts received in excess of basis from whatever source would be capital gain. Clyde C. Pierce Corp. v. Commissioner, supra;R. O. Holton & Co., 44 B. T. A. 202.a purchase, at a flat price, of securities of political subdivisions, which are in default, is a capital transaction. * * a capital gain or loss on account thereof is to be determined by the difference between the amount paid, and the amount received therefor, wholly without regard to whether this amount is received, by resale of265 the securities as a whole, resale of the bonds with coupons detached and a collection of the coupons, or by a collection of the whole principal and accrued interest from the political subdivision. [Clyde C. Pierce Corp. v. Commissioner, supra, at p. 208.]The highly artificial test of whether the ultimate payment of principal is likely leaves us wholly unconvinced. If this were the proper approach, the amounts in question should be viewed as the equivalent of interest, cf. Charles T. Fisher, supra, but respondent concedes, as indeed he probably must under Rev. Rul. 55-433, supra, that this is not interest income. If the principal is so clearly recoverable as to make these payments taxable as ordinary income, then why should petitioner be permitted first to recover her basis? Yet Rev. Rul. 55-433, supra, is clear that no tax will be due until basis has been recovered, a position perhaps forced upon respondent by such cases as Erskine Hewitt and William H. Noll, both supra. We see no more reason than in those266 cases to resort to hairbreadth distinctions and questionable theories. See also, Allen Tobey, 26 T.C. 610">26 T. C. 610.We conclude that, at least as applied to the present facts, Rev. Rul. 55-433, supra, is not a permissible construction of the statute and, accordingly, will not be followed. These amounts were properly reported by petitioner as capital gain.Decisions will be entered under Rule 50. Footnotes1. Respondent makes no contention that this income had not accrued prior to purchase on the ground that interest payments before maturity were dependent on earnings, of which there had been none up to that time. Compare National City Lines v. United States, (C. A. 3) 197 F. 2d 754, with Campbell v. Sailer, (C. A. 5) 224 F. 2d 641↩. We accordingly treat this as a typical instance of interest due but defaulted prior to purchase.2. It is clear that Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46, rehearing denied 350 U.S. 943">350 U.S. 943, is no authority for this statement. There the Supreme Court held (at page 52): "Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by § 117↩ applies to transactions in property which are not the normal source of business income. * * *"3. SEC. 117. CAPITAL GAINS AND LOSSES.(f) Retirement of Bonds, Etc. -- For the purposes of this chapter, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623199/	Edna Morris, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentMorris v. CommissionerDocket Nos. 2752-66, 6478-67, 6479-67, 6480-67, 6497-67United States Tax Court59 T.C. 21; 1972 U.S. Tax Ct. LEXIS 49; October 2, 1972, Filed 49 Decisions in all dockets consolidated for the purpose of this proceeding will be entered under Rule 50. 1. A corporation acquiring property from a bankrupt subject to an indebtedness secured by a first lien on the property may include such indebtedness in its basis for depreciation notwithstanding that the transaction was arranged by its principal stockholder who, as a part of the same plan, acquired the indebtedness from a third party. However, other indebtedness secured by a subordinated lien on the property acquired by the stockholder without consideration was worthless and is not includable as a part of the basis.2. Payments received on account of notes acquired at a discount and secured by a first lien on property having a fair market value in excess of the balance due on the notes must be allocated as between principal and interest or premium.3. Upon the liquidation under sec. 333, I.R.C. 1954, of the corporation receiving payment on such indebtedness, the individual shareholders received a taxable dividend to the extent of the earnings and profits resulting from the interest or premium received on account of the payment of the notes. Arnold Y. Kapiloff and Myles A. Cane, for the petitioners.John J. O'Toole, for the respondent. Quealy, Judge. QUEALY21 These proceedings involve deficiencies in income taxes asserted against the petitioners, as follows: 22 DocketPetitionersTaxable yearsIncome taxNos.Jan. 31, 1962$ 5,155.706480-67Gateway Motor Inn, IncJan. 31, 19633,159.37Jan. 31, 19642,925.032752-66Edna Morris, transferee ofOct. 31, 19594,295.91Palpar, Inc., transferorOct. 31, 19604,116.50Nov. 1, 1960, to May 3, 196159,512.616497-67Sidney Cohn, transferee ofOct. 31, 19594,298.37Palpar, Inc., transferorOct. 31, 19604,178.97Nov. 1, 1960, to May 3, 196159,504.076478-67Edna Morris Cohn1961166,068.806479-67Sidney Cohn and Stella Cohn196119,769.1051 After giving effect to various stipulations and concessions by the parties, the issues remaining for decision are as follows:(1) In docket No. 6480-67, the basis of certain property in the hands of Gateway Motor Inn, Inc., for purposes of depreciation under section 167; 2(2) In docket Nos. 2752-66 and 6497-67, whether payments made to Palpar, Inc., on account of certain notes may be treated as a return of capital;(3) In docket Nos. 6478-67 and 6479-67, whether Edna Morris and Sidney Cohn realized a taxable dividend as a result of the liquidation of Palpar, Inc., under section 333.FINDINGS OF FACTThe cases were consolidated for trial, briefing, and decision. Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.Sidney Cohn (hereinafter referred to as Cohn) and Stella E. Cohn, husband and wife during 1961, timely filed 52 with the district director of internal revenue, Newark, N.J., a joint individual Federal income tax return on a cash basis for the calendar year 1961. During 1961, Cohn and Stella E. Cohn resided at 45 Edgewood Street, Tenafly, N.J. On December 31, 1966, Cohn and Stella E. Cohn were divorced. At the time Cohn and Stella E. Cohn filed their petitions in this case, Cohn resided at 2 Dorchester Road, Englewood Cliffs, N.J., and Stella E. Cohn resided at Horizon Towers South, Horizon Road, Fort Lee, N.J.Cohn was admitted as a member of the New Jersey Bar in 1927, was 66 years old on October 12, 1969, and has been actively engaged on a full-time basis in the practice of law in New Jersey since 1927 specializing in the real estate and real estate finance fields. Stella E. 23 Cohn is retired and has not been gainfully employed for more than 30 years.Edna Morris (hereinafter referred to as Morris) timely filed with the district director of internal revenue, Newark, N.J., an individual Federal income tax return on a cash basis for the calendar year 1961. Cohn and Morris were married on December 31, 1966. Morris was 55 years old on July 4, 1969. At the time Morris filed her petition53 in this case, she resided at 2 Dorchester Road, Englewood Cliffs, N.J.Gateway Motor Inn, Inc. (hereinafter referred to as Gateway), is a New Jersey corporation organized on January 27, 1961. Gateway timely filed U.S. corporate income tax returns on an accrual basis with the district director of internal revenue, Newark, N.J., for its taxable years February 1, 1961, through January 31, 1962; February 1, 1962, through January 31, 1963; and February 1, 1963, through January 31, 1964. The principal office of Gateway is located at 105 State Highway S-3, Secaucus, N.J. 07094. Gateway maintained such principal office at the time it filed its petition in this case.Palpar, Inc. (hereinafter referred to as Palpar), was a New Jersey corporation organized on November 19, 1958, with its principal office located at 232 Broad Avenue, Palisades Park, N.J. Palpar timely filed with the district director of internal revenue, Newark, N.J., U.S. corporate income tax returns on a cash basis for the taxable periods November 1, 1958, through October 31, 1959; November 1, 1959, through October 31, 1960; and for the period November 1, 1960, through May 3, 1961, filed its return on June 24, 1963. On May54 3, 1961, Palpar was dissolved under New Jersey law and liquidated pursuant to section 333.Lincoln Enterprises, Inc. (hereinafter referred to as Lincoln), was a New Jersey corporation organized in 1958 by Salvatore Vitiello (hereinafter referred to as Vitiello) for the purpose of promoting, constructing, owning, and operating a motel (hereinafter referred to as the motel) to be located on real estate to be leased by Lincoln at 105 State Highway S-3, Secaucus, N.J. 07094. Vitiello was the beneficial owner of all of the outstanding stock of Lincoln.On May 9, 1958, Lincoln, as lessee, executed an agreement of lease (hereinafter referred to as the lease) with Eugene and Olive E. Mori and Joan G. and James W. Phillips (hereinafter referred to as the lessor), as lessor, for a term of 75 years with respect to a parcel of unimproved real estate (hereinafter referred to as the leasehold) located at 105 State Highway S-3, Secaucus, N.J. 07094. The lease, among other things, contemplated Lincoln immediately would construct and operate the motel on the leasehold.24 The lease required Lincoln prior to commencing construction of the motel to produce for lessor a mortgage commitment in55 an amount which together with the amount of equity capital of Lincoln equaled at least the amount of a firm bid for the construction of the motel. The lease also provided that the lessor shall have the option to reenter the leased premises and terminate the lease if lessee shall default in the payment of rent or any other sum due under the lease or in the full, faithful, and punctual performance of any other covenant, agreement, provision, or condition on the part of lessee to be performed, or if any execution or attachment shall be issued against the lessee or any of lessee's property. In addition, the lease further provided that if a petition shall be filed, and the lessee shall thereafter be adjudicated bankrupt; or if such petition shall be approved by the court and a receiver or trustee for any portion or all of lessee's property shall be appointed, unless the rental herein reserved is then current and future payments are promptly paid when due, the lease shall, ipso facto, be terminated.Vitiello thereupon contacted Michael Pollotta (hereinafter referred to as Pollotta) for the purpose of engaging him to act as general contractor to construct the motel. Pollotta had been 56 engaged in the building contracting business for approximately 23 years. Pollotta and members of his family organized Mike-Pol Construction Co., Inc. (hereinafter referred to as Mike-Pol), a New Jersey corporation, in 1958 for the purpose of constructing the motel for Lincoln.On August 27, 1958, Mike-Pol and Lincoln executed a contract for the construction by Mike-Pol of the motel for Lincoln for the sum of $ 305,000. Mike-Pol obtained security for the payment of the contract price in the form of an assignment of the lease and a pledge of the stock of Lincoln.On August 27, 1958, as collateral security for the performance by Lincoln of its obligations to Mike-Pol under the contract, Lincoln assigned its rights in the lease to Mike-Pol. At the same time, by agreement the stockholders of Lincoln deposited the certificates representing all the outstanding stock of Lincoln and the officers and directors of Lincoln deposited their undated blank resignations in escrow with Cohn, as escrow agent.Lincoln attempted to obtain permanent mortgage financing to pay for the construction of the motel but was not successful. In the absence of such financing, the lessor waived a provision of the57 lease requiring Lincoln, prior to commencing construction of the motel, to obtain equity capital and a mortgage commitment in an amount equal to the amount of a firm bid for the construction of the motel.Lincoln was obligated to pay Mike-Pol $ 85,000 on August 29, 1958, as the first installment under the construction contract. Lincoln failed 25 to make this payment. By letter dated September 18, 1958, Mike-Pol advised Lincoln that Mike-Pol would not resume work on the motel until it received such payment. Mike-Pol and Lincoln thereupon executed an amendment to the construction contract increasing the amount due by the sum of $ 20,000, plus interest, as an additional charge for financing the construction cost, and Mike-Pol then resumed construction.As a result of Lincoln's default in making the payments on account of the construction, a plan was developed for the purpose of financing such costs in the following manner:(1) Cohn would organize a group to advance $ 130,000 in cash to Palpar in exchange for 65,000 shares of its common stock and $ 65,000 in interest-bearing notes.(2) Mike-Pol would assign to Palpar $ 130,000 of the total amount due it from Lincoln on account58 of construction costs in exchange for 65,000 shares of common stock of Palpar and $ 65,000 in interest-bearing notes.(3) Palpar would advance the sum of $ 260,000 consisting of $ 130,000 in cash to Lincoln and transfer to Lincoln credit for $ 130,000 to Lincoln's indebtedness previously acquired from Mike-Pol. In exchange, Lincoln would issue to Palpar non-interest-bearing notes in the amount of $ 416,000 payable at the rate of $ 1,000 per week for 99 weeks with the balance of $ 317,000 payable 1 week thereafter. These notes would be secured by a first mortgage on the leasehold and the improvements thereon.(4) Lincoln would, in turn, discharge $ 260,000 due to Mike-Pol on account of the construction costs by a payment of $ 130,000 in cash and an offset of $ 130,000 of its indebtedness acquired from Palpar.(5) Lincoln would issue to Mike-Pol on account of the excess of the construction costs over the sum of $ 260,000 a series of 156 non-interest-bearing notes in the aggregate amount of $ 184,000 repayable at the rate of $ 700 per week for 155 weeks with the balance of $ 75,500 payable 1 week thereafter. These notes would be secured by a mortgage constituting a second lien on 59 the leasehold and improvements thereon.Pursuant to plan, Palpar was duly organized on November 19, 1958. The officers of Palpar were: President, Michael Pollotta; secretary, George Fellman; and treasurer, Philip Garmain. Mike-Pol thereupon assigned to Palpar $ 130,000 of the total amount due it from Lincoln under the construction contract in exchange for 65,000 shares of common stock of Palpar and $ 65,000 in 2-year, 6-percent notes of Palpar. Cohn's group paid $ 130,000 in cash to Palpar in exchange for 65,000 shares of common stock of Palpar and $ 65,000 in 2-year, 6-percent notes of Palpar.26 Pursuant to plan, on December 2, 1958, Lincoln and Palpar executed a purchase agreement pursuant to which Palpar agreed to lend to Lincoln the sum of $ 260,000. Simultaneously, Palpar executed an indenture of trust appointing Cohn as trustee for and on behalf of Palpar (Cohn as such trustee is referred to as trustee) in connection with all matters contemplated by the purchase agreement, authorized the trustee to enter into a loan agreement with Lincoln, and authorized the trustee to act with full authority on behalf of Palpar in connection with the purchase agreement and the loan60 agreement.On December 2, 1958, Lincoln, its stockholders, officers, directors, and trustee executed a loan agreement pursuant to which Palpar advanced $ 130,000 in cash to Lincoln and refinanced or gave credit for $ 130,000 payable on the construction contract. In exchange, Lincoln delivered to Palpar the $ 416,000 in notes of which the sum of $ 156,000 represented consideration for the loan.Palpar also acquired as security for payment of the notes by Lincoln the following:(1) A mortgage duly recorded in favor of Palpar constituting a first lien on the motel and improvements thereon;(2) A mortgage duly recorded in favor of Palpar constituting a first lien on all chattels owned by Lincoln;(3) A duly recorded assignment of the lease from Lincoln to Palpar;(4) A duly recorded assignment from Mike-Pol to Palpar of its rights under the construction contract;(5) A subordination agreement executed by Mike-Pol in favor of Palpar subordinating all claims of Mike-Pol against Lincoln to the liens of all instruments held by Palpar to the extent of $ 416,000; and(6) A duly recorded mortgage executed by the Lincoln stockholders in favor of Palpar constituting a first lien on the certificates61 representing all the outstanding shares of Lincoln and an assignment from all stockholders, officers, and directors of Lincoln to Palpar of the certificates representing all the outstanding shares of Lincoln, together with the resignations of all officers and directors of Lincoln.In the event of default by Lincoln, the loan agreement expressly granted Palpar the right to enforce the terms and conditions of the security delivered to Palpar, the collection thereof, the right to foreclose the mortgage on the motel, the mortgage on the chattels, and the right to possession under the lease.Simultaneously, with the transactions between Lincoln and Palpar on December 3, 1958, Lincoln and Mike-Pol settled and stated their account at $ 184,000 with respect to work, labor, and material performed and supplied by Mike-Pol after giving effect to the receipt by Mike-Pol of $ 130,000 in value evidenced by its Palpar stock and 2-year, 27 6-percent notes and $ 130,000 in cash from Lincoln. A portion of the agreed sum of $ 184,000 related to matters other than the construction of the motel.Pursuant to plan and simultaneously with the transactions between Lincoln and Palpar on December 3, 62 1958, Lincoln delivered to Mike-Pol its notes for $ 184,000. As security for payment of the notes:(1) Lincoln executed in favor of Mike-Pol a second mortgage duly recorded constituting a lien on the motel subordinate to the lien of Palpar;(2) Lincoln executed in favor of Mike-Pol a second mortgage duly recorded constituting a lien on the chattels owned by Lincoln subordinate to the lien of Palpar;(3) Lincoln executed in favor of Mike-Pol an assignment duly recorded of the leasehold subordinate to the lien of Palpar; and(4) Lincoln's stockholders executed in favor of Mike-Pol a mortgage duly recorded constituting a lien on the certificates representing all the outstanding shares of Lincoln subordinate to the lien of Palpar.Pursuant to plan and simultaneously with the transactions on December 3, 1958, Mike-Pol executed and delivered to Palpar assignments, duly recorded, of the interests of Mike-Pol in the assignments of the lease to Mike-Pol and in the Lincoln stock originally deposited under the construction contract.Although not entirely completed, the motel opened for business in January 1959. At that time, Lincoln was unable to obtain any permanent mortgage financing with63 which to satisfy the $ 416,000 notes held by Palpar or the $ 184,000 notes held by Mike-Pol. Lincoln was not, therefore, in a position to meet its obligations under the lease and the notes.On September 2, 1959, the lessor notified Lincoln of its election to cancel and terminate the lease because Lincoln was in default with respect to payment of taxes. Mike-Pol thereupon paid the rent due and the quarterly installment of real estate taxes. Mike-Pol simultaneously commenced proceedings to foreclose its second mortgage on the chattels and its second mortgage on the Lincoln stock, both of which were subordinated to the rights of Palpar.On November 12, 1959, Lincoln surrendered possession of the motel to Mike-Pol as mortgagee in possession, its officers and directors submitted their resignations, and its stockholders surrendered the stock of Lincoln to Mike-Pol. Also, on that day Lincoln assigned the lease and executed a release and surrender of all the chattels to Mik-Pol.On November 17, 1959, John Bertoni, constable, published notices of the public foreclosure sales under the second mortgage on the chattels and under the second mortgage on the stock. On the same day creditors64 of Lincoln filed an involuntary petition in bankruptcy against 28 Lincoln in the U.S. District Court, District of New Jersey. On November 18, 1959, the U.S. District Court adjudicated Lincoln bankrupt. The U.S. District Court enjoined the public foreclosure sales that had been scheduled for November 19, 1959, and ordered an investigation to determine the consideration for the second mortgage on the chattels.On November 30, 1959, the U.S. District Court, pending the outcome of the bankruptcy proceedings, restrained foreclosure of the mortgages held by Mike-Pol.On December 28, 1959, the trustee in bankruptcy challenged the validity of the second mortgage on the leasehold, the second mortgage on the chattels, the first mortgage on the leasehold, and the first mortgage on the chattels, on the grounds of usury, and questioned the amounts due on account of the notes for $ 184,000 and on account of the notes for $ 416,000.Mike-Pol operated the motel in a fiduciary capacity as mortgagee in possession from November 1959 until April 1960. In April 1960, Mike-Pol, as mortgagee in possession, surrendered possession of the motel to Palpar. Palpar took possession of the motel as mortgagee65 in possession under the first mortgage on the leasehold and the first mortgage on the chattels. Palpar operated the motel in a fiduciary capacity as mortgagee in possession from April 1960 to February 6, 1961. During 1959 and 1960, Palpar received payments of $ 41,000 from Lincoln and $ 41,200 from Mike-Pol and itself, as mortgagees in possession, with respect to the $ 416,000 notes, reducing the face amount of such notes to $ 333,800. Palpar treated these receipts on its corporate income tax returns for such years as repayments of principal.During the period Mike-Pol operated the motel, Pollotta approached Morris in regard to working at the motel. Morris was engaged in the real estate business as a broker and, in that capacity, had become acquainted with Cohn. She had no motel experience at that time and worked for Pollotta at the switchboard and as a desk clerk for only a few months. Subsequently, Morris was approached by Cohn to discuss the possibility of their purchasing the motel and her managing it.During October 1960, Cohn wrote a series of letters to the New Jersey secretary of state requesting clearance of a name for a corporation which he proposed to organize for66 the purpose of consummating the purchase of the motel assets from the trustee in bankruptcy. Simultaneously, Cohn made an offer by form letter to each of the Cohn group personally to purchase their respective shares of Palpar stock and Palpar notes at the rate of $ 7,500 for each 5,000 shares and $ 5,000 note. The offer was intended to return to each the cash invested in Palpar less the amount they previously had collected. The offer was subject to the condition, inter alia, that Cohn or his nominee or assignee acquire 29 all of the right, title, and interest of the trustee in bankruptcy in the motel assets for the sum of $ 25,000.By letter dated November 1, 1960, Cohn or his nominee or assignee also made an offer to purchase for the sum of $ 97,500 Palpar stock, Palpar notes, and the unpaid balance of the $ 184,000 notes held by Mike-Pol.Between February 1, 1961, and April 13, 1961, Cohn personally acquired the Palpar stock and Palpar 2-year, 6-percent notes owned by the investors comprising the Cohn group for the sum of $ 97,500.During February 1961, Cohn also acquired from Mike-Pol its Palpar stock, its Palpar notes, and the notes secured by the second mortgage 67 upon payment of the sum of $ 97,500. The price paid to Mike-Pol for the Palpar stock and Palpar notes, and the $ 184,000 notes was not separately negotiated. Cohn would not acquire the Palpar stock and Palpar notes without also acquiring the $ 184,000 notes. At all times material herein, Michael Pollotta and the members of his family who organized Mike-Pol were, and for many years had been, clients of Cohn. The investors comprising the Cohn group who had subscribed to the stock and purchased the notes of Palpar were also clients and/or business associates of Cohn.On October 25, 1960, Cohn submitted an offer to Sanford Silverman, attorney for the trustee in bankruptcy, to purchase all of the trustee's right, title, and interest in and to the motel assets subject to the liens representing the security for the $ 416,000 notes and $ 184,000 notes, for $ 25,000, subject further to the condition that the trustee terminate the litigation involving such notes. Silverman also represented at least two-thirds of the general creditors of Lincoln.On December 28, 1960, Silverman filed a petition and order to show cause in the bankruptcy proceeding. On December 29, 1960, the U.S. District68 Court entered an order to show cause addressed to the creditors of Lincoln returnable on January 19, 1961, why the trustee in bankruptcy should not accept an offer of $ 25,000 for his interest in all the motel assets of Lincoln and mailed notice thereof to all creditors.Silverman mailed a copy of the show-cause order to Cohn on December 31, 1960. Cohn, upon receipt of the copy of the order to show cause, telephoned Silverman and advised him that the offer had not been made by Mike-Pol and Palpar. Silverman advised Cohn that to correct the various papers to reflect the identity of the real purchaser would entail filing a new petition and new order to show cause and a new mailing to creditors upon a minimum of 10 days' notice.On January 19, 1961, the referee in bankruptcy signed an order authorizing the trustee in bankruptcy to accept the offer of $ 25,000 for the motel assets of Lincoln.30 On or about January 23, 1961, Cohn obtained clearance from the secretary for the use of the corporate name "Gateway Motor Courts, Inc." On January 27, 1961, Cohn and Morris, as equal stockholders, organized a corporation named Gateway Motor Inn, Inc.By letter dated February 2, 1961, Cohn69 advised Silverman, counsel for the trustee in bankruptcy, that the acceptance of the offer made by Mike-Pol and Palpar to purchase the assets of Lincoln from the trustee in bankruptcy had been assigned to Gateway. Cohn requested Silverman to prepare the bill of sale designating Gateway as the purchaser. In reply, Silverman advised Cohn that he would prepare the bill of sale in the name of Palpar and Mike-Pol in order to be consistent with the order.On February 6, 1961, Gateway drew a check on its checking account in the amount of $ 25,000 payable to the order of the trustee in bankruptcy and delivered it to Silverman. Silverman delivered the bill of sale and a release with respect to the trustee's alleged claims. Palpar, as mortgagee in possession, thereupon surrendered possession to Gateway of the motel.By letter dated February 20, 1961, Cohn forwarded lessor a copy of the recorded assignment of the lease from Mike-Pol to Gateway, together with an agreement executed by Gateway in favor of lessor in which Gateway agreed to comply with the terms of the lease.For Federal income tax purposes, Gateway computed its initial basis for depreciation of the motel assets acquired from70 the trustee in bankruptcy as follows:Cash$ 25,000.00Unpaid balance of $ 416,000 notes333,800.00Unpaid balance of $ 184,000 notes173,962.67532,762.67Less amount allocated to nondepreciable assets purchased32,664.41Initial basis for depreciation500,098.26From December 3, 1958, to February 6, 1961, Palpar received payments in cash on account of the $ 416,000 notes in the following amounts during the following fiscal years of Palpar:Fiscal yearsAmountsNov. 1, 1958, thru Oct. 31, 1959$ 41,000Nov. 1, 1959, thru Oct. 31, 196041,200Nov. 1, 1960, thru May 30, 19610Total82,200Between November 1, 1958, and October 31, 1960, Palpar paid pro rata to the Cohn group and Mike-Pol a total of $ 71,398.60.31 In May 1961, Palpar adopted a plan of liquidation under section 333 of the Internal Revenue Code of 1954, as amended. Pursuant to such plan, Palpar distributed to Cohn the unpaid balance of the notes amounting to $ 333,800.During the taxable years 1961 to 1964 inclusive, the motel consisted of 52 units and a swimming pool. The motel did not have sufficient rooms to acquire a nationally advertised franchise such as a Holiday Inn71 or Howard Johnson. The motel was situated on a tract of land containing 7.185 acres. The parcel had been leased pursuant to the lease, which provided, among other things, that the lessee could only use the land for the purposes of a motel business (during the first 20 years of the term), that any mortgage of the motel would be subordinate to the lease, and that the lessor could terminate the lease in the event of any attempted taking or other similar action with respect to the premises.The initial construction cost of the motel, excluding furnishings and land, approximated $ 305,000, plus extras. Furnishings approximated $ 80,000.Shortly after Gateway purchased the motel, approximately $ 100,000 was expended for repairs and improvements. Subsequently, an additional sum approximating $ 250,000 was invested in connection with the addition of 36 units.During the period November 11, 1959, to October 31, 1960, the motel generated gross income of $ 208,135 and a cash flow of approximately $ 75,000. For the period February 1, 1961, to January 31, 1962, the motel had gross revenues of $ 225,847 and a cash flow of $ 88,039, consisting of $ 24,047 profit plus $ 35,487 depreciation plus72 $ 28,505 mortgage-interest service.For the period February 1, 1962, to January 31, 1963, the motel had gross revenues of $ 266,304 and a cash flow of $ 85,708, consisting of $ 11,704 profit plus $ 45,499 depreciation plus $ 28,505 mortgage-interest service.For the period February 1, 1963, to January 31, 1964, the motel had gross revenues of $ 297,116 and a cash flow of $ 83,086, consisting of $ 4,539 profit plus $ 50,042 depreciation plus $ 28,505 mortgage-interest service.As of February 1961, the fair market value of the $ 333,800 of notes of Lincoln held by Palpar and secured by a first lien on the leasehold did not exceed the sum of $ 195,000. The $ 173,962 of notes of Lincoln secured by a subordinated mortgage on the leasehold were worthless. The fair market value of the leasehold, including both the motel and its furnishings, acquired by Gateway was $ 333,800.32 OPINIONDocket No. 6480-67In docket No. 6480-67, the Court is called upon to determine the basis for depreciation of the motel in the hands of Gateway. Section 167(g) provides that the basis for depreciation shall be the adjusted basis provided in section 1011 for the purpose of determining the gain 73 on the sale or disposition of the property. Insofar as material herein, section 1011 provides that the basis for determining gain shall be determined under section 1012. As determined under section 1012, the basis of Gateway for purposes of depreciation of the motel is prescribed as the cost of such property.Gateway claims to have acquired the motel from the trustees in bankruptcy for the payment of $ 25,000 in cash, subject to non-interest-bearing notes in the principal amount of $ 333,800 secured by a first lien on the motel, and to non-interest-bearing notes in the principal amount of $ 173,962 secured by a second lien on the motel. Gateway claims that its "cost" in the acquisition of the motel thus consisted of the sum of $ 25,000 plus the unpaid balance of both series of notes, relying on Crane v. Commissioner, 331 U.S. 1 (1947), and Manuel D. Mayerson, 47 T.C. 340">47 T.C. 340 (1966).The respondent argues, inter alia, that the motel was acquired in the first instance by the holder of the secured notes in what was tantamount to a voluntary foreclosure. On that assumption, respondent contends that basis for the property74 is fair market value. When Gateway subsequently acquired the motel, it took over that basis. In support of this position, respondent relies on I.T. 3548, 1 C.B. 74">1942-1 C.B. 74, and sec. 1.166-6, Income Tax Regs. In addition, the respondent contends that the notes were, in part, worthless and that even under the Crane rule there should be excluded any liabilities which exceeded the value of the property.In considering this issue, we need only look to the situation that prevailed at the time that Gateway acquired the motel. Lincoln held the leasehold. The motel had been substantially completed. Lincoln was hopelessly insolvent. Its obligations included the sum of $ 333,800 secured by a first lien on the motel, the sum of $ 173,962 secured by a second lien on the motel, and the sum of $ 78,980.49 in unsecured claims. In a forced sale, it was doubtful whether the motel could be sold for as much as $ 250,000.It is clear from the record that assuming the validity of the notes secured by a first lien on the motel -- and the parties do not question their validity -- neither Mike-Pol as the holder of the subordinated notes nor the unsecured creditors stood75 to recover anything in the event of a foreclosure sale. For all practical purposes, the subordinated 33 series of notes and the unsecured claims had become worthless. On the other hand, without a formal foreclosure, the holder of the notes secured by a first lien on the motel could not take over the motel free and clear of other claims. In the final analysis, therefore, the only value which might be attributable to those claims was a "nuisance value."At this point, Cohn evolved a plan to take over and operate the motel. He purchased the stock and notes of Palpar held by a group of his clients and associates at a price which would make them "whole." At the same time, he purchased the stock and notes of Palpar held by Mike-Pol, the corporation organized to construct the motel, together with the subordinated notes of Lincoln held by Mike-Pol, at the same price. Cohn then submitted an offer to the trustee in bankruptcy to purchase the motel subject to the secured obligations for the sum of $ 25,000. Upon the acceptance of that offer, Cohn or Gateway, as his nominee, became the owner of the motel free and clear of all obligations except those held by Cohn.The offer to purchase76 the motel subject to the secured obligations was treated by the trustee in bankruptcy as having been made on behalf of Palpar and Mike-Pol, the holders of record of those obligations. The notices were sent out, and the sale was approved in that form. Petitioners contend, however, that this was in error. Petitioners argue that the transaction was a purchase of the motel by Gateway subject to the secured obligations for the sum of $ 25,000. The difficulty with petitioners' characterization of the transaction is that without the cooperation and consent of the holders of the secured obligations -- and specifically of Cohn himself -- the transaction could not have been consummated. If we are to look to the substance of the transaction, therefore, the holder of the secured debt must be regarded as having caused the property to be transferred to Gateway subject to such debt.While the Court must, as a matter of record, regard the proposal as having been made on behalf of Palpar and Mike-Pol, respondent's reliance on that is misplaced. The conclusion is inescapable that it was never intended for either Palpar or Mike-Pol to acquire the motel. What we have is a situation in which a 77 secured creditor arranges for a purchase by a third party of the property securing his debt from the bankrupt's estate. Cf. Parker v. Delaney, 186 F. 2d 455 (C.A. 1, 1950). Where a corporate purchaser takes property subject to a debt, the fact that the same individual or individuals own the stock of both the debtor and the creditor is not sufficient reason to disregard the debt. Imperial Car Distributors, Inc. v. Commissioner, 427 F. 2d 1334 (C.A. 3, 1970). To the extent that the motel was burdened with secured debt not in 34 excess of the fair market value of the property, the basis in the hands of Gateway would under the Crane case include the amount of such debt as a part of its cost. When Gateway acquired the motel subject to the indebtedness owing to Palpar and constituting a first lien against such property, the amount of such indebtedness became a part of the basis of Gateway for purposes of computing depreciation.It does not follow that the same rule would apply in the case of the indebtedness due to Mike-Pol which was secured by a subordinated lien on the property. In the event of a forced78 sale, the motel would not bring a sufficient amount to pay the indebtedness secured by the first lien. Unsuccessful efforts had been made to find a buyer for or to refinance the property in order to preserve both the indebtedness due to Palpar and the indebtedness due to Mike-Pol. Cohn had represented the stockholders of Mike-Pol for many years. He paid nothing additional for the notes held by Mike-Pol. Unless those notes were considered by the parties as worthless, Cohn would be in a position favoring one group of his clients over the other. We must assume that no consideration was attributed to the notes held by Mike-Pol because the notes were worthless.Where worthless debt is acquired without consideration, as a part of an overall plan to transfer the property to a corporation to be owned and controlled by the holder of the debt, such debt becomes solely a device to inflate the true cost of the property for tax purposes. Neither the Crane case, nor any decision which followed, warrants the inclusion of such worthless paper as a part of the taxpayers' cost or basis for depreciation. See Burr Oaks Corporation v. Commissioner, 365 F. 2d 2479 (C.A. 7, 1966).Regardless, however, whether we treat the transaction whereby Gateway acquired the property as contended for by petitioners, or whether it is considered as being tantamount to a voluntary foreclosure on the part of the holder of the secured obligations as contended for by respondent, the result would be the same.The cost of construction of the motel exceeded the sum of $ 305,000. An additional $ 80,000 had been spent for furnishings. The financial difficulties resulted not from the motel itself, but from the lack of financial resources on the part of its original owner. Expert witnesses placed a sales value on the motel ranging from $ 250,000 to $ 400,000 with a substantial initial investment.After considering all of the evidence with respect to value, it is our opinion that the fair market value of the motel as of the date of its acquisition by Gateway was $ 333,800. Under either view of the transaction, therefore, an amount equivalent to the notes secured by a first lien on the property would properly be includable in the basis of Gateway.35 Docket Nos. 2752-66 and 6497-67These proceedings involve or relate to the tax liability of Palpar on account80 of payments received prior to its liquidation on the notes of Lincoln secured by a first mortgage on the leasehold. In the notices of deficiencies, the respondent determined that Palpar received interest on account of such notes as follows:Fiscal year ended Oct. 31, 1959$ 15,375.00Fiscal year ended Oct. 31, 196015,047.10Taxable period ended May 31, 1961125,175.00The petitioners, Edna Morris and Sidney Cohn, do not contest their liability as transferees for such taxes as may be owing from Palpar. However, the petitioners contend that there are no taxes due.Palpar was organized on November 19, 1958, with a purpose of refinancing costs incurred in the construction of the motel. On December 3, 1958, Palpar advanced to Lincoln a total of $ 260,000, in cash or its equivalent, on account of which Palpar received non-interest-bearing notes of Lincoln in the amount of $ 416,000. These notes were repayable over 100 consecutive weeks at the rate of $ 1,000 per week for 99 weeks and $ 317,000 at maturity. The notes constituted a first lien on the lease, improvements, chattels, and stock of Lincoln.During the taxable year ended October 31, 1959, Palpar received a total81 of $ 41,000 in payment of the notes. In its Federal income tax return for such year, Palpar treated such payments as a return of capital and paid no tax thereon.During the taxable year ended October 31, 1960, Palpar received a total of $ 41,200 in payment of the notes. In its Federal income tax return for such year, Palpar treated such payments as a return of capital and paid no tax thereon.In his determination of deficiency for those years, respondent takes the position that such payments represented in part the repayment of principal and in part the payment of interest. By allocating the respective amounts to principal and interest on the basis of the premium of $ 156,000 received by Palpar as a result of its loan of $ 260,000 to Lincoln, respondent determined that the amounts of $ 15,375 and $ 15,047.10, respectively, constituted interest received during the years in question.In addition, for the taxable period ended May 30, 1961, the respondent determined that Palpar received the balance of the premium amounting to $ 125,175 as a result of acquiring the motel from the trustee in bankruptcy in a voluntary foreclosure.Petitioners contend that the payment of the notes was 82 "speculative" 36 and that no income could be realized as a result thereof until Palpar recovered the principal amount which it had loaned to Lincoln citing Wingate E. Underhill, 489">45 T.C. 489 (1966). In reply, respondent cites Morton Liftin, 36 T.C. 909">36 T.C. 909 (1961), affd. 317 F. 2d 234 (C.A. 4, 1963), as supporting the basis for his determination.The respondent seeks to invoke the rule that where the value of the security exceeds the amount of the obligation, so that there is a reasonable expectation that the full amount might be recovered either through payment or foreclosure, the taxpayer must treat a portion of each payment as interest received. As respondent points out in his brief, it is manifestly inconsistent for petitioners to argue on the one hand that the fair market value of the property exceeded the face amount of both the first lien and the second lien notes, while at the same time contending that payment of the preferred obligations was "speculative."With respect to the payments actually received by Palpar, we find no justification for excluding from income so much of the amount83 actually paid which is allocable to premium or interest. In fact, for the fiscal year ending October 31, 1959, $ 41,000 of the notes were paid prior to any default on the part of Lincoln. Subsequent to Lincoln's default, while it might have been anticipated that there would be some delay in the payment of the notes, Palpar actually collected an additional $ 41,200 on account of such notes. Based upon the testimony of expert witnesses, the Court has found that the fair market value of the security equaled the remaining amount due, which included both principal and interest or premium. It necessarily follows that the security for the repayment of "cost" was at all times more than adequate.As distinguished from the obligations in the Underhill and Liftin cases, the notes held by Palpar constituted a first lien on the motel and its furnishings. Since the Court has found that the fair market value of the motel equaled the unpaid balance of the notes when distributed by Palpar in liquidation, there was ample security for the recovery of "cost." Therefore, we do not regard the circumstances in this case as affording sufficient basis for the application of the exception to the84 normal reporting of income.With respect to the remainder of the premium amounting to some $ 125,175, admittedly Palpar received nothing during the period ended May 31, 1961. Rather, respondent would treat the transaction as if Palpar had bid in the property for the full amount of its notes at foreclosure. To adopt the respondent's theory would be incompatible with the facts. Accordingly, we find no basis for treating the premium of $ 125,175 as having been received by Palpar.37 Docket Nos. 6478-67 and 6479-67In docket Nos. 6478-67 and 6479-67 there remains for determination the amount, if any, taxable as a dividend upon the liquidation of Palpar. The petitioners, as stockholders of Palpar, received all of its assets upon such liquidation on May 31, 1961. The sole question for decision is whether there were earnings and profits of Palpar taxable to petitioners as a dividend pursuant to section 333(e). This depends, in turn, upon whether Palpar realized any income on account of the payments of $ 41,000 during the taxable year ended October 31, 1959, and $ 41,200 during the taxable year ended October 31, 1960, on account of the notes of Lincoln, and whether Palpar *85 realized income in the form of interest or premium in the purchase of the motel by Gateway. Our decision in docket Nos. 2752-66 and 6497-67 are determinative of these questions. In light of that decision, the parties will be afforded an opportunity to recompute the earnings and profits of Palpar under Rule 50.In order to reflect the opinions herein,Decisions in all dockets consolidated for the purpose of this proceeding will be entered under Rule 50. Footnotes1. Cases of the following petitioners are consolidated herewith: Edna Morris Cohn, docket No. 6478-67; Sidney Cohn and Stella Cohn, docket No. 6479-67; Gateway Motor Inn, Inc., docket No. 6480-67; and Sidney Cohn, docket No. 6497-67.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623201/	INDEPENDENT INSURANCE AGENTS OF HUNTSVILLE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentIndependent Ins. Agents of Huntsville, Inc. v. CommissionerDocket No. 25616-89United States Tax CourtT.C. Memo 1992-163; 1992 Tax Ct. Memo LEXIS 175; 63 T.C.M. (CCH) 2468; March 23, 1992, Filed 175 Decision will be entered for respondent. John R. Wynn, for petitioner. Linda J. Wise, for respondent. FAYFAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in income tax for the years in issue as follows: Year EndedDeficiencyMarch 31, 1985$ 21,655.11March 31, 198625,642.04March 31, 198732,764.89The issues presented for our decision are as follows: (1) Whether income derived by petitioner from its public insurance activity is taxable as unrelated business taxable income, and, if we conclude that such income is taxable as unrelated business taxable income, (2) whether petitioner should be allowed to deduct expenses in excess of those allowed in the notice of deficiency. We conclude that the income derived from petitioner's public insurance activity is taxable as unrelated business taxable income and that petitioner is not entitled to deductions in excess of those allowed in the notice of deficiency. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner's principal place of business176 was in Huntsville, Alabama, at the time of the filing of the petition. Petitioner is a corporation organized under the Alabama Non-Profit Corporation Act. Petitioner's membership is open to insurance agencies, licensed brokers, and licensed agents who have their principal office in Madison County, Alabama, and who represent at least two fire and/or casualty companies on a commission basis. Currently, petitioner has approximately 18 member agencies. 1As provided for in petitioner's articles of incorporation, the purposes for petitioner's incorporation and existence are, among others, to (1) improve conditions in the insurance business, (2) advance the public interest through high insurance standards and practices, and (3) secure and maintain good relations between the insurance industry and the insuring public. In April 1974, petitioner applied for exempt status pursuant to section 501(c)(6), 2 and, on its Exemption Application 177 (Form 1024), petitioner stated that the purposes for its formation and existence include, among others, overseeing the writing of insurance for public authorities to insure that such authorities are receiving the best insurance protection and services available. Petitioner's bylaws authorize the creation of the Association Account Assignment and Review Committee (Committee). In addition, the bylaws indicate that the duties of this Committee include supervision over all lines of insurance (except life, accident, and health insurance), the premiums for which are paid in whole or in part by certain public authorities. 3178 However, the primary function of the Committee is to assign public accounts to qualified members. To receive an assignment of a public account from the Committee, a member agency must (1) have been licensed to write insurance for a minimum of 3 years, (2) be a member in good standing with the corporation, (3) be active in the corporation by having agency representation at not less than six meetings of the members, and (4) be able to properly service the account and have adequate access to markets. Approximately half of the member agencies of petitioner handle these public accounts. The qualified member assigned a public account in many instances first determines the insurance specifications of the public authority. Then the assigned member solicits the handful of insurance companies it represents for a suitable policy. In the typical case, the assigned member does not submit the specifications to other member agencies (or nonmember agencies). After evaluating the different insurance policies received from the insurance companies solicited, the assigned member presents a policy (or several policies) to the public authority. If the public authority agrees to purchase insurance179 through the assigned member, the assigned member and petitioner share the commission. In the circumstance where certain coverage could not be provided through the insurance companies it represents, the assigned member might consult other members and may ultimately recommend a policy marketed by another member. 4 In that situation, some arrangement to split the assigned member's share of the commission with the other member would probably be made. Petitioner's share of the total commissions received from each public account approximates 40 to 60 percent. Petitioner's share of these commissions represents practically all of petitioner's operating income. Petitioner's operating income is used, in part, to make donations to charitable organizations, to provide for institutional advertising and educational programs, to reimburse members for conventions, seminars, and licensing school, and to pay dues to the State and the national180 organization on behalf of its members. As already mentioned, petitioner applied for exempt status pursuant to section 501(c)(6) in April 1974. In response to petitioner's Exemption Application, the Exempt Organizations Branch of the Internal Revenue Service (Exempt Organizations Branch) requested additional information, including a breakdown of time spent on petitioner's corporate activities. In response to this request, petitioner submitted a detailed breakdown of activities which indicated that 33.8 percent of time spent was related to its public insurance activity. 5 By letter dated January 6, 1975, the Exempt Organizations Branch advised petitioner that it had been determined to be exempt from Federal income tax pursuant to section 501(c)(6). However, the Exempt Organizations Branch also advised petitioner that no determination was made concerning whether any present or proposed activities are unrelated trade or businesses as defined in section 513. 181 OPINION Section 501(a) and (c)(6) provides for an exemption from income tax for certain business leagues which promote their members' common business interest without engaging in regular business activities ordinarily carried on for profit. However, section 511 imposes a tax on the income generated from an unrelated trade or business of such organizations. Section 513 defines an "unrelated trade or business" as "any trade or business the conduct of which is not substantially related * * to 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". Thus, while petitioner is exempt from taxation under section 501(c)(6) as a business league, the commissions it earns from its public insurance activity may be subject to tax if those commissions are unrelated business taxable income (UBTI). The regulations set forth the following three elements necessary to find an unrelated trade or business: (1) The activity is a trade or business, (2) the trade or business is regularly carried on by the organization, and (3) the conduct of the trade or business is not substantially 182 related (other than through the need for or use of the funds produced) to the organization's tax-exempt purpose. Sec. 1.513-1(a), Income Tax Regs. In this case, petitioner does not dispute that its public insurance activity constitutes a trade or business which is regularly carried on by petitioner. Thus, the remaining question is whether petitioner's public insurance activity is "substantially related" to petitioner's tax exempt purposes. Petitioner has the burden of proof. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). The regulations provide that, for such a substantial relationship to exist, the business activities must contribute importantly to the accomplishment of the organization's exempt purposes. Sec. 1.513-1(d)(2), Income Tax Regs. Whether the activities contribute importantly to the accomplishment of the organization's exempt purposes depends in each case upon the facts and circumstances involved. Sec. 1.513-1(d)(2), Income Tax Regs.Petitioner cites Independent Insurance Agents of Northern Nevada, Inc. v. United States, 44 AFTR 2d 79-5880, 79-2 USTC par. 9601 (D. Nev. 1979), as persuasive authority regarding183 this case. In Independent Insurance Agents of Northern Nevada, the District Court held that the commission income received from a section 501(c)(6) organization's public insurance activity was related to its exempt purpose. In so holding, the District Court found that placing the insurance on the open market for bids should result in the lowest cost to the public authority. Here, by contrast, the insurance needs of the public authorities were not placed on the open market for bids. Rather, the Committee merely assigned public accounts to a member agency, and, in obtaining insurance for the public authority, the assigned member agency typically contacted only the handful of insurance companies it represented. Furthermore, as discussed in more detail below, petitioner has failed to prove that the public authorities receiving insurance through petitioner were receiving the best insurance at the lowest overall cost. Petitioner also argues that its public insurance activity must be substantially related to its stated purposes since "overseeing the writing of insurance for public authorities" is listed as one of the purposes on its exemption application. 6 Upon review184 of the manner in which petitioner's public insurance activity was conducted, however, we disagree. See United States v. American College of Physicians, 475 U.S. 834">475 U.S. 834, 849 (1986); Texas Apartment Association v. United States, 869 F.2d 884">869 F.2d 884, 887 (5th Cir. 1989). In its exemption application, petitioner did state that it was formed to "oversee the writing of insurance for public authorities to insure that such authorities are receiving the best insurance protection and service available." However, other than the statements by petitioner's witnesses that public accounts were "monitored", "analyzed", and "reviewed" 7 by the Committee, 185 there is no indication of regular independent oversight by the Committee over the servicing of public accounts. 8 In this regard, we do not find sufficient evidence indicating that, upon review, the Committee informs the assigned member agency that, based on the market, the best insurance at the lowest cost had not been provided or that a certain coverage should be recommended (although the Committee's right to make such recommendations is expressly reserved in petitioner's bylaws). 9186 Petitioner did present testimony concerning certain instances where the assigned member agency could not, through the insurance companies it represented, write the particular policy needed by the public authority. In those instances the assigned member agency would contact one or more of the other member agencies in an effort to search for a suitable policy. Petitioner, however, presented no evidence as to the frequency in which these searches occurred or whether any such searches occurred during the years in issue. Further, petitioner failed to establish that a nonmember independent agent in the same circumstances would not be capable of making a similar search among other independent agents. In addition, petitioner argues its public insurance activity is substantially related to its stated purposes of advancing the public interest, 10 improving the conditions in the insurance industry, and maintaining good relations between the insurance industry and the issuing public. In this regard, petitioner contends that its public insurance activity provides public authorities with the best insurance for the lowest cost, eliminates political influence from the public insurance procurement187 process, provides insurance for difficult to insure risks, and coordinates coverage so as to reduce policy gaps and conflicts. We, however, find that petitioner has failed to carry its burden of proof regarding these issues. Accordingly, we cannot conclude petitioner's public insurance activity is substantially related to any of its stated purposes. With regard to providing the best insurance for the lowest cost, for the most part, the administrators of the public authorities who served as witnesses for petitioner were not qualified to evaluate whether they were obtaining the best insurance for the lowest cost. Except for Mr. Fitzpatrick, the City of Huntsville risk manager, these witnesses had no special expertise in making such an evaluation. 188 While Mr. Fitzpatrick is qualified to make such an evaluation, he did not do so in this case. He did not perform any significant comparison shopping, nor did he review the assigned member agency's work. Thus, none of these witnesses could reasonably determine whether purchasing insurance through petitioner provides the best insurance with the lowest overall cost. Furthermore, contrary to petitioner's assertions, the mere fact that, in a few instances, a public authority pays lower premiums in a subsequent year does not establish that petitioner provides the best insurance for the lowest cost, especially when the prior years were handled through petitioner as well. With regard to removing political influence, not one of petitioner's witnesses testified to having personal knowledge of how the system worked prior to petitioner's existence or whether the prior system was even subject to political influence. Furthermore, none of petitioner's witnesses could give a detailed explanation of how petitioner accomplished this. Thus, we cannot conclude petitioner reduced or eliminated political influence from the public insurance procurement process. With regard to providing insurance189 for difficult to insure risks, the record reflects that petitioner itself is not an insurance company but, rather, an organization whose membership is composed of numerous independent insurance agencies. Petitioner has failed to prove that the same insurance was not available through other nonmember independent agents. Petitioner has also failed to prove that the same insurance was not available through companies that market their insurance solely through their own employees. Thus, we cannot conclude petitioner provided coverage for risks otherwise not available to the public authorities. With regard to coordinating coverages so as to reduce policy gaps and conflicts, petitioner failed to prove that its public insurance activities reduced policy gaps and conflicts any more than if a public authority obtained insurance through a single nonmember independent agent. 11Finally, petitioner argues that, in the event*190 we find the commissions received constitute UBTI, we should allow petitioner to deduct certain expenses in addition to those allowed in the notice of deficiency. We disagree. First, petitioner is not entitled to deduct charitable contributions in excess of 10 percent of UBTI (before any deduction for charitable contributions). Sec. 512(b)(10). Second, gross income from an unrelated trade or business may be reduced by deductions (otherwise allowable) which are directly connected with such trade or business. Sec. 512(a). We find that petitioner has failed to establish that these expenses are directly connected to petitioner's public insurance activity. Thus, we do not reach the questions concerning whether these expenses are reasonable and substantiated. Decision will be entered for respondent. Footnotes1. All independent agencies in the City of Huntsville are members of petitioner.↩2. 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.↩3. These public authorities include City of Huntsville, Madison County, Huntsville-Madison County Library, Von Braun Civic Center, Burritt Museum, Huntsville City schools, Transportation Department of the City of Huntsville, Senior Center, Airport Authority, and Huntsville utilities.↩4. The assigned member may also solicit insurance companies not represented by any member.↩5. For the years in issue, petitioner submitted a detailed breakdown of activities which indicated that approximately 29 percent of time spent was related to its public insurance activity.↩6. In addition to her "not substantially related" argument, respondent argues that overseeing the writing of insurance for public authorities is not a valid exempt purpose for a sec. 501(c)(6) organization. Since we find that petitioner's public insurance activity is not substantially related to any of its stated purposes, we do not reach this issue.↩7. The testimony indicates that these "reviews" occurred during quarterly meetings. However, the suggestion for quarterly meetings appears to have been first raised in early 1986. (See Joint Exhibit 20T.) Further, there is nothing in the record establishing that this suggestion was actually implemented during any of the years in issue. ↩8. We recognize petitioner's bylaws call for review of each public account every 3 years and petitioner has stated that 29 percent of its time during the years in issue involved public insurance activities. However, petitioner called three witnesses all who have served on the Committee for numerous years. Based on the evidence, including their testimony at trial, we conclude that, during the years in issue, the Committee did not perform regular independent oversight activities. ↩9. The bylaws also provide that each year the president or a designated representative shall contact each public authority assigned to a member agency in an attempt to obtain feedback on the handling of the account. The bylaws further provide that the president shall prepare a summary of the information obtained and submit it to the Committee. None of petitioner's witnesses even mentioned such activities.↩10. Respondent also argues that advancing the public interest is not a valid exempt purpose for a sec. 501(c)(6) organization. Since we find that petitioner's public insurance activity is not substantially related to any of its stated purposes, we do not reach this issue.↩11. We have reviewed petitioner's remaining arguments regarding this issue, but find them meritless.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623203/	Herbert C. McManus and Myrtle G. McManus v. Commissioner.McManus v. CommissionerDocket No. 951-70.United States Tax CourtT.C. Memo 1972-200; 1972 Tax Ct. Memo LEXIS 58; 31 T.C.M. (CCH) 999; T.C.M. (RIA) 72200; September 14, 1972John B. Fisher, 1113-1115 Virginia St., East., Charleston, W. Va., for the petitioners. Juandell D. Glass, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined the following Federal income tax deficiencies and additions to tax against the petitioners: TaxableAdditionsto TaxYearDeficiencySec. 6653(b)Sec. 6654 11959$ 9,238.68$4,619.34$ 17.37196016,321.138,160.5718.37196115,062.467,531.2327.1619625,616.082,808.04Respondent has conceded that the petitioner, Myrtle G. McManus, is not liable for the additions to tax under section 6653 (b) because of his failure to prove that a part of the underpayment of tax was due to her fraud. On February 23, 1972, respondent filed a motion for an order to show cause, pursuant to Rule 31(b)(5) 60 of the Court's Rules of Practice, why the facts and evidence recited in his proposed stipulation of facts attached to the motion should not be accepted as established for the purposes of this case. On February 24, 1972, the Court entered an Order to Show Cause which was served on petitioners' counsel. On March 6, 1972, petitioners' counsel filed a short, sketchy response to the Order to Show Cause. The Court regarded the response as inadequate and not in compliance with the provisions of Rule 31(b)(5). Consequently, the Court entered a further order on March 9, 1972, directing the parties to appear in Washington, D.C., on March 21, 1972, for a hearing on the Order to Show Cause. A hearing was held on March 21, 1972, at which respondent's proposed stipulation of facts and exhibits were considered. Arguments were heard with respect to all paragraphs of the proposed stipulation of facts and, subject to various changes indicated in the record, the facts and evidence contained therein were declared established for the purposes of the case. When the case was called for trial in Charleston, West Virginia, on April 4, 1972, petitioners' counsel expressed his objection to the proposed stipulation61 of facts and exhibits, primarily on the grounds of relevance and materiality. The Court overuled the objection and stated that an order would be entered making the Order to Show Cause absolute. On April 10, 1972, the Court entered an order making the Order to Show Cause under Rule 31(b)(5) absolute, and further ordered that the facts and evidence contained in respondent's proposed stipulation of facts were accepted as established for the purposes of this case. 1001 The issues for decision are: (1) Whether the petitioners understated ordinary income from their partnership business and their taxable income on their joint Federal income tax returns for each of the years 1959 through 1962 in the amounts determined by respondent by the specific item method of proof; (2) whether petitioners had unreported interest income, unreported capital gains and unallowable business expenses in the year 1962; (3) whether any part of the underpayment of tax for each of the taxable years 1959 through 1962 was due to fraud with intent to evade tax; (4) whether assessment of any deficiencies determined by respondent for the years 1959 through 1962 is barred by the statute of limitations; (5) whether62 the petitioner-wife is liable for the determined deficiencies in tax; and (6) whether this Court has jurisdiction over the additions to tax under section 6654 detemined by respondent for the years 1959 through 1961. Findings of Fact Herbert C. McManus and Myrtle G. McManus (herein called petitioners) are husband and wife whose legal residence was Charleston, West Virginia, when they filed their petition in this case. Petitioners filed their joint Federal income tax returns for each of the years 1959 through 1962 with the district director of internal revenue at Parkersburg, West Virginia. The statutory notice of deficiency was mailed to the petitioners on November 20, 1969. During the years 1959 through 1962 the petitioners operated the General Window Cleaning Company, Charleston, West Virginia, as partners. The General Window Cleaning Company engaged in the window cleaning business and related services in Virginia, South Carolina and the Charleston, West Virginia, area during the years in question. Partnership income tax returns (Forms 1065) were prepared and filed by Herbert C. McManus (herein called petitioner) on behalf of the General Window Cleaning Company for each63 of the taxable years 1959, 1960, 1961 and 1962 with the district director of internal revenue, Parkersburg, West Virginia. Petitioner's formal education ended at the seventh grade. He had no training in bookkeeping. Petitioner personally supervised the business operations of the General Window Cleaning Company. The books and records of the business were maintained by or at the direction and under the supervision of petitioner during the years 1959 through 1962. The books and records were sketchy and inaccurate. They consisted mainly of an accounts receivable ledger, general expense accounts, miscellaneous payroll records and some checks and bank statements, all of which were voluntarily made available by petitioner to respondent's agents. Petitioner prepared and filed the joint Federal income tax returns for himself and his wife for each of the years 1959 through 1962. Customer accounts receivable ledgers showing billings (debits) to and payments (credits) by customers of General Window Cleaning Company were a part of the books and records maintained by petitioners. Herbert C. McManus personally computed gross receipts for the General Window Cleaning Company for each of the64 years 1959 through 1962 by running an adding machine tape total of credits (payments) shown on the accounts receivable ledgers. General Window Cleaning Company did not have accounts receivable ledgers showing payments received from a substantial number of customers. Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by E.I. du Pont deNemours & Company from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: RecordedGrossPaid byon A/RReceiptsYearduPontLedgersOmitted1959$ 1,601.60No Ledger$ 1,601.60196015,277,27$ 1,118.0014,159.27196123,722.4923,379.56342.931962 18,451.5412,720.065,731.48Total $59,052.90$37,217.62$21,835.28 Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by OwensIllinois from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the65 years 1959 through 1962 as follows: Paid byRecordedGrossOwens-on A/RReceiptsYearIllinoisLedgersOmitted1959$3,023.70No Ledger$3,023.7019602,371.20No Ledger2,371.2019612,099.90$2,099.9001962 1,651.00No Ledger1,651.00Total $9,145.80$2,099.90$7,045.90 Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by Union Carbide Corporation from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: Paid byRecordedGrossUnionon A/RReceiptsYearCarbideLedgersOmitted1959$19,454.99No Ledger$19,454.99196035,829.25$12,788.3223,040.93196124,983.043,926.3621,056.681962 27,023.2926,450.21573.08Total $107,290.57$43,164.89$64,125.68 Petitioners establish a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by White Sulphur Springs Company from the accounts66 receivable ledgers during each of the years 1959 through 1962 as follows: Paid byRecordedGrossWhiteon A/RReceiptsYearSulphurLedgersOmitted1959$18,534.20$18,534.20$ 0196019,059.9318,473.40586.53196120,705.9220,705.9201962 25,090.8218,379.616,711.21Total $83,390.87$76,093.13$7,297.74 Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by Hewmont Construction Company by failing to prepare accounts receivable ledgers during each of the years 1961 through 1962, as follows: RecordedGrossPaid byon A/RReceiptsYearHewmontLedgersOmitted1961$2,534.40No Ledger$2,534.401962 70.60No Ledger70.60Total $2,605.00$ 0$2,605.00 In 1961, petitioners failed to record two items of gross receipts paid to General Window Cleaning Company by Associated Engineers in the amounts of $1,490 and $255. Petitioners established a pattern of consistently omitting gross receipts paid to General Window Cleaning Company by H. B. Agsten67 & Sons, Inc., by failing to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: Paid byRecordedGrossAgstenon A/RReceiptsYear& SonsLedgersOmitted1959$ 143.00No Ledger$ 143.001960584.00No Ledger584.001961266.00No Ledger266.001962 555.45No Ledger555.45Total $1,548.45$ 0$1,548.45 Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by Bell Lines, Inc., from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: Paid byRecorded onGross ReceiptsYearBellLinesA/R LedgersOmitted1959$ 960.00$1,040.00$ (80.00)1960880.00No Ledger880.001961960.00No Ledger960.001962 880.00880.000Total $3,680.00$1,920.00$1,760.00 Petitioners established a pattern of consistently omitting numerous and substantial items of gross receipts paid to General Window Cleaning Company by B.F. Goodrich Company68 from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: GrossPaid byRecorded onReceiptsYearGoodrichA/R LedgersOmitted1959$1,807.96$ 459.00$1,348.961960853.96853.96019611,771.961,771.9601962 881.96No Ledger881.96Total $5,315.84$3,084.92$2,230.92 In 1959, petitioners omitted gross receipts in the amount of $1,467 paid to General Window Cleaning Company by Pure Oil Company by failing to prepare accounts receivable ledgers. Petitioners omitted numerous and substantial items of gross receipts paid to General Window Cleaning Company by Kroger Company from the accounts receivable ledgers, or they failed to prepare accounts receivable ledgers during each of the years 1959 through 1962, as follows: 1003 GrossPaid byRecorded onReceiptsYearKrogerA/R LedgersOmitted1959$ 3,421.25No Ledger$3,421.2519603,819.55$2,094.851,724.7019613,626.553,491.55135.001962 3,603.553,583.5520.00Total $14,470.90$9,169.95$5,300.9569 The omitted gross receipts set out above, when added to reported gross receipts on the partnership returns, substantially equal gross receipts determined in respondent's statutory notice of deficiency, as follows: Gross ReceiptsYearPer ReturnOmittedTotalPer Stat. Notice1959$ 51,103.34$ 30,380.50$ 81,483.84$ 84,199.44196058,723.5743,346.63102,070.20110,964.51196165,404.0427,040.0192,444.05113,819.631962 96,613.8616,194.78112,808.64110,615.24Total $271,844.81$116,961.92$388,806.73$419,598.82The difference between General Window Cleaning Company's reported gross receipts and gross receipts recorded on the accounts receivable ledgers for each of the years 1959 through 1962 is as follows: Gross ReceiptsYearPer ReturnPer A/RDifference1959$ 51,103.34$ 43,460.32$ 7,643.02196058,723.5760,119.90(1,396.33)196165,404.0481,217.05(15,813.01)196296,613.8686,597.7510,016.11Total$271,844.81$271,395.02$ 449.79 The petitioner did not explain the various differences between gross receipts in the accounts70 receivable ledgers and gross receipts in the partnership returns. The petitioners did not receive nontaxable income during the years 1959 through 1962. General Window Cleaning Company's deposited gross receipts exceeded gross receipts per accounts receivable ledgers for each of the years 1959 through 1962, as follows: Gross ReceiptsDepositsA/RExceedingYearDepositsLedgersA/R Ledgers1959$ 67, 442.43$ 43,460.32$23,982.11196084,264.8060,119.9024,144.90196187,377.2581,217.056,160.20196291,389.7086,597.754,791.95Total$330,474.18$271,395.02$59,079.16 General Window Cleaning Company's deposited gross receipts exceeded gross receipts reported on the partnership returns in all years except 1962, as follows: Gross ReceiptsDepositsExceedingGross ReceiptsYearDepositedReportedReported1959$ 67,442.43$ 51,103.34$16,339.09196084,264.8058,723.5725,541.23196187,377.2565,404.0421,973.211962 91,389.7096,613.86(5,224.16)Total $330,474.18$271,844.81$58,629.37 Herbert C. McManus did not71 explain the substantial differences between gross receipts reported on the partnership returns and gross receipts shown by the partnership accounts receivable ledgers and bank deposits for each of the years 1959 through 1962. Petitioners used regular employees as a nucleus of the work force, but additional temporary help was employed when needed. The allowable business expenses petitioners failed to claim on the 1959 through 1961 partnership returns exceeded the reported partnership ordinary income for each year as follows: 195919601961Ordinary Income per Return$4,778.20$ 4,992.65$7,002.68Unclaimed Business Expenses 5,063.8810,110.399,332.39Excess ($ 285.68)($ 5,117.74)($2,329,71) 1004 The totals of petitioners' nondeductible personal expenses, expenditures for personal asset acquisitions, and reductions of personal liabilities during 1959 through 1962 are as follows: Nondeductible Personal Living Expenses, etc.Item1959196019611962Dixie Lee Shires$ 2,975.00$ 1,165.00$ 470.000Stock1,250.00$ 500.00Lake Cabin4,825.00Personal Living Expenses10,482.8814,355.0112,502.7810,385.56Savings Account1,200.00812.486,912.451959 DeSoto1,500.001960 Corvette1,618.101960 Thunderbird2,500.00Liability Reduction 1,930.442,410.504,156.062,443.72Total $16,888.32$28,073.61$19,191.32$20,241.7372 Petitioners failed to reveal their ownership or sale of Kanawha City Savings and Loan Company stock for $2,100 in 1962, and failed to report their realized gain of $1,135. Petitioners offered no evidence as to the disallowance of business expenses in 1962 in the amount of $1,468.59. Petitioners offered no evidence as to the determination of interest income of $58.69 in 1962 which was not reported on their Federal income tax return. Prior to filing General Window Cleaning Company's 1962 partnership tax return, the petitioner raised gross receipts about $10,000 above recorded gross receipts per accounts receivable ledgers, and still understated gross receipts by about $16,000. At the initial interview with respondent's agents on July 17, 1962, and at the interview on September 9, 1962, the petitioner concealed a bank account and a savings account he maintained at the First National Bank of Hinton. Petitioner stated to respondent's agents that his payroll records for 1959 through 1962 were complete, accurate and correct in every detail. Petitioner attempted to conceal from respondent's agents his stock holdings in Kanawha City Savings and Loan Company, Charleston Senators, 73 Inc., West Virginia Acceptance Company and Duplicating Creative Services, Inc.Petitioner falsely stated to respondent's agents that he deposited all his business gross receipts in bank accounts. The accounts receivable ledgers of General Window Cleaning Company were the only records furnished to petitioners' accountant, William M. Ellis. Petitioners did not engage William M. Ellis or Edward McManus for the purpose of auditing records, verifying income or expenses, or verifying the correctness of respondent's determination of corrected taxable income. After telling respondent's agents and testifying in Court that checks drawn to cash and marked "payroll" or "PR" were for salaries, wages, or crew expenses, the petitioner admitted that he deposited many checks so marked in the bank account of Dixie Lee Shires, who was not an employee of the General Window Cleaning Company. The petitioner, Herbert C. McManus, was indicted for willful evasion of income taxes for the years 1960, 1961 and 1962 in violation of section 7201. On May 27, 1969, he entered a plea of nolo contendere to all three counts of the indictment in the United States District Court for the Southern District of West74 Virginia. On June 3, 1969, he was fined a total of $8,000 and placed on probation for two years. Ultimate Findings 1. Petitioners have inadequate and incomplete books and records to show partnership gross receipts and ordinary income for the years 1959 through 1962. 2. Petitioners have failed to establish that they are entitled to business expenses in excess of those allowed by respondent. 3. Petitioners failed to show any error in the determination made by respondent of petitioners' taxable income for each of the years 1959 through 1962 by use of the specific item method of proof. 4. Petitioners understated their taxable income in each of the years 1959 through 1962, as follows: 1005 YearAmount1959$28,049.22196042,130.55196139,083.20196215,804.135. Petitioner, Herbert C. McManus, willfully and knowingly filed partnership income tax returns for each of the years 1959 through 1962 which he knew were false and fraudulent. 6. For each of the years 1959 through 1962 a part of the underpayment of tax by the petitioner, Herbert C. McManus, was due to fraud with intent to evade tax, and each of the Federal income tax returns for75 those years was a false and fraudulent return with intent to evade tax. 7. Petitioner, Myrtle G. McManus, is liable for the deficiencies determined by respondent, even though she is not liable for the fraud penalty, because she has failed to establish her eligibility for relief under section 6013(e) of the Code. Opinion Issue 1. Determination of Taxable Income During the years 1959 through 1962 the petitioners operated a profitable window cleaning business as a wholly owned partnership. The business operations were supervised and directed by petitioner Herbert C. McManus. It was he who kept under his control and supervision the books and records of partnership income and expenses and who prepared the partnership and individual income tax returns of the petitioners. Respondent's examination of the partnership books and records revealed that many items of gross receipts were not recorded therein. In view of their gross inadequacy, respondent computed partnership ordinary income by using the specific item method of proof. Partnership customers were contacted and payments made to the partnership for services rendered were carefully documented. A comparison of the partnership76 and customers' records revealed that gross receipts shown by customers' records were substantially in excess of gross receipts reported on the partnership records and returns for each year. The partnership records also revealed that the petitioners failed to claim certain amounts of allowable business expenses on the partnership returns for each of the years 1959 through 1961, all of which were allowed in respondent's computation of partnership ordinary income. It is well settled that taxpayers are required to report every item of gross income received and to maintain records to establish the correct amount of gross income, deductions and credits required to be shown on their tax returns. Marko Durovic, 54 T.C. 1364">54 T.C. 1364, 1391 (1970). In this case, where the petitioner has failed to keep the required records, and the books and records he kept were inadequate, the respondent was justified in determining petitioners' tax liabilities for the years 1959 through 1962 by the specific item method of proof. See Harold E. Harbin, 40 T.C. 373">40 T.C. 373, 377 (1963). Respondent's determination of the deficiencies in tax is presumed to be correct in the absence of proof to the77 contrary. Welch v. Helvering, 290 U.S. III (1933); Lawrence Sunbrock, 48 T.C. 55">48 T.C. 55 (1967). Petitioners have introduced no evidence to show that respondent's determination of additional unreported gross receipts was erroneous, excessive, unreasonable or arbitrary. In fact, their accountants were not given access to all of the partnership records and they were neither asked to nor did they verify the correctness of respondent's determination of gross receipts and business expenses. Aside from the presumption of correctness, respondent has presented convincing evidence which establishes that substantial amounts of gross receipts were not recorded on the partnership records and were not reported on the partnership or individual income tax returns, but were knowingly diverted to petitioners' own personal use and benefit. Petitioners' attack is based upon vague and unsubstantiated allegations that they incurred additional business expenses above and beyond the additional amounts allowed by respondent. The only basis petitioners offer to support this allegation is that the net profit percentages shown by the partnership returns for subsequent years were lower and, therefore, 78 those lower percentages should be applied to the years in question. In essence, they are asking that business expenses be determined upon the basis of an indirect method of proof, using approximations rather than the specific expenses claimed on their partnership returns. This is plainly without merit. Although the petitioner Berbert C. MCManus swore under penalty of perjury that expenses claimed in the partnership returns were true, correct and complete, 1006 respondent found and allowed additional unclaimed business expenses shown on petitioners' books and records in amounts which exceeded reported partnership ordinary income in three out of four years. In addition, the petitioner told respondent's agents that the business expenses were correct and accurate in every detail. Other than the vague and unconvincing testimony of Herbert C. McManus, the petitioners have failed to introduce evidence to support their allegations. They did not testify to or offer any evidence of any specific business expenses incurred during those years which they had not been previously allowed. Cf. 79 Anson v. Commissioner, 328 F. 2d 703 (C.A. 10, 1964), affirming a Memorandum Opinion of this Court. Petitioners contend that respondent used the wrong method of proof in determining the understatements of taxable income. The assertion that respondent should have used the net worth method rather than the specific item method completely lacks merit, especially in light of the facts of this case. Petitioners are urging that an indirect method of proof be utilized in determining taxable income instead of a direct method of proof based upon the method of accounting they used. The net worth computation in evidence was prepared by Special Agent Stuckey to corroborate the specific item criminal income tax evasion case against the petitioner. It is admittedly incomplete for civil income tax purposes. The net worth method of proof was not used by respondent in either the criminal case or this case and, while it is an acceptable method of determining taxable income, it is less accurate than the specific item method used by respondent. See and compare 80 Emilie Furnish Funk, 29 T.C. 279">29 T.C. 279 (1957), affirmed in part and remanded in part 262 F. 2d 727 (C.A. 9, 1958). It is significant that the petitioners have not directly attacked respondent's determination of taxable income under the specific item method of proof, nor have they offered an iota of evidence to show that the items of omitted gross receipts were erroneous. Not only have petitioners failed to prove error in the determined gross receipts, but they have also failed to prove that the partnership incurred deductible business expenses in excess of those allowed by respondent which were greatly in excess of the expenses claimed by petitioners on their partnership tax returns. Respondent submits, and we agree, that the taxable income of petitioners was clearly and accurately computed under the method of accounting utilized by them and that the method of proof used by respondent clearly and accurately shows such taxable income.This is simply a situation where respondent has corrected petitioners' reported income by adding to it gross receipts which Herbert C. McManus willfully and deliberately omitted from the partnership records. There can be no more definite81 and accurate method of computing the partnership gross receipts in these circumstances. Consequently, we reject petitioners' contention that the net worth method of proof is the more accurate and the only feasible method avilable. On this record we hold that the petitioners have not proved error in the respondent's determination and, therefore, we sustain it. Issue 2. Unreported Interest Income and Capital Gain In his statutory notice of deficiency the respondent determined that the petitioners failed to report in the year 1962 interest income of $58.69, realized gain from the sale of stock in the amount of $1,135, and unallowable business expenses of $1,468.59. Petitioners offered no evidence on these adjustments. Therefore, we sustain respondent's determination. Issue 3. Additions to Tax under Section 6653(b) The parties are in agreement that unless fraud is found to exist the deficiencies herein are barred by the statute of limitations. Respondent must prove the requisite fraud by clear and convincing evidence to support the additions to tax under section 6653(b). See section 7454(a); 82 Arlette Coat Co., 14 T.C. 751">14 T.C. 751 (1950); Luerana Pigman, 31 T.C. 356">31 T.C. 356, 370 (1958); and Hicks Co., 56 T.C. 982">56 T.C. 982, 1019 (1971), on appeal C.A. 1. We think he has successfully carried such burden of proof. The statute and the decided cases establish that if any part of the underpayment of tax is due to fraud the addition to tax attaches to the entire deficiency. Lawrence Sunbrock, supra at 65. The "fraud" mentioned in section 6653 (b) and its predecessor provisions is 1007 "actual, intentional wrongding, and the intent required is the specific purpose to evade a tax believed to be owing." Mitchell v. Commissioner, 118 F. 2d 308, 310 (C.A. 5, 1941); Tomlinson v. Lefkowitz, 334 F. 2d 262, 265 (C.A. 5, 1964), certiorari denied 379 U.S. 962">379 U.S. 962 (1965). It is now well settled that in a civil tax fraud case "consistent failure to report substantial amounts of income over a number of years, standing alone, is effective evidence of fraudulent intent." Schwarzkopf v. Commissioner, 246 F.2d 731">246 F. 2d 731, 734 (C.A. 3, 1957), affirming a Memorandum Opinion of this Court; 83 Kurnick v. Commissioner, 232 F. 2d 678 (C.A. 6, 1956). If this flagrant, repetitive pattern of substantial omissions of income by a man of petitioner's perception and business acumen were the only factors involved, we would feel justified in finding a fraudulent intent in this case. But here other indicia of fraud are unmistakably clear: (1) inadequate and incomplete books and records; (2) false and misleading statements made to respondent's agents with intent to conceal bank accounts, payments to Dixie Lee Shires, stock ownership and the use of payroll checks for other expenses; (3) intentional understatements of allowable business expenses in a scheme to conceal unreported income by juggling figures so that the returns would not arouse suspicion on their face; (4) personal living expenses greatly in excess of the taxable income reported on petitioners' returns, Friedman v. Commissioner, 421 F. 2d 658 (C.A. 6, 1970); and (5) the prior conviction (on a plea of nolo contendere) of petitioner Hebert C. McManus for willful evasion of income taxes for the years 1960, 1961, and 1962. 84 Masters v. Commissioner, 243 F.2d 335">243 F. 2d 335, 338 (C. A. 3, 1957). All in all, on the basis of this record and our evaluation of the credibility of the witnesses, there is clear and convincing evidence that petitioner Herbert C. McManus received substantial amounts of unreported income and deliberately failed to report the same in each of the years at issue. Thus we conclude that there was fraud proved for each of those years. Our ultimate findings of fact so reflect. See Friedman v. Commissioner, supra; Adler v. Commissioner, 422 F. 2d 63 (C.A. 6, 1970), affirming a Memorandum Opinion of this Court; Foster v. Commissioner, 391 F.2d 727">391 F. 2d 727, 733 (C.A. 4, 1968), affirming on this issue a Memorandum Opinion of this Court; and Morris Lipsitz, 21 T.C. 917">21 T.C. 917 (1954), affirmed 220 F. 2d 871 (C.A. 4, 1955). Issue4. Statute of Limitations Having decided that a part of the underpayment of tax in each of the years 1959 through 1962 was due to the fraud of Herbert C. McManus with intent to evade tax, it follows that the assessment of deficiencies against both petitioners for such years is not barred by the statute of limitations.85 See section 6501(c)(1) of the Code. Fraud by the husband alone does not relieve the petitioner-wife of liability for the deficiencies or prevent the assessment thereof against her unless she qualifies as an "innocent spouse" under the provisions of section 6013(e). See Senate Rept. No. 1537, 91st Cong., 2d Sess. (1970), 1 C.B. 606">1971-1 C.B. 606, 608; Ginsberg's Estate v. Commissioner, 271 F.2d 511">271 F. 2d 511, 513-514 (C.A. 5, 1959); Kathleen C. Vannaman, 54 T.C. 1011">54 T.C. 1011, 1017-1018 (1970); and Tsuneo Otsuki, 53 T.C. 96">53 T.C. 96, 112-113 (1969). Issue 5. Innocent Spouse Provisions of Section 6013(e)We must consider the effect of the provisions relating to innocent spouses that were enacted on January 12, 1971. Pub. L. 91-679 (84 Stat. 2063, 1 C.B. 547">1971-1 C.B. 547). Section 6013, relating to joint returns, was amended to add subsection (e), which provides in pertinent part: (e) Spouse Relieved of Liability in Certain Cases. - (1) In General. Under regulations prescribed by the Secretary or his delegate, if - (A) a joint return has been made under this section for a taxable year and on such return there was omitted from gross income an amount properly86 includable therein which is attributable to one spouse and which is in excess of 25 percent of the amount of gross income stated in the return, (B) the other spouse establishes that in signing the return he or she did not know of, and had no reason to know of, such omission, and (C) taking into account whether or not the other spouse significantly benefited directly or indirectly from the items omitted from gross income and taking 1008 into account all other facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such omission, then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent that such liability is attributable to such omission from gross income. Section 6653(b), relating to the addition to tax for fraud, was also amended to add the following new sentence: (b) Fraud. - * * In the case of a joint return under section 6013, this subsection shall not apply with respect to the tax of a spouse unless some part of the underpayment is due to the fraud of such spouse. These amendments are applicable87 to this case. See section 3, Pub. L. 91-679, supra. Absence of the spouse's fraud is conceded. Under section 6013(e) Myrtle G. McManus may be relieved of any liability for the deficiencies in tax, but to be entitled to such relief she has the burden of proving that (1) she did not know of or have reason to know of the omissions from income [subsection (e)(1)(B)] and (2) that she did not significantly benefit directly or indirectly from the items omitted from gross income [subsection (e)(1)(C)]. Jerome J. Sonnenborn, 57 T.C. 373">57 T.C. 373 (1971); Nathaniel M. Stone, 56 T.C. 213">56 T.C. 213 (1971). Except for two cursory references in the opening brief 2 of petitioners' counsel, there is nothing in this record to show whether the petitioner-wife had any knowledge of such omissions or significantly benefited therefrom. We simply have no evidence with respect to this vital information. The failure of Mrs. McManus to testify creates the normal inference that, if she had appeared and testified, such testimony would have been unfavorable. 88 Jerome J. Sonnenborn, supra at 383. Accordingly, we conclude that she has failed to prove that she is entitled to be relieved of liability for the deficiencies under the provisions of the statute. Issue6. Additions to Tax under Section 6654 In his statutory notice of deficiency the respondent determined that the petitioners were liable for additions to tax under section 6654 for the underpayment of estimated taxes for the years 1959, 1960 and 1961. Petitioners offered no evidence with respect to this determination. However, in view of the fact that the petitioners filed income tax returns for those years, this Court has no jurisdiction over the section 6654 additions to tax. See section 6659(b) (2) of the Code. Decision will be entered under Rule 50. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Petitioners filed no reply brief.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623206/	JAMES B. MUNSON AND MARGARET C. MUNSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMunson v. CommissionerDocket No. 3905-78.United States Tax CourtT.C. Memo 1980-121; 1980 Tax Ct. Memo LEXIS 465; 40 T.C.M. (CCH) 173; T.C.M. (RIA) 80121; April 16, 1980, Filed James G. Howard, for the petitioners. Robert E. Dallman, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined the following deficiencies in petitioners' income taxes: YearAmount1975$ 2,537.6219762,397.49The sole issue is whether the amounts paid for petitioner James B. Munson's air fare between Florida and Wisconsin during the winters of 1975 and 1976 by Munson, Inc. constituted constructive dividends to petitioners. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioners James B. Munson and his wife Margaret C. Munson resided in Wisconsin when they filed their petition. Mrs. Munson is a petitioner solely because she filed a joint return with her husband, and when we refer to petitioner466 herein we will be referring to Mr. Munson. During 1975 and 1976 petitifoner was president and chief executive officer of Munson, Inc. Petitioner owned 85 percent of the outstanding stock of Munson, Inc., Frank Armstrong, vice president of Munson, Inc., owned 9 percent, Mrs. Munson owned 3 percent, and certain unrelated employees of Munson, Inc. owned the remaining 3 percent. Munson, Inc.'s principal place of business in 1975 and 1976 was Glendale, Wisconsin. Glendale is a suburb of Milwaukee. Munson, Inc. was primarily engaged in the business of installing chain link fencing and blacktopping driveways in southeastern Wisconsin. Munson, Inc. completed most of its fencing and blacktopping contracts during the spring, summer and fall. During the witner months new contracts and bids were sought by Munson, Inc. for the ensuing construction season. During the spring, summer and fall petitioner and his wife lived in their home in Whitefish Bay, Wisconsin. Whitefish Bay is a suburb of Milwaukee. During the winter petitioner and his wife vacationed in Florida. Petitioner transacted no business in Florida. He did, however, keep in regular telephone contact with the employees467 of Munson, Inc. in Wisconsin. Four times each winter in 1975 and 1976 petitioner flew from Florida to Wisconsin where he attended to the business of Munson, Inc. During these trips he personally reviewed the current status of the corporation with respect to inventory and equipment needs, personnel, bidding advertising, installations and estimating, and he made customer contacts. Each trip lasted two or three week days. While in Wisconsin petitioner stayed at his home in Whitefish Bay. Munson, Inc. paid for petitioner's round-trip airline tickets from Florida for each of the eight trips in issue here. Petitioner paid for his own initial ticket to Florida and his final return ticket back to Wisconsin at the end of his vacation. OPINION The issue for decision is whether petitioner received a constructive dividend in each of 1975 and 1976 when the corporation that petitioner controlled paid his air fare for eight round trips he made from Florida to Wisconsin. Respondent contends that these travel expenses were personal expenses in the nature of commuting expenses, and we agree. Petitioner's home is Whitefish Bay, Wisconsin. From his home he commutes to his job with Munson, 468 Inc. in Glendale, Wisconsin, during the spring, summer and fall. During the winter petitioner chooses to live in Florida. To the extent his is able, he conducts his business as chief executive officer of Munson, Inc. from Florida by telephone. But his job requires him to be in Glendale, Wisconsin, at least once a month to review the business operations of the company and to make important decisions for the company. Petitioner's travel from Florida to Glendale, Wisconsin, is commuting just as much as is his travel from his home in Whitefish Bay to Glendale. Petitioner's tax home is his place of business, in this case Glendale, Wisconsin. Kroll v. Commissioner, 49 T.C. 557">49 T.C. 557, 561-62, 564-65 (1968). It was petitioner's personal choice rather than the corporation's choice that he and his family vacation in Florida during the winter months. Neither the corporation nor petitioner had any business in Florida. Consequently, petitioner was not away from home on business during the time he and his family vacationed in Florida. The cost of flying from Florida to Wisconsin to attend to the company's business, which cost was paid for by the company, was a commuting expense. 469 See Beckley v. Commissioner, 44 P-H Memo. T.C. par. 75,037. Commuting expenses are nondeductible personal expenses. Fausner v. Commissioner, 413 U.S. 838 (1973); Flowers v. Commissioner, 326 U.S. 465">326 U.S. 465, 470 (1946); Section 1.162-2(e), Income Tax Regs. Munson, Inc.'s reimbursements of petitioner's commuting expenses constitute constructive dividends to petitioner in an amount equal to the price paid for the airline tickets.1Challenge Manufacturing Co. v. Commissioner, 37 T.C. 650">37 T.C. 650, 663 (1962); Perrotto v. Commissioner, 46 P-H Memo. T.C. par. 77,099. Neither party contended that the reimbursements of petitioner's commuting expenses constituted additional compensation to petitioner and, therefore, we do not address that possibility. Decision will be entered under Rule 155. Footnotes1. Petitioner has not shown that there were not earnings and profits available to Munson, Inc. out of which this constructive dividend could be paid.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623207/	CALVIN CROUSE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Crouse v. CommissionerDocket No. 3717.United States Board of Tax Appeals11 B.T.A. 1327; 1928 BTA LEXIS 3633; May 14, 1928, Promulgated 3633 INCOME. - The value of a purchase money note and mortgage on the date received by petitioner, determined and also gain derived from sale of farm determined. F. E. Northrup, Esq., for the petitioner. A. H. Murray, Esq., for the respondent. TRUSSELL 1327 Petitioner appeals from the respondent's determination of a deficiency in the amount of $990.32 in his income tax for the calendar year 1920, and alleges that respondent erred in determining that petitioner realized a profit in the amount of $23,320 from the sale of a farm in 1920. FINDINGS OF FACT. Some time prior to March 1, 1913, petitioner acquired a 120 acre farm in Grundy County, Iowa. He lived upon and operated that farm property from the time he purchased it until on or about March 1, 1920. The March 1, 1913, value of that farm with buildings and equipment was $27,000. Subsequent to March 1, 1913, and prior to the date of the sale, petitioner added improvements costing $1,000. The reasonable allowance for exhaustion, wear and tear of buildings subject to depreciation during the period from March 1, 1913, to date of sale amounted to $1,120. In August, 1919, petitioner entered3634 into a contract for the sale of his 120 acre farm, the sale to be made and the property to be transferred on March 1, 1920. On the latter date the sale was made and petitioner deeded his farm property to the purchaser and received from the purchaser a cash payment of $20,000, together with a purchase money note and first mortgage for the further sum of $29,200. The purchaser entered upon the property and remained in possession thereof until on or about March 1, 1926, when, being unable to continue making payments of interest on his note secured by the mortgage, he reconveyed the property to the petitioner. The purchaser of petitioner's farm owned no other property aside from the interest he acquired in the property in question. The purchase money note had a value only to the extent of the security represented by the first mortgage upon the farm. The sale price of $49,200 was greatly in excess of the intrinsic value of the farm in 1920, and was a speculative figure brought about by the speculative buying and selling of Iowa farms at that time. Petitioner could 1328 have sold the mortgage on March 1, 1920, only at a discount of from 40 to 50 per cent. For the calendar3635 year 1920, the petitioner made an individual income-tax return showing a gross income in the amount of $20,187.75, in which amount he included the sum of $19,120 as profit from the sale of the farm. Upon the audit of petitioner's return, the Commissioner added depreciation sustained in the amount of $1,120, to the sale price of $49,200; subtracted therefrom the March 1, 1913, value of $27,000, and computed the amount of $23,320 as the profit realized by petitioner upon the sale of his farm. OPINION. TRUSSELL: This record contains the testimony of two experienced dealers in Iowa farm lands and farm loans who testified at length to market values of farm property as of March 1, 1920, and also as to such values of farm mortgage loans made on the basis of the then prevailing selling prices. The testimony is convincing that there were many sales of farms made in the State in 1919 and 1920, at grossly inflated prices; that such prices were far in excess of any intrinsic values in farm property and that practically all of the buyers during those years were people who expected to make a quick turnover of their purchase and had no thought of retaining properties for farming purposes. 3636 They also agreed that there was no true market for farm mortgages taken during those years at the prevailing inflated prices, although there were occasionally found persons who would buy such mortgages at discounts ranging from 40 to 50 per cent. All of this testimony taken as a whole convinces us that the note and mortgage taken by the petitioner on March 1, 1920, had a then value of not in excess of 60 per cent of its face, or $17,520. Upon this basis petitioner received for his farm cash and mortgage notes aggregating a value of $37,520. The depreciated March 1, 1913, value of his farm and cost of additions to the buildings thereon was $26,880, his net gain, therefore, upon the transaction was $10,640. Petitioner's income-tax return for the year 1920 should be amended in accordance with the findings of fact and this opinion and the deficiency or overassessment, as the case may be, recomputed upon that basis. Judgment will be entered pursuant to Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623208/	Estate of Bert L. Sivyer, Louis S. Shank, Executor, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Sivyer v. CommissionerDocket No. 1473-75United States Tax Court64 T.C. 581; 1975 U.S. Tax Ct. LEXIS 110; July 17, 1975, Filed 110 Rule 53, Tax Court Rules of Practice and Procedure. -- Shank was released, pursuant to sec. 2204(a), I.R.C. 1954, from personal liability for estate tax imposed upon him as executor of decedent's estate. Held, that a release from personal liability under sec. 2204(a) has no bearing on whether sec. 6903, I.R.C. 1954, requiring notice of termination of fiduciary capacity, has been satisfied. Held, further: That sec. 6903 was not complied with and the notice of deficiency was valid. The petition filed herein confers jurisdiction on this Court to redetermine the estate tax deficiency. Robert E. Kovacevich, for the petitioner.Kenneth W. McWade, for the respondent. Fay, Judge. FAY582 This case is before us on petitioner's motion to dismiss for lack of jurisdiction pursuant to Rule 53, Tax Court Rules of Practice and Procedure, on ground that the statutory notice of deficiency was not sent to the proper party. A hearing on the motion was held in Boise, Idaho, on April 21, 1975.FINDINGS OF FACTOn February 9, 1972, Louis S. Shank (Shank) filed a United States estate tax return for the Estate of Bert L. Sivyer with the District Director of Internal Revenue, Seattle, Wash. Shank, a residuary legatee, was designated executor of the estate on the face of the return.On February 25, 1972, Shank filed a request, pursuant to section 2204(a), 1 for discharge112 from personal liability for estate tax imposed upon him in his capacity as executor by section 2002. No action on this request was taken by the Commissioner.On April 23, 1973, an attorney representing Shank sent a letter to the Estate Tax Division, Internal Revenue Service, Spokane, Wash., indicating an intention to distribute the assets of the estate and requesting that the amount of estate tax be determined. Subsequent letters to the same effect were sent to the Estate Tax Division on June 1, 1973, and to the United States attorney's office, Spokane, Wash., on November 21, 1973.At some later date Shank distributed all of the assets of the estate.Respondent determined deficiencies in estate tax of $ 221,006, and on December 27, 1974, mailed a statutory notice of deficiency to "Estate of Bert L. Sivyer, Louis S. Shank, Executor."On February 18, 1975, a petition in the name113 of "Estate of Bert L. Sivyer, Louis S. Shank, Executor" was filed with this Court, accompanied by a motion to dismiss the notice of deficiency on jurisdictional grounds.OPINIONThe issue presented is whether Shank was the proper party to be sent the statutory notice of deficiency.583 In approaching this issue we acknowledge that Shank had been discharged under section 2204(a)3114 from the personal liability for estate tax imposed upon him in his capacity as executor under section 2002. 4 However, in our opinion, it has no bearing on the issue presented that Shank may have obtained such a discharge. Shank, in his representative capacity, was the proper party unless prior to the mailing of the deficiency notice his fiduciary capacity as executor was terminated, and he gave respondent written notice of that termination in accordance with section 6903 and the regulations thereunder. 5Estate of Theodore Geddings Tarver, 26 T.C. 490 (1956), affd. on this issue 255 F.2d 913">255 F.2d 913 (4th Cir. 1958); Estate of Ella T. Meyer, 58 T.C. 69">58 T.C. 69 (1972).115 584 Shank asserts that the letters sent by his attorneys to the Estate Tax Division requesting an acceleration of the determination of the estate tax satisfied the notice requirement of section 6903. We find that they did not constitute a notice of termination but merely advised the District Director of Shank's future intention to close the estate and terminate his fiduciary capacity as executor if and when a final determination of estate tax was made.We therefore hold that having failed to give the requisite notice, Shank was the proper party to be sent the notice of deficiency and the proper party in this proceeding. Sanborn v. Helvering, 108 F.2d 311">108 F.2d 311 (8th Cir. 1940), affg. 39 B.T.A. 721">39 B.T.A. 721 (1939); Estate of Nellie L. Rhodes, 44 B.T.A. 1315">44 B.T.A. 1315 (1941); John M. Eversole, 46 T.C. 56">46 T.C. 56 (1966); David Krueger, 48 T.C. 824 (1967). Accordingly, petitioner's motion to dismiss for lack of jurisdiction will be denied.An appropriate order will be entered. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 in effect during the taxable years in issue.↩3. SEC. 2204. DISCHARGE OF FIDUCIARY FROM PERSONAL LIABILITY.(a) General Rule. -- If the executor makes written application to the Secretary or his delegate for determination of the amount of the tax and discharge from personal liability therefor, the Secretary or his delegate (as soon as possible, and in any event within 1 year after the making of such application, or, if the application is made before the return is filed, then within 1 year after the return is filed, but not after the expiration of the period prescribed for the assessment of the tax in section 6501) shall notify the executor of the amount of the tax. The executor, on payment of the amount of which he is notified * * * and on furnishing any bond which may be required for any amount for which the time for payment is extended, shall be discharged from personal liability for any deficiency in tax thereafter found to be due and shall be entitled to a receipt or writing showing such discharge.Sec. 20.2204-1(a), Estate Tax Regs., provides:(a) General rule↩. * * * If no such notification is received, the executor is discharged at the end of such 9 month (1 year if applicable) period from personal liability for any deficiency thereafter found to be due. The discharge of the executor from personal liability under this section applies only to him in his personal capacity and to his personal assets. The discharge is not applicable to his liability as executor to the extent of the assets of the estate in his possession or control. Further, the discharge is not to operate as a release of any part of the gross estate from the lien for estate tax for any deficiency that may thereafter be determined to be due.4. SEC. 2002. LIABILITY FOR PAYMENT.The tax imposed by this chapter shall be paid by the executor.↩5. SEC. 6903. NOTICE OF FIDUCIARY RELATIONSHIP.(a) Rights and Obligations of Fiduciary. -- Upon notice to the Secretary or his delegate that any person is acting for another person in a fiduciary capacity, such fiduciary shall assume the powers, rights, duties, and privileges of such other person in respect of a tax imposed by this title (except as otherwise specifically provided and except that the tax shall be collected from the estate of such other person), until notice is given that the fiduciary capacity has terminated.(b) Manner of Notice. -- Notice under this section shall be given in accordance with regulations prescribed by the Secretary or his delegate.Sec. 301.6903-1(b), Proced. & Admin. Regs., provides:(b) Manner of notice↩. * * * When the fiduciary capacity has terminated, the fiduciary, in order to be relieved of any further duty or liability as such, must file with the district director with whom the notice of fiduciary relationship was filed written notice that the fiduciary capacity has terminated as to him, accompanied by satisfactory evidence of the termination of the fiduciary capacity. The notice of termination should state the name and address of the person, if any, who has been substituted as fiduciary. * * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623211/	ILLINOIS CENTRAL RAILROAD COMPANY AND YAZOO & MISSISSIPPI VALLEY RAILROAD COMPANY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Illinois Cent R.R. v. CommissionerDocket Nos. 62023, 62991.United States Board of Tax Appeals34 B.T.A. 1; 1936 BTA LEXIS 761; March 4, 1936, Promulgated 761 Amounts of deductions allowable to lessee on account of its liability to replace wornout or discarded equipment, determined. R. C. Beckett, Esq., and Edward C. Craig, Esq., for the petitioners. E. C. Algire, Esq., and Lloyd B. Harrison, Esq., for the respondent. OPINION. TRAMMELL 1 TRAMMELL: 1 The opinion of the Board in these proceedings, 30 B.T.A. 1107">30 B.T.A. 1107, was promulgated on June 29, 1934. On September 24, 1934, petitioner filed a motion for further hearing of the proceedings, for the purpose of (a) filing an amended petition in Docket No. 62023, in order to claim a deduction for each of the years 1926 to 1929, inclusive, of the liability of the Yazoo & Mississippi Valley Railroad Co. arising out of retirements of leased equipment in those years; (b) introduction of evidence to prove the amount of the said liability for each of said years; (c) modification of the opinion so as to include appropriate findings of fact based on the amendment and proof; (d) correction of the findings in the said opinion with respect to the amount of the deduction allowed by respondent for 1928 for replacement of leased properties; and762 (e) correction of the findings and modification of the opinion with respect to the cost of tie replacements on leased tracks and the quantum of the allowable deduction therefor for 1928. On March 15, 1935, respondent filed a motion for further hearing of the proceedings, for the purpose of (1) the introduction of additional evidence with respect to the issues of (a) the deduction in 1928 of cost of tie replacements on leased tracks, and (b) the deduction, 2 in each of the taxable years, of the liability of the Yazoo & Mississippi Valley Railroad Co. arising out of retirements of leased equipment; and (2) reconsideration of the opinion with respect to those issues. These motions were duly granted on September 25, 1934, and March 20, 1935, respectively, and a further hearing, limited to the matters set forth in the motions, was accorded the parties on May 15, 1935. Upon reconsideration of the entire record, we are now convinced that our earlier opinion is wrong in several respects and should be set aside. Accordingly, the following opinion is substituted for the earlier one promulgated on June 29, 1934. 763 Respondent determined deficiencies in petitioners' income taxes, of $27,088.88 for 1926, $84,611.39 for 1927, $46,663.09 for 1928, and $29,463.82 for 1929. In the original petitions, the petitioners alleged that the respondent's determination is erroneous as to each taxable year, in that he did not deduct from the income of the Yazoo & Mississippi Valley Railroad Co., the cost of making replacements of leased railroad properties which that company retired from service. In the amended petitions, which were filed to conform the pleadings with the Board's earlier opinion, the petitioners, while maintaining the allegations of error of the original petitions, further allege that the determination is erroneous, in that respondent did not deduct from the income of each year, the amount of the Yazoo & Mississippi Valley Railroad Co's. liability to replace leased properties which it retired within the year. The respondent claims increased deficiencies for all of the taxable years, on the ground that he erred in allowing certain deductions from the income of the Yazoo & Mississippi Valley Railroad Co., which deductions will be pointed out as they are considered. The parties submitted written764 stipulations embodying substantially all of the material facts, which are incorporated herein by reference. The proceedings were consolidated for hearing and decision. Petitioner Illinois Central Railroad Co. is an Illinois corporation, with its principal office at Chicago. It filed consolidated returns for the taxable years, which included the net income of, among others, petitioner Yazoo & Mississippi Valley Railroad Co. It is liable for any and all deficiencies, and is entitled to recover any overpayment for 1929 based upon the consolidated returns. On March 31, 1925, the Yazoo & Mississippi Valley Railroad Co., herein called the lessee, entered into separate agreements with the Alabama & Vicksburg Railway Co., and the Vicksburg, Shreveport & Pacific Railway Co., herein called the lessors, by the terms of which it leased the properties of the two last mentioned companies until July 1, 2282, with options to renew the leases for an additional period of 999 years. The lessee agreed that it would keep up, maintain, 3 repair, replace, and renew the leased properties during the terms of the leases, so that such properties would at all times be in substantially as good765 repair, working order, and condition as they were at the effective date of the lease agreements; and that, whenever during the terms of the leases any part of the leased properties, including rolling stock and equipment, should be damaged, destroyed, or otherwise become unfit for its appropriate use and purpose, it would cause the same to be repaired, renewed, rebuilt, or replaced by property of equal value. These covenants were to be performed at the lessee's sole cost and expense. The agreements also provided that the lessee should have the right to make such additions and extensions to, and betterments and improvements of, the leased properties as it deemed necessary, for which it was to be reimbursed by the lessors. The leases became effective on June 2, 1926, and the lessee took over the leased properties on that day. (a) In computing the lessee's net income, the respondent allowed deductions of $229,119.70 for 1926, $293,019.01 for 1927, $285,528.91 for 1928, and $232,102.40 for 1929, representing, in each instance, the lessors' cost, less salvage recovered, of properties retired and replaced by the lessee during the taxable year. Respondent urges that he erred in allowing766 these deductions and makes claim to any increased deficiencies that may result from the correction of his error. Petitioners concede that the lessee is not entitled to these deductions, because it was not the owner of, and had no capital investment in, the retired and replaced properties. We agree with this concession; it is in line with the authorities on the question. Duffy v. Central Railroad Co.,268 U.S. 55">268 U.S. 55; Weiss v. Wiener,279 U.S. 333">279 U.S. 333; Brevoort Hotel Co. v. Reinecke, 36 Fed.(2d) 51; Belt Railway Co. of Chicago,9 B.T.A. 304">9 B.T.A. 304; affd., 36 Fed.(2d) 541; certiorari denied, 281 U.S. 742">281 U.S. 742; and Michigan Central Railroad Co.,28 B.T.A. 437">28 B.T.A. 437. The respondent's action in allowing the deductions is reversed, and his claim to the resulting increased deficiencies is allowed. (b) The lessee expended $394,875.75 in 1926, $427,166.24 in 1927, $399,714.22 in 1928, and $320,032.73 in 1929, in replacing rail and other track materials on the leased roadways. Most, if not all, of the rail and other materials used in making the replacements were heavier than the rail and materials767 replaced, and, to that extent, the replacements were betterments or improvements. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $61,974.23 in 1926, $68,453.73 in 1927, $58,942.51 in 1928, and $50,672.52 in 1929, as the cost of the betterments or improvements. No part of the lessee's material expenditures in any of the taxable years has been allowed as a deduction by the respondent. 4 The labor costs incurred and borne by the lessee in making the above replacements were $32,439.33 for 1926, $41,492.71 for 1927, $27,615.87 for 1928, and $22,984.56 for 1929. One half of these labor costs were incurred in taking up the replaced rail and materials and one half in laying the replacements. These labor costs were allowed as deductions by the respondent, but he now asserts that he erred in this respect and makes claim to any increased deficiencies that may result from the correction of his error. There can be no doubt that these expenditures for both material and labor under the facts of this case, to the extent they were actually borne by the lessee, constitute ordinary and necessary expenses of its business and are deductible in768 computing taxable net income, unless the respondent shows that some portion thereof related to betterments and improvements. The burden of proof on this issue is on the respondent and he has failed to show what portion, if any, should be allocated to capital. The maintenance engineer of the petitioners testified that the replaced rail was from 12 to 18 years old and in poor condition; that the replacements were made in pursuance of the maintenance program adopted and followed by the Illinois Central, of which the lessee is a subsidiary line; and that such replacements were necessary to the proper upkeep and maintenance of the leased properties. There is nothing in the record to the contrary. The expenditures are ordinary in the business in which the lessee is engaged and they are necessary, because the lessee was required to make them in the performance of its covenants to keep up and maintain the properties. To the extent indicated, that is, to the extent that these expenditures for labor and material were borne by the lessee, the expenditures did not contain anything of a capital nature; the cost of all additions, betterments, and improvements was charged to and borne by the769 lessors. Obviously, the deductions must be limited to the lessee's burden of the expenditures; for the statute will not permit the deduction of amounts for which it was reimbursed, or to be reimbursed, by the lessors. New York, Chicago & St. Louis Railroad Co.,26 B.T.A. 1229">26 B.T.A. 1229, 1289, and cases therein cited. The respondent's claim that he erred in allowing the labor costs as deductions is disallowed. The lessee is entitled to deductions of $332,901.52 for 1926, $358,712.51 for 1927, $340,771.71 for 1928, and $269,360.21 for 1929, these being the expenditures actually borne by the lessee and not shown to have been of a capital nature, that is for improvements and betterments. (c) The lessee expended $65,500.82 in 1926, $50,321.05 in 1927, $181,115.43 in 1928, and $268,126.92 in 1929, in replacing 57, more or less, bridges and trestles on the leased roadways. Most, if not all, 5 of the replacements were improvements over the removed structures. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $27,904.76 in 1926, $40,916.79 in 1927, $128,773.23 in 1928, and $190,689.90 in 1929 as the costs of the betterments or improvements. 770 Also, the lessee expended $23,665.41 in 1926, $355,855.39 in 1927, $127,393.98 in 1928, and $152,971.38 in 1929, in replacing other parts of roadways and roadway structures, extending and rearranging existging trackage, constructing new facilities, installing tie plates, and otherwise making changes on the leased properties. Most, if not all, of these changes were betterments or improvements. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $20,974.38 in 1926, $282,126.57 in 1927, $106,155.71 in 1928, and $121,238.20 in 1929, as the costs of the betterments or improvements. The respondent did not deduct any part of these expenditures in computing the lessee's taxable net income. While expenditures for ordinary upkeep and maintenance, such as those for rail and other track material replacements referred to under (b), are proper deductions from income, the lessee may not deduct expenditures made primarily for adding to and improving the leased properties. Duffy v. Central Railroad Co., supra. The latter must be charged to capital and written off over the terms of the leases or the life of the property, whichever771 is shorter, by annual pro rata charges against income. As to all but three items covered by the expenditures here considered, the evidence is insufficient to enable us to determine whether or not they may be deducted from income, even to the extent that they were borne by the lessee. Petitioner's maintenance engineer, without stating his reasons therefor and apparently basing his opinion on the meager facts in the stipulation, expressed the opinion that all of the expenditures were necessary to the proper maintenance of the leased properties. If by that he meant that they were necessary in order to keep the properties in good repair and good running condition, and no more than that, the inaccuracy of his opinion is clearly disclosed by the stipulated facts. The depression and rearrangement of existing tracks, the construction of concrete subways where none existed before, the extension of yard leads, and the application of more than a hundred thousand additional tie plates to the roadways are clearly betterments or improvements and can not be ascribed categorically to that kind of upkeep and maintenance that may be deducted from income. Further, it is to be noted that some of772 the bridges and trestles replaced in the taxable years were constructed 6 or erected as late as 1917 and 1918, and, as to them, while we have been given no evidence as to the usual normal life of this type of structures, there obviously must be some doubt that their replacement was due to normal upkeep and maintenance and not to betterment or improvement of the leased properties. The three excepted items are $283.80 expended in 1926 for replacement of a worn-out cypress shingle roof on a section house; $36,174.22 expended in 1927 for replacing 17 miles of main track that had been washed out by flood conditions; and $6,470.90 for replacing 36,292 tie plates in 1928. These three items are proper deductions in computing the lessee's taxable net income. Deduction of all other expenditures here considered must be denied for lack of proof that they are ordinary and necessary expenses. (d) The respondent contends that the deductions allowed under (b) and (c) should be reduced by the amounts of salvage recovered in the taxable years from retired and replaced leased properties. We disagree with this. The lessors, being the owners of the retired and replaced properties, were773 likewise the owners of the materials salvaged therefrom and the proceeds of any sales of such materials, unless, by virtue of some provision of the lease agreements, the materials and proceeds were to belong to the lessee. We find no such provision in the lease agreements; and that it was the intent of the parties that materials salvaged from retired properties and the proceeds from the sale thereof should belong to the lessors, and not the lessee, is deducible from the fact that the lessee consistently credited its lessors, on its books of account, with the value of such salvaged materials and any proceeds from the sale thereof. (e) During the taxable years and 1930, the lessee retired 1,464 units of leased equipment, such as locomotives and freight train cars, having a depreciated book value as of June 2, 1926, as agreed upon by the lessee and lessors, of $1,157,752.92. These retirements took place as follows: 1926, 81 units valued at $72,785.86; 1927, 757 units valued at $497,295.33; 1928, 389 units valued at $356,371.48; 1929, 164 units valued at $161,026.82; and 1930, 73 units valued at $70,273.43. Under the lease agreements, the petitioner was required to replace these774 units with units of like values. As each equipment unit was retired, the lessee recorded its liability for replacement thereof on its books, in an amount equal to its depreciated book value at June 2, 1926, by a credit to the account of the lessor owning the unit. These retired units were replaced by the lessee with equipment furnished by the Illinois Central, as guarantor under the lease agreements, as follows: 577 units in 1929, and 29 units in 1930, a total of 606 units; but title thereto was not conveyed to the lessors at the times of replacement. The value of these replacement units on the petitioner's 7 books, which was cost less depreciation previously allowed, was $1,020,121.99, but for the purposes of the replacements, the lessee and lessors agreed upon values of $1,103,579.22 for the 1929 replacements, and $60,408.60 for the 1930 replacements, a total of $1,163,987.22. In August 1929, it was agreed that the lessee should convey to the lessors title to all such equipment replacements and to such other equipment as was necessary to replace all units of leased equipment that had been and would be retired up to December 31 of that year, in order that all such equipment775 might be brought immediately within the liens of the lessors' mortgages. By reason of the delay in agreeing upon the values and classes of replacement units that were to be conveyed to the lessors, the conveyances of titles were not formally made to the lessors until 1932. The accounting for the transfer of the replacement units was made on the books of the lessee and lessors in 1932. The expenditures represented by these replacements were not "ordinary and necessary expenses paid or incurred during the taxable [years] in carrying on any trade or business", within the meaning of section 214(a)(1) of the 1926 Act and section 23(a) of the 1928 Act, but were for permanent additions and betterments to the leased properties, such as would, if made by the owners of these properties, come within the provisions of section 215(a)(2) of the 1926 Act and section 24(a)(2) of the 1928 Act, "that no deduction shall in any case be allowed in respect of any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property." "They constituted, not upkeep, but investment; not maintenance or operating expenses, but capital, subject to annual*776 allowances for exhaustion or depreciation." Duffy v. Central Railroad Co., supra. The petitioners' contention that they are deductible, in computing the lessee's taxable net income, is, therefore, denied. (f) The last issue for consideration is respondent's alternative claim that he erred in deducting $74,774.05 from the lessee's income for 1929, for depreciation of the equipment replacement units conveyed to the lessors in 1932, and asking for an increased deficiency for 1929 on this account. He urges it only if the Board holds that the lessee is entitled to deduct from the income for 1929, the entire amount of its liability to the close of that year for replacement of leased equipment which it retired. We have already held that the lessee is not entitled to deduct the cost of its replacements of retired leased equipment. Consequently, respondent's alternative claim needs no further consideration. Reviewed by the Board. Judgment will be entered under Rule 50.Footnotes1. This decision was prepared during Mr. Trammell's term of office. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623212/	Vincent P. McKilligan v. Commissioner.McKilligan v. CommissionerDocket No. 6363-65.United States Tax CourtT.C. Memo 1968-211; 1968 Tax Ct. Memo LEXIS 90; 27 T.C.M. (CCH) 1045; T.C.M. (RIA) 68211; September 23, 1968, Filed 90 The petitioner, an unmarried individual, lived in California until July 1961. At that time, he began work on a job in Rochester, New York, that lasted until October 1962. Thereafter, he worked on a job in Utica, New York, that lasted from November 1962 until December 1963. During the 1046 first part of 1962, he paid some of the rent of his sister's apartment in California, and in September of that year, he purchased property at Unadilla, New York. Held: The petitioner's expenses for food and lodging inRochester and Utica during 1962 and 1963 were not deductible traveling expenses since the petitioner was not "away from home." Vincent P. McKilligan, pro se, R.D. 1, Unadilla, 91 N. Y. David H. Julian, for the respondent. SIMPSONMemorandum Findings of Fact and Opinion SIMPSON, Judge: The respondent determined a deficiency in the petitioner's income tax of $845.10 for the taxable year 1962 and $760.79 for the taxable year 1963. The issue for decision is whether certain expenses for food and lodging were incurred by the petitioner while "away from home" within the meaning of section 162(a)(2) of the Internal Revenue Code of 1954. 1 The petitioner also received, but did not include in gross income, allowances from his employer in 1962 as reimbursement for such food and lodging expenses. Findings of Fact Some of the facts were stipulated, and those facts are so found. The petitioner is an unmarried individual who filed Federal income tax returns for the calendar year 1962 with the district director of internal revenue, Syracuse, New York, and for the calendar year 1963 with the district director of internal revenue, Buffalo, New York. In 1943, the petitioner, at the age of 11, moved with his family to Unadilla, New York, where he lived for92 5 years before moving with his family to Kingston, New York. He graduated from high school in Kingston, and after completing military service, he joined his family, who were then in California. In 1956, the petitioner returned to Unadilla where he lived until 1958, when he again joined his family in California. From July 1959 to October 1959, the petitioner was employed as a draftsman by Admerco, Inc., in Sunland, California. From October 1959 to December 1960, the petitioner was employed by On Mark Engineering Co., Van Nuys, California. From January 1961 to June 1961, he was employed by Northrop Corp. in Van Nuys. The petitioner considered each of these three positions as "permanent" employment. In 1961, the petitioner decided to enter a more highly paid branch of his profession. Many contractors employ technical personnel, such as draftsmen and engineers, for particular projects, when the need is urgent and the project will not last indefinitely. The draftsmen who engage in this type of work are highly paid, but they must be willing to move from project to project and to go anywhere in this country or abroad. There are publications which inform them of such opportunities. 93 In July 1961, the petitioner was hired by the California branch office of Consultants and Designers, Inc., for assignment to a contract job for the Eastman Kodak Company. Such assignment was in Rochester, New York. While on such assignment, the petitioner received a per diem subsistence allowance from his employer that was not included in gross income on his 1962 return. The petitioner was told that the duration of the assignment was 3 months, but the term was extended several times until his employment in Rochester with Consultants and Designers, Inc., was terminated in October 1962. In November 1962, the petitioner was employed by Hamilton Research Associates for assignment to a contract at the Univac Division of Sperry Rand Corporation, Utica, New York. Although the petitioner first believed that the duration of this assignment would be several months, it continued until December 1963. He did not receive a subsistence allowance while working on this assignment. During the first 8 months of 1962, the petitioner paid half of the rent on his sister's apartment in California, where he stored several suitcases. On September 8, 1962, he purchased a "house" near Unadilla, New York. 94 This was a one-room structure with no electric, phone, water, or gas service and no indoor plumbing facilities. The house was about 700 feet from a hard surface road and could be reached only by means of a dirt road. In addition to the house, the petitioner kept a "camper" on the property in which he occasionally slept. 1047 The camper was supplied with gas and water. The petitioner spent some weekends and some time between the assignments in Rochester and Utica at the property. While there, he did some research on the development of an automobile starter. In addition to the amounts paid for the purchase of the property, his only expenses during the years 1962 and 1963 for the property were taxes and some unspecified amounts for repairs. Opinion The basic issue in this case is whether the petitioner's expenses for food and lodging while he worked in Rochester and Utica during 1962 and 1963 are deductible. He considers that his home was in California during the first part of 1962 and in Unadilla, New York, during the rest of 1962 and 1963. He argues that his assignments in Rochester and Utica were temporary and that he was away from home while working on such assignments. 95 Section 162(a) allows a deduction for the ordinary and necessary expenses of traveling while away from home. For traveling expenses to be deductible under this provision, the petitioner must show that such expenses were ordinary and necessary, that they were incurred while he was traveling away from home, and that they were incurred for a business purpose. Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465 (1946). In the case before us, the deductibility of the traveling expenses turns on whether the petitioner was away from home while working in Rochester and Utica. The petitioner apparently believes that his residence was in California and Unadilla during the years 1962 and 1963, but this Court has repeatedly held that the location of a taxpayer's tax home is not based upon his residence.. Ronald D. Kroll, 49 T.C. 557">49 T.C. 557 (1968). In that case, we said: This Court has long and consistently held that "home" as used in section 162 means the vicinity of the taxpayer's principal place of employment and not where his personal residence is located, if such residence is located in a different place from his principal place of employment. * * * But if a taxpayer has a principal96 place of employment in one location and accepts temporary work at another location, his presence at the second location is regarded as "away from home." * * However, if the taxpayer, having a principal place of employment in one location, accepts work at another location which is not temporary but is of indefinite or indeterminate period, his presence at the second location is not regarded as "away from home." * * * The purpose of the "away from home" provision is to mitigate the burden of the taxpayer who, because of the exigencies of his trade or business, must maintain two places of abode and thereby incur additional and duplicate living expenses. * * * [49 T.C. at 561] In James v. United States, 308 F. 2d 204 (C.A. 9, 1962), the court, in discussing the reasons for allowing a deduction for traveling expenses while away from home, concluded that the deduction is allowed because traveling expenses ordinarily exceed the expenses of living at home and because a taxpayer who is traveling in his business may have to incur duplicate living expenses. The court said that the deduction is allowed only when the taxpayer has a "home," the maintenance of97 which involves substantial continuing expenses which will be duplicated by the expenditures which the taxpayer must make when required to travel elsewhere for business purposes. [308 F. 2d at 207] When these tests are applied to the facts of this case, it is clear that the petitioner is not entitled to a deduction for his living expenses while working in Rochester and Utica. In the first place, the petitioner did not continue to have a principal place of employment in California after he left there in 1961; nor did he have a principal place of employment in Unadilla in 1962 and 1963. Howe A. Stidger 40 T.C. 896">40 T.C. 896 (1963), revd. 355 F. 2d 294 (C.A. 9, 1965), revd. 386 U.S. 287">386 U.S. 287 (1967); Leo M. Verner 39 T.C. 749">39 T.C. 749 (1963); Mort L. Bixler, 5 B.T.A. 1181">5 B.T.A. 1181 (1927). The evidence shows that when he left California in 1961, he began a new type of work. Under the new arrangement, he expected to move from one short-term employment to another, anywhere in or out of the United States. He then became a man on the move. Scotten v. Commissioner, 391 F. 2d 274 (C.A. 5, 1968), affg. per curiam 25 T. C.M. 1054, 35 P.-H. Memo. T.C. par. 66,206 (1966);98 Kenneth H. Hicks, 47 T.C. 71">47 T.C. 71 (1966). He did not expect to return to California in the foreseeable future, and he never acquired any principal place of employment in Unadilla during the years before us. The petitioner may have engaged in some productive work in Unadilla on the automobile starter, but such activity did not constitute his principal employment. Moreover, in view of the lack of services 1048 and remote location, the property appears to have been more suitable as a weekend retreat than as a full-time residence for one whose principal employment was in Unadilla. In addition, the petitioner has failed to furnish us with evidence as to the amount which he contributed toward the rent of his sister's apartment. We do not know whether it was a large or small apartment, or whether it was expensive or inexpensive. Also, we have not been told exactly what was spent on the Unadilla property. We do know that the only expenses were for taxes and some repairs. Despite the lack of specific information, it seems clear that the amounts spent by the petitioner for these purposes were not substantial and continuing. The evidence before us does not show a taxpayer who is*99 burdened with the expenses of maintaining both a permanent home and a temporary home. The petitioner's expenses for maintaining the Unadilla property were slight, and it would be a miscarriage of the law to allow them to constitute a basis for deducting his living expenses while working in Rochester and Utica. Thus, we hold that the petitioner has failed to prove that he had a permanent tax home which he was away from while working in Rochester and Utica. Since we have found that the petitioner was not away from home during 1962 and 1963, the subsistence allowances which he received in 1962 to cover his living expenses while working on the Rochester project are includable in his income. Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623213/	Marvin Dugro Buttles v. Commissioner.Buttles v. CommissionerDocket No. 3510-63.United States Tax CourtT.C. Memo 1964-236; 1964 Tax Ct. Memo LEXIS 103; 23 T.C.M. (CCH) 1420; T.C.M. (RIA) 64236; September 9, 1964Paul M. Bodner, for the petitioner. O'Hear W. Fraser, Jr., for the respondent. FORRESTERMemorandum Findings of Fact and Opinion FORRESTER, Judge: Respondent has determined a deficiency in petitioner's income tax for the calendar year 1954 in the amount of $4,384.42. Petitioner has conceded all but104 one of the adjustments to his return which were made by the statutory deficiency notice so that the sole issue now remaining before us is whether the petitioner is entitled to a claimed theft loss deduction of $5,000 under section 165(a) and (c)(3) of the Internal Revenue Code of 1954. 1Some of the facts have been stipulated and are so found. Marvin Dugro Buttles, hereinafter referred to as petitioner, filed his individual income tax return for the calendar year 1954, with the district director of internal revenue, Upper Manhattan, New York, New York. On such return, which was timely filed on April 15, 1955, petitioner claimed a theft loss deduction in the amount of $5,000 by attaching thereto a memorandum reading in pertinent part: Prior to Mr. Buttles105 departure for Europe on March 6, 1954, Mrs. Buttles [his mother] had given him as a gift a diamond brooch * * * [which] had been inherited through taxpayer's father's side of the family, and as elder son, taxpayer's mother felt that he should have the pin in the event of her death. * * * Since she gave the brooch to taxpayer, * * . When Mr. Buttles visited his mother's apartment after his return from Europe at the time of death, the apartment was in a considerable state of confusion. There were clothes strewn around, and one friend of the family located two gold bracelets lying under articles on the bedroom floor. Taxpayer suspected that things were not all as they should be and had a detective look into the matter, after he discovered that the aforementioned brooch that his mother had given him could not be located. Mr. Buttles had left it in safe-keeping with her while he was in Europe. Petitioner went to Europe on or about March 6, 1954, at which time the brooch was in the possession of his mother. She became seriously ill a short time later and was taken from her apartment in New York City to Doctors' Hospital on March 13 or 14 and died at the hospital on March 15, 1954. Petitioner106 returned from Europe later that same day and though a search was made the brooch could not be found. On March 20, 1954, a friend of petitioner reported the above circumstances to the police, and city detective, William J. Curnan, on that same day went to the mother's apartment and interviewed petitioner, who stated that his mother's pin, with a value of $2,500, had been lost. On September 27, 1955, petitioner, who was then serving as executor of his mother's estate, made an affidavit which was filed in Surrogate's Court in connection with the determination of the New York estate tax upon her estate and which affidavit also comprised a claim on petitioner's part against his mother's estate. Said affidavit reads in pertinent part: I make this affidavit to explain the consideration and other facts relating to a demand note of the decedent, dated August 18, 1951, in the face amount of $5,000, which is payable to me. This note was executed by the decedent to evidence her indebtedness to me in the amount of $5,000 for loans I had made to her and expenses I paid in her behalf during the period from 1941 to August 18, 1951. * * * Although the jewelry owned by my mother had a value107 in excess of $10,000, she was very fond of it and she was reluctant to sell it if this could be avoided. * * In 1951, it was agreed that the amount I had loaned to her, including the amount remaining unpaid on her note dated October 23, 1942, was in excess of $5,000. We agreed that a new note would be executed to evidence her indebtedness, which would be in the sum of $5,000, and that the old note would be cancelled. On August 18, 1951, my mother executed and delivered to me a demand note bearing that date in the sum of $5,000. A photostatic copy of this note is attached hereto. No part of the note dated August 18, 1951 was ever repaid by my mother prior to her death. My brother, Paul V. Buttles, who is entitled to the income from the entire residue of my mother's estate, has approved the payment by me as executor of the note dated August 18, 1951, as evidenced in an instrument executed by him on May 28, 1955, a photostatic copy of which is annexed hereto. On May 31, 1961, a revenue agent proposed to disallow petitioner's claimed theft loss deduction and petitioner made an affidavit in protest dated August 1, 1961, stating in pertinent part: The casualty loss of $5,000108 deducted in the return and disallowed by the Revenue Agent arose from the theft of a diamond brooch, the property of taxpayer, * . A rider setting forth the facts concerning the theft was attached to 1954 U.S. income tax return of taxpayer and is incorporated in this Protest by reference. It is to be noted that the diamond brooch was a gift to taxpayer by his mother Mrs. Nana H. Buttles prior to March 6, 1954. Mr. Buttles left on Mar. 6, 1954 for a vacation business trip to Europe and left the brooch with his mother at her apartment expecting to take possession of the brooch on his return. * * Petitioner did not appear as a witness at the trial of this case but his deposition, which was taken on March 18, 1964, and signed and sworn to by him on March 27, 1964, was offered jointly and received in evidence as Exhibit 3-C. Petitioner's version of the facts had undergone a drastic change by the time his deposition was taken. In answer to the question: "How did you acquire this brooch?" he replied: "My mother gave it to my [me] in lieu of a loan of $5,000 that I made to her." Later in the deposition petitioner was asked to describe the circumstances under which he obtained the109 brooch and replied: What do you mean obtained it? I had a note for $5,000 from my mother and she, so that I could have the brooch in lieu of it, she wanted me to have it anyhow, eventually, and I said I thought that was a fair deal, what was I going to do with it? I didn't want to keep it. She could use it. It made her happy and she liked it so much. Petitioner was then asked: Q. On what date did your mother give you the jewelry? and he replied: A. I can't answer that. I can tell you before, we will say, Christmas of '53, somewhere there. I don't know just how far before, I couldn't possibly remember, but it seems to me - there was no reason for me to remember them. Q. What did you mother give you the brooch for, Mr. Buttles? A. For the note, to reimburse for the note. Q. In other words, Mr. Buttles, is it that the jewelry was given to you in satisfaction of the note? A. That was the intent. In fact, I considered that she no longer owed me $5,000 when she told me that the brooch was mine. Q. Mr. Buttles, do you recall having told us, by way of a protest letter to the Appellate Division, as well as by way of a statement attached to your return, that this jewelry110 was a gift to you from your mother? A. I don't recall it, but if I did, then I probably didn't distinguish between a gift and a debt. That was, those things weren't important to me, I didn't think and if I said such a thing, it was due to a statement that was given to me to sign by my lawyers who have done all my legal work since 1939 and I think they are reputable people. * * Q. Mr. Buttles, it is your story then that this brooch was given to you by your mother in exchange for the satisfaction of a $5,000 note which she executed some time prior to 1954, is that correct? A. That's correct. Q. You did say earlier, however, that this was a gift to you by your mother? A. Well, it was originally intended as a gift. Q. Yes or no, Mr. Buttles. A. I don't remember, but it was originally intended to be a gift, eventually when she died or whenever, but then she decided that she would rather straighten it out with the $5,000 and get that off her chest. Q. She then, in fact, gave you the brooch in satisfaction of the note, is that correct? A. That's correct. At this point the petitioner's affidavit of September 27, 1955, which was filed in the Surrogate's Court was111 identified as Exhibit B and the questions and answers continued. Q. Mr. Buttles, I hand you Respondent's Exhibit B for identification and ask you if you can tell us what this is? A. It's about the note. Q. What is this document, Mr. Buttles? A. It's an affidavit. Q. Who is that affidavit signed by, Mr. Buttles? A. I signed it. Q. Did you say you signed it, Mr. Buttles? A. Yes, I did say I signed it. Q. Did you sign that affidavit under oath? A. Yes. Q. What is the date of that affidavit? A. September, 1955. Q. Did you say September? A. September of 1955. Q. What date? September the what? Could it be September 27th? A. Yes, I see it now. Q. September 27, 1955? A. That's right. The deposition was finally closed with the following question and answer: Q. Mr. Buttles, would you know the difference between paying off a note and a gift? A. I think so, yes. Petitioner's current contention that he obtained the brooch from his mother in payment for and satisfaction of her $5,000 note is substantiated only by his own testimony. He called Agnes McGovern, a long-time friend of his and his mother, as a witness, but we found her admissible testimony to112 be mainly confusing. It was in substance that Mrs. Buttles wore the brooch constantly; that she could not recall a period when it was not in her possession; that she had never seen the brooch in petitioner's possession; and that Mrs. Buttles always referred to the brooch as "Marvin's pin." It is fundamental that the threshold consideration for a claimed theft loss deduction under section 165(a) and (c)(3) (hereinbefore set out in footnote 1) is that the taxpayer be the owner of the purloined property. In New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, the Supreme Court said: Whether and to what extent deductions shall be allowed depends upon legislative grace; * Obviously, therefore, a taxpayer seeking a deduction must be able to point to an applicable statute and show that he comes within its terms. We have carefully considered the evidence of record and have quoted at length from exhibits and testimony which demonstrate the three successive positions taken by petitioner regarding ownership and his claimed acquisition of the diamond pin in question. His three positions have been: first, that it was his mother's pin; second, that she had given it to him; 113 and third, that she had "given" it to him in satisfaction of, and in payment for, her $5,000 note. We can speculate that petitioner's last change in position may have been prompted by the realization that if it were established that he had obtained the pin by gift from his mother that the amount of his deduction under section 165(b) of the Internal Revenue Code of 1954 would be the adjusted basis provided in section 1011, Internal Revenue Code of 1954, and might therefore be severely limited. See Jane U. Elliott, 40 T.C. 304">40 T.C. 304. Be that as it may, we are entirely unimpressed by petitioner's explanation that his various positions were due to statements given him to sign by his lawyers and that such things weren't important to him. It is our conclusion from the entire record that petitioner has not satisfied his burden of proving ownership of the missing diamond pin and we so hold. Even if we were to assume that petitioner's last position were the true one and that he had acquired the pin from his mother as in payment for her note, he would be no better off because it is evident from the last paragraph of his affidavit114 of September 27, 1955, which was filed in the Surrogate's Court and which is set out supra that nothing stood between him and collection of the note in full from his mother's estate. We would even be justified in assuming on the basis of the record before us that such payment was made, and this obviously brings the instant case within the ambit of George M. Still, Inc., 19 T.C. 1072">19 T.C. 1072, affirmed per curiam, 218 F. 2d 639 (C.A. 2). Decision will be entered for the 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 - * (3) losses of property * * if such losses arise from * * * theft. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623214/	PETER S. RUBIN AND GAIL A. RUBIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRubin v. CommissionerDocket No. 17490-86.United States Tax CourtT.C. Memo 1989-290; 1989 Tax Ct. Memo LEXIS 290; 57 T.C.M. (CCH) 706; T.C.M. (RIA) 89290; June 14, 1989. Peter S. Rubin, pro se. James C. Fee, Jr., for the respondent. WELLSMEMORANDUM FINDINGS OF FACT AND OPINION WELLS, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: Taxable YearDeficiency1981$ 2,627.6619823,121.6819832,632.0019841,008.00By motion to amend the answer to conform to the proof at trial, respondent seeks additional deficiencies in petitioners' Federal income taxes as follows: AdditionalTotal Original andTaxable YearDeficiencyAdditional Deficiency1981$ 395.00$ 3,022.661982291.003,412.6819834,257.916,889.9119845,040.256,048.25292 After concessions, the issues for decision are (1) whether petitioners' Amway products distributorship activity constituted a trade or business or an "activity not engaged in for profit" within the meaning of section 183(a), 1 and (2) whether respondent may amend his answer to seek increased deficiencies and, if so, whether there are increased deficiencies due from petitioners. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of fact and attached exhibits are incorporated herein by reference. Petitioners, Peter S. Rubin ("Mr. Rubin") and Gail A. Rubin ("Mrs. Rubin"), are husband and wife who resided in Cherry Hill, New Jersey, when their petition was filed. On their tax returns for the taxable years in issue, Mr. Rubin's occupation was reported as "sales" or "sales management," and Mrs. Rubin's occupation was reported as "real estate broker." Throughout all of taxable years 1981 and293 1982 and during part of taxable year 1983, Mr. Rubin was employed by various transportation equipment leasing companies. From May 1983 through February 1985, he was not employed full-time by any one of those companies, but he earned substantial brokerage fees and finders fees from Interstate Truck Sales. During that period, he also began installing security alarm systems. In February 1985, Mr. Rubin became a new and used car sales manager at Charles Oldsmobile. Mrs. Rubin maintained full-time employment as a broker for Maffucci Realty, Inc., during the years in issue. For each of the taxable years in issue, petitioners filed with their Federal income tax return a Schedule C bearing the name "GPR Associates." From taxable year 1981 through taxable year 1984, petitioners claimed losses from GPR Associates on the Schedules C as follows: Taxable YearLoss1981$ 8,276.0019827,595.0519838,588.0019843,204.00The "Main Business Activity" and "Product" spaces on the GPR Associates Schedule C for the taxable years in issue were filled in as follows: Taxable YearMain Business ActivityProduct1981DistributorAmway1982DistributorVaried-Amway1983Marketing and MotivationVaried1984Marketing and DistributionVaried294 Mrs. Rubin had become an Amway distributor in July 1981. Mr. Rubin became an Amway distributor in May or June of 1984. For the taxable years in issue, petitioners' combined gross incomes, excluding unemployment compensation, unearned income, and the Amway products distributorship activity, were as follows: Taxable Years1981198219831984Mr. RubinWages, Commissions, and Fees$ 31,082$ 27,909$ 28,101$ 6,647Mrs. RubinWages and Real EstateCommissions20,79624,09236,75858,972Total Earned Gross Income$ 51,878$ 52,001$ 64,859$ 65,619Mr. Rubin also collected unemployment compensation in the amounts of $ 5,116 and $ 1,414 during taxable years 1983 and 1984, respectively. For taxable years 1981 through 1984, petitioners' Amway products distributorship activity, distinguishing between alarm and non-alarm sales, is summarized as follows: Taxable Years1981198219831984ReceiptsRetail$ -0- $ 1,168 $ 1,419 $ 21,314 Downline3,004 6,018 5,584 13,259 Total Receipts$ 3,004 $ 7,186 $ 7,003 $ 34,573 Less: Cost of GoodsSold 4,410 9,693 9,026 31,247 Gross Profit (Loss)$ (1,406)$ ( 2,507)$ ( 2,023)$ 3,326 Less: Net Income fromAlarm InstallationSales-0- -0- -0- 2 5,249 Gross Profit (Loss)$ (1,406)$ ( 2,507)$ ( 2,023)$ ( 1,923)Plus: Commission Income181 1,102 1,027 3,570 Gross Income (Loss)$ (1,225)$ ( 1,405)$ ( 996)$ 1,647 Less: ExpensesAdvertising62 -0- -0- 367 Car and Truck678 777 5,395 6,805 Commissions2,686 304 46 1,455 Dues and Publications747 431 -0- 102 Office Supplies,Postage and Freight282 448 1,411 1,422 Travel andEntertainment1,108 2,071 6,685 5,088 Meeting Room andChairs53 -0- -0- -0- Meeting Fees,Seminars, Rallies104 -0- 1,119 843 Utilities and Telephone-0- 596 1,086 600 Home Office and Storage1,331 1,563 1,717 -0- Bank Charges-0- -0- -0- 64 Total Expenses$ 7,051 $ 6,190 2 $ 17,459 2 $ 16,746 Net Loss$ (8,276)$ ( 7,595)2 $ (18,455)$ (15,099) Cost of Goods Sold:Purchases$ 5,274 $ 12,116 $ 12,035 $ 21,882 Plus alarm parts-0- -0- -0- 15,666 Total Purchases5,274 12,116 12,035 37,548 Less: Personal Use864 2,423 3,009 3,181 Closing Inventory-0- -0- -0- 3,120 Cost of Goods Sold$ 4,410 $ 9,693 $ 9,026 $ 31,247 295 Petitioners maintained no ledgers in connection with their Amway product distributorship activity during the taxable years in issue. At the end of each of the years in issue, petitioners merely added the amounts of their checks, invoices, receipts, and Amway order forms for purposes of reporting income and expenses on the Schedule C of their tax return. Petitioners' expenditures for their Amway products distributorship activity were made from their personal checking accounts until 1984, when they opened a separate checking account for such expenditures. Petitioners maintained diaries showing the names of individuals with whom petitioners shared the Amway sales and marketing plan. Petitioners' diaries generally, however, do not include entries which reflect the time, place, or business purpose of any meetings with or entertainment of individuals named in the diaries. Furthermore, the diaries do not reflect the business relationship of any of those individuals to petitioners. Petitioners deducted $ 2,686296 for cash payments made to their children during 1981, and reflected those amounts as "commissions" on their GPR Associates Schedule C for 1981. Petitioners maintained no records in support of that deduction. Petitioners claimed deductions on their Schedules C for telephone expenses. Petitioners computed their telephone expenses by subtracting the basic monthly charge for telephone service from their telephone bill and claiming the balance as a deduction. Petitioners made no further computations to account for long distance charges relating to any personal usage. Petitioners claimed deductions for storage and a home office on their Schedules C for the years in issue. The amounts claimed by petitioners represent the expenses associated with one room, or approximately one-eighth, of their personal residence during the years in issue. Petitioners claimed travel and entertainment deductions for the cost paid for numerous meals during the taxable years in issue. Such expenditures included the cost of food when Mr. Rubin dined alone in local restaurants and fast food establishments. During taxable years 1981 through 1983 and part of taxable year 1984, petitioners maintained little297 or no inventory of Amway products, but they did maintain Amway pamphlets and tapes. Petitioners made no written projections for profit, loss, or break-even with regard to the Amway products distributorship activity during the taxable years in issue. Petitioners measured their profit potential by the number of individuals recruited as distributors. Petitioners often gave complimentary Amway products to individuals with whom they discussed Amway, but they kept no record of the items given away or to whom they were given. Petitioners sponsored 13 individuals who became Amway distributors from 1981 through the date of trial. Promotional literature provided to prospective Amway distributors states that an individual does not need special skills to engage in an Amway products distributorship activity and that a distributor could achieve financial independence in two to five years. In addition, Mr. Rubin told prospective distributors that it takes ten to fifteen hours per week over a three to five year period to become successful in an Amway products distribution activity. The Amway promotional literature claims that distributors potentially could save $ 1,500 or $ 2,000 per year298 on items used personally. Amway distributors are able to purchase products from their "up-line distributors" with an average discount of about 30 percent from the suggested retail price. Gross income for Amway distributors is based on retail sales and performance bonuses. Points leading to performance bonuses are based on both retail sales and personal consumption of the Amway products. During the years in issue, petitioners sold $ 2,988 of Amway non-alarm products at retail and used $ 9,477 of Amway products for personal use. According to surveys performed for Amway, the average monthly gross income (retail margin plus performance bonus) for "active" distributors was $ 67 for the period surveyed February 1980 through January 1981, and $ 76 for the period surveyed May 1984 through April 1985. An "active" Amway distributor is defined in those surveys as one who has paid his annual $ 15 renewal fee and attempted to make a retail sale, presented the Sales and Marketing Plan, received bonus money, or attended a company or distributorship meeting in the month surveyed. During the periods of those surveys, 38 to 40 percent of all Amway distributors were defined as "active." Respondent299 filed a motion subsequent to the trial of the instant case to amend his answer to conform to the proof. Respondent's motion states that he was misled by petitioner's presentation of all income and expenses from three separate activities in one combined GPR Associates Schedule C for taxable years 1983 and 1984. Respondent asserts that such a presentation led to the erroneous disallowance of only the net combined losses of the three activities, instead of disallowance of the loss from each unprofitable activity without offset for the amount of profits from each profitable activity. Respondent also alleges that the notices of deficiency for taxable years 1981 and 1982 erroneously disallowed only the expenses portion of petitioners' net Schedule C losses for those years, without disallowing the excess of cost of goods sold over gross receipts. Accordingly, respondent asserts that the full amount of the claimed losses for the years 1981 through 1984 ($ 8,276.00, $ 7,595.05, $ 18,555.00, and $ 15,099.00, respectively) should be disallowed under section 183. OPINION Respondent contends that section 183 disallows all deductions attributable to petitioners' Amway products distributorship300 activity. Section 183(a) supplies the general rule which disallows all deductions attributable to activities "not engaged in for profit." Section 183(b)(1) then allows those deductions otherwise allowable regardless of profit motive, e.g., interest and State and local taxes. In addition, section 183(b)(2) allows those deductions which would have been allowable had the activity been engaged in for profit, but only to the extent that gross income from the activity exceeds the deductions allowable under section 183(b)(1). Respondent argues that petitioners' Amway products distributorship activity was "not engaged in for profit" and that, therefore, deductions taken by petitioners for taxable years 1981 through 1984 which are attributable to that activity must be disallowed to the extent they exceed gross income from the activity. Petitioners contend that they commenced and continued their Amway products distributorship activity with the requisite profit objective. Thus, petitioners argue, section 183 is inapplicable, and the deductions attributable to that activity are fully deductible. 301 We must decide whether section 183 applies to petitioners' Amway products distributorship activity. Section 183(c) defines an "activity not engaged in for profit" as "any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212." Thus, section 183 does not apply if petitioners' Amway products distributorship activity gives rise to deductions under section 162 or under section 212(1) or (2). Deductions are permitted under those sections if an activity is commenced and continued with the "actual and honest objective of making a profit." Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983); Engdahl v. Commissioner,72 T.C. 659">72 T.C. 659, 666 (1979); Golanty v. Commissioner,72 T.C. 411">72 T.C. 411, 426-427 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981); Brannen v. Commissioner,78 T.C. 471">78 T.C. 471, 501 (1982), affd. 722 F.2d 695">722 F.2d 695 (11th Cir. 1984).302 Petitioners need not, however, establish that they had a "reasonable" expectation of profit. Sec. 1.183-2(a), Income Tax Regs.; Dreicer v. Commissioner, supra at 644-645. Whether petitioners had the requisite intent is an issue of fact to be resolved on the basis of all of the facts and circumstances. Sec. 1.183-2(b), Income Tax Regs.; Elliott v. Commissioner,84 T.C. 227">84 T.C. 227, 236 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986); Dreicer v. Commissioner, supra at 645. In making our determination, we give greater weight to objective factors than to petitioners' statements of intent. Sec. 1.183-2(a), Income Tax Regs.; Dreicer v. Commissioner, supra at 645. Petitioners bear the burden of proof. Rule 142(a); Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). Giving due regard to the aforementioned precepts, we conclude that petitioners have failed to prove that they possessed the requisite profit objective. Therefore, section 183 applies to the deductions at issue. 303 Section 1.183-2(b), Income Tax Regs., contains a nonexclusive list of nine factors, derived from case law, to be considered in determining whether an activity is engaged in for profit. Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 33 (1979); Benz v. Commissioner,63 T.C. 375">63 T.C. 375, 382-383 (1974). The factors are: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. No single factor is determinative, and all facts and circumstances, including factors not listed, are to be considered. Sec. 1.183-2(b), Income Tax Regs.304 ; Abramson v. Commissioner,86 T.C. 360">86 T.C. 360, 371 (1986). The expertise of petitioners and their advisors is a factor in deciding whether profit objective is present. Sec. 1.183-2(b)(2), Income Tax Regs. Mr. Rubin testified that petitioners tried to build their business in conformity with Amway's recommendations and the instruction provided by their up-line sponsors. Petitioners, however, did not offer any evidence to show what kind of advice was provided to petitioners. The Amway literature claims that financial independence can be obtained within two to five years. Yet, there is no indication that petitioners sought advice to determine why they fell short of those expectations. Petitioners were experienced sales persons, and we normally might consider such expertise a factor in petitioners' favor. Mr. Rubin, however, testified that such skills are actually detrimental to a successful Amway products distributorship. In either event, we do not consider petitioners' other sales expertise as a significant factor in our decision. We also consider the time and effort expended by petitioners in carrying on the activity. Sec. 1.183-2(b)(3), Income Tax Regs.305 Petitioners spent substantial amounts and took substantial deductions for entertainment, which suggests that much of their personal time was devoted to the Amway products distributorship activity. Mr. Rubin testified that he spent three to four nights a week in pursuit of the activity. Like the taxpayers in Elliott v. Commissioner,90 T.C. 960">90 T.C. 960, 973 (1988), however, petitioners have made no showing that their activities extended beyond maintenance of an active social schedule. The financial status of petitioners is also relevant. Sec. 1.183-2(b)(8). Petitioners assert that because they held positions which afforded them the opportunity to claim tax deductions other than those claimed in connection with the Amway products distributorship activity, they did not need to use the Amway activity for additional tax deductions. We disagree. The record in the instant case does not convince us that petitioners used Amway as a medium other than to claim tax deductions for personal expenditures made for their home, social engagements, travel, and payments to their children. Further, petitioners offered no evidence that any assets used in the activity were expected to306 appreciate ( section 1.183-2(b)(4), Income Tax Regs.), that they successfully had carried on similar activities in the past ( section 1.183-2(b)(5), Income Tax Regs.), or that they had a history of profits ( section 1.183-2(b)(6), Income Tax Regs.). Another factor listed in the regulations is the element of personal pleasure or recreation involved in the activity. Sec. 1.183-2(b)(9). Respondent contends that petitioners' Amway products distributorship activity was motivated by the opportunity to purchase consumer goods at sizable discounts as well as the ability to claim tax deductions for personal expenses. In response, petitioners rely on the testimony of their witnesses, De Monso Waters and Armand Bagatta. 3 Although Mr. Waters and Mr. Bagatta testified that they became involved with Amway to make money, their testimony lends little support to petitioners' arguments. To the contrary, both witnesses acknowledge the personal benefits gained from Amway product distributorship activities. Mr. Bagatta explained that distributors receive a 30 percent discount on products consumed in their own household, 307 referring to this discount as the "immediate gross profit." Mr. Waters testified that in addition to being able to supply his home with the discounted Amway products, he also gained friends and a "family type of unity" through Amway. We further note that, during the taxable years in issue, petitioners' personal usage of Amway products was more than three times the level of their retail sales of such products. Considering petitioners' personal usage of Amway products, along with their substantial entertainment deductions and the testimony of Mr. Waters and Mr. Bagatta, we are not convinced that petitioners' Amway products distributorship activity provided merely incidental elements of recreation and other personal pleasure and benefit. The manner in which petitioners carried on their Amway products distributorship activity ( sec. 1.183-2(b)(1), Income Tax Regs.), however, is the most telling indication that they were not engaged in the activity with the requisite profit objective. 308 The regulations cite complete and accurate recordkeeping as indicative of an activity engaged in for profit. Sec. 1.183-2(b)(1), Income Tax Regs. In Elliott v. Commissioner, supra, a recent opinion deciding that the taxpayers did not engage in an Amway products distributorship activity with the intent to make a profit, we focused on the unbusinesslike manner in which the taxpayers' activity was conducted. Of particular concern was the "cursory and sloppy fashion" in which the taxpayers kept their records. Elliott v. Commissioner, supra at 971-972. In the instant case, petitioners' records consisted primarily of cancelled checks from their personal checking account, loose invoices, credit card receipts, Amway order forms, and entries in diaries, none of which ever was recorded in ledgers. Those documents were summarized only at the end of each year for the purpose of transcribing the information onto petitioners' tax return for that taxable year. During the taxable years at issue, petitioners kept no record of how much product was sold, 309 given away, or used personally. Moreover, petitioners had no summaries or reports to evaluate the success or failure of their efforts during the year. Although Mr. Rubin testified that he had numerous meetings with prospective customers or distributors, petitioners kept no written account of the nature and results of their meetings, the strategies and sales methods used during these meetings, or whether any methods implemented had been successful. Petitioners' diaries contain little more than names of individuals whose association with petitioners generally cannot be determined from the evidence contained in the record. Further, petitioners offered no corroborating evidence that would show the purpose and nature of the numerous out-of-town seminars which they attended. As an excuse for the manner in which their Amway products distributorship activity was conducted, petitioners assert that they lacked the necessary knowledge during the early years of their distributorship activity. They argue that as their experience progressed over the years, they kept better records. While we accept that petitioners lacked knowledge of Amway procedures when they first became involved with310 Amway, we do not believe they lacked the level of business sophistication necessary to keep proper records. Because petitioners were experienced salespersons when they first entered into the Amway products distributorship activity, we decline to accept petitioners' excuse. Their experience with their other businesses should have taught petitioners the importance of recordkeeping. The regulations also state that "a change of operating methods * * * or abandonment of unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit motive." Sec. 1.183-2(b)(1), Income Tax Regs. Petitioners argue that they changed their operating methods as they went forward with the activity. However, the only indication of that sort is the opening in 1984 of a checking account in the name of GPR Associates. We do not believe that opening a checking account is the sort of activity to which the regulation provision refers when it speaks of "a change of operating methods * * * or abandonment of unprofitable methods." By taxable year 1984, 311 petitioners' activity still had not produced a profit. In short, we agree with respondent that "petitioners maintained records in much the same fashion as that described by the Court as 'cursory and sloppy' in Elliott v. Commissioner, supra." The thin line between the business and personal elements of petitioners' Amway products distributorship activity causes us to require more concerned and detailed recordkeeping than that evinced by petitioners before we will find that the manner in which the activity was carried on is satisfactory. If petitioners truly had been concerned about making a profit, we think they would have kept records better suited to allowing them to evaluate the success of their Amway products distributorship activity. 4 See Elliott v. Commissioner,90 T.C. at 972. Based upon the foregoing, we find that petitioners have failed to prove that their Amway products distribution activity was entered into with the requisite objective of making a profit. We hold that petitioners therefore are liable for the deficiencies determined by respondent in the notices of deficiency. 312 We next must decide whether respondent may amend his answer in the instant case to seek increased deficiencies. Respondent first raised the issue of the increased deficiencies in his motion to amend the answer to conform to the proof at trial. Respondent contends that petitioners, on their tax returns, offset the deductions from their Amway product distributorship activity against substantial other income not related to that activity. Respondent argues that he has raised no new theory of liability in the instant case, but merely seeks additional deficiencies from petitioners because income allegedly unrelated to the Amway products distributorship activity was combined with and erroneously offset by deductions from the Amway products distributorship activity that otherwise would not be allowable under section 183. In response to respondent's motion, petitioners argue that they would be prejudiced if respondent were allowed to amend his answer after the trial because they would not have the opportunity to offer evidence on the issue of whether the income shown and deductions taken on the Schedules C were related to not just one, but a number of activities. Respondent replies313 that there is no element of surprise with respect to the amendment because much of the evidence upon which he relies in his motion is contained in the stipulation of facts, which was "the product of conferences between the parties." We do not agree with respondent's argument. It is evident that respondent possessed the evidence prior to trial, given his assertion that the stipulations upon which he now relies were the product of pre-trial conferences between the parties. We believe that the proper time for respondent to have moved to amend the answer was before the trial. Inasmuch as respondent's trial memorandum and opening statement make no mention of the additional deficiencies, it is clear that he did not raise the matter before trial, even though the evidence upon which respondent relies was in his possession. Respondent also relies on Rule 41(b) which provides that when issues not previously raised are tried with the express or implied consent of the parties, the pleadings may be amended to conform to the evidence. We can find no indication, however, of any "consent" on petitioners' 314 part, other than the fact that some, but not all, of the evidence necessary to decide the issue of the additional deficiencies was presented at trial. Respondent, represented by counsel, and petitioners, pro se, each submitted a trial memorandum in which the issue of the additional deficiencies was not raised. It therefore is clear to us that petitioners did not consent to the raising of the issue of the additional deficiencies. The record is devoid of any facts which would lead us to conclude that petitioners had any knowledge of respondent's contentions that some of the income reported on the GPR Associates Schedules C was unrelated to the deductions taken on those schedules. The contentions raised in respondent's motion appear by all accounts to be a new theory, despite respondent's opposite characterization. Because petitioners were not given notice of respondent's new theory, they were denied the opportunity to prepare their case for trial on that theory. We conclude that to allow respondent's amendment would prejudice petitioners and violate fundamental fairness. Markwardt v. Commissioner,64 T.C. 989">64 T.C. 989, 997-998 (1975); Ross Glove Co. v. Commissioner,60 T.C. 569">60 T.C. 569, 595 (1973).315 See also Estate of Mandels v. Commissioner,64 T.C. 61">64 T.C. 61, 73 (1975). Respondent's motion to amend his answer therefore will be denied. An appropriate order will be issued, and a decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section and Code references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩. Includes $ 20,914 of alarm installation sales. ↩2. We have corrected these figures for obvious addition and transposition errors in the tax returns or stipulation.↩3. Mr. Waters did not become associated with Mr. Rubin until after the taxable years in issue. Mr. Bagatta did not become an Amway distributor until taxable year 1984.↩4. See Mulvaney v. Commissioner,T.C. Memo. 1988-243↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623218/	Lorenz Bros. Inc. v. Commissioner.Lorenz Bros. v. CommissionerDocket No. 6426.United States Tax Court1946 Tax Ct. Memo LEXIS 167; 5 T.C.M. (CCH) 567; T.C.M. (RIA) 46142; June 13, 1946Clarence Bradford, Esq., 932 Buhl Bldg., Detroit 26, Mich., for the petitioner. A. J. Friedman, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: Respondent determined deficiencies in petitioner's tax liability as follows: DeclaredIncomeValue ExcessExcessYearTaxProfits TaxProfits Tax1940$ 938.09$647.0219411,843.95202.43$2,790.8519421,410.1357.37The questions for our decision are: (1) whether respondent correctly disallowed certain amounts as deductions by petitioner on the ground that such amounts constituted excessive compensation to its officers during the taxable years, and (2) whether respondent correctly computed petitioner's equity invested capital. Petitioner filed its168 returns with the collector of internal revenue for the district of Michigan at Detroit. The record consists of a stipulation of facts, exhibits and testimony adduced at the hearing. The facts as stipulated are so found. Other facts have been found from the exhibits and testimony. Findings of Fact Petitioner, a Michigan corporation, was organized in 1923 and during the taxable years here involved was primarily engaged in the automobile sales and servicing business in Lansing, Michigan. In 1923 petitioner's capital stock consisted of 5,595 shares of common stock with a par value of $10 each and 2,350 shares of preferred stock with a par value of $10 each. In 1933 petitioner's capital structure was modified, which involved a write-down of the preferred and common stock and also of stockholders' indebtedness. After 1933 and during the taxable years here involved, petitioner's outstanding capital stock consisted of 1,008 shares of common stock having a par value of $10 each. During the taxable years all this outstanding stock was owned by two brothers and their wives, Harold T. and Ruth Lorenz owning 501 1/2 shares and Rolland K. and Viola Lorenz owning 506 1/2 shares. Petitioner's169 business activities consisted primarily of selling Buick automobiles as an authorized dealer, buying and selling secondhand cars, and servicing and repairing all makes of automobiles. Harold T. Lorenz was petitioner's president and sales manager. During the taxable years he employed and supervised for petitioner from four to six salesmen, who devoted their time to selling new Buicks. Harold also employed for petitioner two to three salesmen who were engaged in buying and selling secondhand cars. In addition to supervising this sales force, Harold also acted as salesman, appraised secondhand cars and closed transactions which the salesmen brought to petitioner. Harold had no vacation during the taxable years. In 1940 petitioner sold 150 new and 300 used cars. In 1941 it sold 325 new cars and 400 old ones. In 1942 it sold 125 new cars with a proportionate drop in the sales of old cars. The reduced sales in 1942 were largely the result of wartime restrictions. Sometime in 1942 petitioner undertook the selling and servicing of certain agricultural machinery to take up the slack in automobile sales. Petitioner's activity with respect to these agricultural machines consisted predominantly170 of servicing and repairs. Rolland K. Lorenz, Harold's brother, was petitioner's secretary-treasurer and general service manager. He was in charge of maintaining petitioner's buildings which consisted of a 2-story building at the corner of Kalamazoo and River Streets and a parking lot and 1-story building across the road from the 2-story building on River Street. Rolland was also in charge of servicing the new cars sold by petitioner and reconditioning secondhand cars for sale. He employed and supervised, on behalf of petitioner, some 22 to 30 repairmen and mechanics. He was in charge of operating a truck service for petitioner which consisted of hauling machinery. Petitioner represented the American Automobile Association which involved keeping three or four men on the job 24 hours a day, 7 days a week. Rolland was in charge of this activity also. Harold and Rolland each received a salary of $7,500 in 1940 and $9,000 for each of the years 1941 and 1942. In addition to these fixed salaries Harold and Rolland received a total bonus of $6,472.37 in 1940, $10,935.45 in 1941 and $5,373.95 in 1942. This bonus was shared equally by Harold and Rolland in each of these years. On January 27, 1940, petitioner's171 board of directors voted Harold and Rolland each a salary of $500 a month plus a bonus. On June 28, 1940, the board of directors voted to increase these salaries to $750 a month for the last six months of that year plus a bonus. On January 20, 1941 and January 19, 1942, the board of directors voted each brother a salary of $750 a month plus bonus for each of those years. The minutes of the board of directors' meeting held on January 20, 1941, are typical of the other minutes relating to the salaries and bonuses under discussion and are in pertinent part as follows: The matter of salaries for the officers of the company was brought up by R. K. Lorenz. It was moved by Carl Reynolds that the salaries for the year 1941 be as follows: H. T. Lorenz and R. K. Lorenz shall receive (750.00) seven hundred and fifty dollars per month each, plus a bonus of 25% each payable on December 31, 1941, applicable to that portion of net profits in excess of 10% on the outstanding capital stock of the company. Motion seconded by H. T. Lorenz. Motion carried. The following is a schedule of the net sales, net income after salaries were paid, officers' salaries and percentage of salaries to sales, as shown172 by the books of petitioner: Officers'Per CentYearSalesNet IncomeSalariesto Sales1936$ 331,315.03$ 4,109.84$ 12,866.673.883%1937388,681.623,097.1116,129.104.1491938281,532.14431.0610,440.003.7081939354,159.883,551.5514,621.564.1281940553,512.457,480.3721,472.373,8791941653,068.6111,946.6528,935.454.4301942248,453.146,381.9523,373.959.407$2,810,722.87$36,998.53$127,839.10The column headed "Officers' Salaries" represents the total combined salaries and bonuses of Harold and Rolland of which they each received one-half. The capital and surplus at the close of each of the taxable years 1940, 1941 and 1942, as shown on petitioner's tax returns, was $37,647.08, $46,108.10 and $50,866.92, respectively. No dividends were paid by petitioner during the years here involved and there is no record of dividends paid in any year subsequent to the reorganization in 1933. Petitioner deducted as a business expense $21,472.37 in 1940, $28,935.45 in 1941 and $23,373.95 in 1942, which amounts represent the salaries and bonuses paid to Harold and Rolland in those years. Respondent173 allowed as a deduction the fixed salaries but disallowed as a deduction the bonuses paid Harold and Rolland. In the notice of deficiency respondent explained the disallowance of the bonuses for 1940, which is typical of the explanation for the other two years, as follows: You claimed a deduction for compensation paid to your officers of $15,000.00 under line 15 of the return and an additional deduction of $6,472.32 paid to your officers included in the item "salaries and wages" deducted on line 16 of the return. The payment of $6,472.32 represents a bonus of 25% of the net profit of the business in excess of 10% of the outstanding capital stock of your corporation. The amounts paid were divided equally between Harold T. Lorenz, president, and Rolland K. Lorenz, secretary and treasurer. Of the deduction claimed the amount of $6,472.32 is considered excessive compensation within the purview of Section 23(a) of the Internal Revenue Code and hence has been disallowed. Reasonable compensation for the services rendered to petitioner by Harold and Rolland was $7,500 each in 1940 and $9,000 in 1941 and 1942. Opinion Respondent contends that the bonuses paid174 by petitioner to Harold and Rolland during the taxable years constituted excessive compensation and disallowed them as deductions on this ground. Petitioner argues that these bonuses were reasonable compensation and are deductible as such under section 23 (a), Internal Revenue Code. 1 We agree with respondent that the compensation paid by petitioner to its officers during the taxable years was excessive in amount to the extent of the bonuses in question. In our opinion the bonus payments do not appear to bear a realistic relationship to the actual value of the services rendered by Harold and Rolland. Harold was in charge of the sales activities of petitioner and Rolland was in charge of servicing, repairs and miscellaneous activities. There is no175 indication that the activities over which each exercised supervision contributed equally to petitioner's income. On the contrary, the record indicates that the income from sales were quite considerable in 1940 and 1941 but dropped sharply in 1942 due to wartime restrictions. The record further indicates that in 1942 petitioner undertook the selling and servicing of certain agricultural machinery to take up the slack in automobile sales and that petitioner's activities with respect to these agricultural machines consisted predominantly of servicing and repairs. Consequently it would appear that sales accounted largely for petitioner's income in certain years where as the repair work and miscellaneous activities largely accounted for such income in other years. The equality of the bonuses granted by petitioner therefor would seem inconsistent with any intention to compensate on the basis of the value of the services rendered. Nor can the bonus payments be justified as reasonable compensation on the theory that they created incentive. Since Harold and Rolland with their wives were owners of all the outstanding stock of petitioner they would benefit from any increase in petitioner's income176 in any event. There is also lacking in the instant case any element of an arm's length bargaining between petitioner and its officers with respect to compensation. The record does not disclose who the directors of petitioner were but it is clear that Harold and Rolland were as a practical matter in complete control. Consequently, they fixed the amount of their own compensation. It was advantageous to petitioner taxwise to distribute as much of its profits as possible as compensation rather than as dividends. Also, to so distribute its profits was obviously economically advantageous to the two Lorenz families who owned all of petitioner's outstanding stock. It is significant in this connection that there is no indication in the record that petitioner paid any dividends subsequent to its reorganization in 1933. While the bonus arrangement might be considered fair as between the officers and in a sense not unfair to petitioner, petitioner must nonetheless properly account for its income for tax purposes. See Helvering v. Superior Wines & Liquors, Inc., 134 Fed. (2d) 373, and Am-Plus Storage Battery Co. v. Commissioner, 35 Fed. (2d) 167. The method adopted177 to compute the bonus payments further indicates, in our opinion, that the bonuses had no relation to reasonable compensation but were essentially a means of distributing profits. The bonuses were based on percentages of net income in excess of 10 per cent of the outstanding capital stock. Thus, the bonuses resulted from petitioner's income from all sources and were in no way proportionate to income created by the individual activities of either Harold or Rolland. Under this formula the bonuses would necessarily increase or decrease as petitioner's net income increased or decreased. It is conceivable that petitioner's income might substantially increase without necessarily involving any increased efforts on the part of its officers. It is not improbable, for instance, that the large sales in 1940 and 1941 resulted from economic conditions prevailing at that time rather than upon increased sales efforts on the part of petitioner's officers. Thus, it is apparent that the bonus formula in practical effect equally divided profits without regard to the value of services rendered. See Botany Worsted Mills v. United States, 278 U.S. 282">278 U.S. 282; Twin City Tile & Marble Co. v. Commissioner, 32 Fed. (2d) 229;178 Am-Plus Storage Battery Co. v. Commissioner, supra; General Water Heater Corp. v. Commissioner, 42 Fed. (2d) 419; Samuel Heath Co. v. United States, 2 Fed. Supp. 637. Harold's and Rolland's fixed salaries were increased by $250 a month in July 1940. If Harold's and Rolland's activities on behalf of petitioner were greater during the taxable years than in former years, it has not been shown to our satisfaction that this increase in fixed salaries did not adequately compensate therefor. From the record before us it is impossible to contrast their activities during the taxable years with their activities prior thereto. Nor is there any satisfactory evidence comparing the compensation received by Harold and Rolland with compensation paid similar officers by comparable businesses. Under all these circumstances we hold that the bonus payments in question constituted excessive compensation and were correctly disallowed by respondent as a deduction under section 23 (a). The pleadings raised a further question involving the proper computation of petitioner's equity invested capital. In this connection petitioner introduced an exhibit representing179 its computation of equity invested capital. Respondent conceded that this exhibit correctly reflects the figures recorded in petitioner's books and had no objection to its being received in evidence for that purpose. Except for this exhibit there is nothing in the record and no further explanation in petitioner's brief which would enable us to consider the merits of the question raised. Respondent, on brief, pointed out that petitioner had failed to present this issue in a manner enabling consideration on the merits. Petitioner, in its reply brief, did not deny, explain, or otherwise discuss this point. The method of respondent's computation is in accordance with the statutory provisions and pertinent regulations and in the absence of any evidence upon which to base any substantive inquiry, we hold such computation correct. Decision will be entered for respondent. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: (a) Expenses. - (1) Trade or Business Expenses. - (A) In General. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623219/	J. A. Tobin Construction Company, Petitioner v. Commissioner of Internal Revenue, RespondentJ. A. Tobin Constr. Co. v. CommissionerDocket No. 10063-82United States Tax Court85 T.C. 1005; 1985 U.S. Tax Ct. LEXIS 7; 85 T.C. No. 58; December 18, 1985, Filed 7 Decision will be entered under Rule 155. The availability of loss carryforwards and loss carrybacks of members of an affiliated group to offset separate income of other members of the affiliated group determined. Respondent's adjustment under sec. 482, I.R.C. 1954, for imputed interest income rejected. Richard S. Managhan and Ernest M. Fleischer, for the petitioner.Alan V. Jacobson, for the respondent. Swift, Judge. SWIFT1005 Respondent determined a deficiency in petitioner's Federal income tax liability for the year 1975 in the amount of $ 306,958.67. The parties have reached a partial settlement and the remaining issues for the Court to decide concern the loss carryback and loss carryforward rules of the consolidated return regulations and the validity of certain adjustments made under section 4821 for imputed interest income.Although the tax deficiency involved herein pertains only to the Federal corporate income tax liability of J.A. Tobin Construction Co., Inc. (Tobin Construction) for 1975, the issues in this case arise out of certain corporate 8 reorganizations involving Tobin Construction and three affiliated corporations which occurred in 1975, 1976, and 1977, and the extent to 1006 which loss carrybacks and loss carryforwards of the affiliated corporations are available to reduce Tobin Construction's taxable income for 1975. Similarly, our decision on the section 482 issue, which directly involves 1977 and 1978, will affect the amount of net operating losses that will be available as a carryback to offset Tobin Construction's 1975 taxable income.FINDINGS OF FACTSome of the facts were stipulated and are so found.Tobin Construction timely filed its Federal corporate income tax return for 1975. Tobin Construction was a Missouri corporation doing business in Kansas and Missouri at the time it filed its petition herein. Its corporate headquarters were located in Kansas City, Kansas.Tobin Construction was formed in 1928 as a closely held, family owned construction company. In 1974 and for a number of years prior thereto, Joseph Tobin (Joseph) and his sister Patricia A. O'Rourke (Patricia) each owned 50 percent of the stock of Tobin Construction.Rosedale Development Co., Inc. (Rosedale) also was a construction and real estate 9 development company owned by members of the Tobin family. Rosedale was incorporated on May 2, 1924, and in 1974 the stock of Rosedale was owned 30 percent by Patricia and 70 percent by her mother, Mrs. F.M. Tobin.In 1975, Patricia initiated negotiations with Joseph concerning the ownership and operations of Tobin Construction that might lead to her children's becoming involved with the management of the company. As a result of the negotiations, Joseph agreed to sell his entire stock interest in Tobin Construction to a corporation wholly owned by Patricia.To accomplish her indirect acquisition of Joseph's stock in Tobin Construction, Patricia, on the advice of her attorneys, utilized a corporation by the name of Three Central United, Inc. (Three Central). On December 9, 1975, Patricia exchanged her 50-percent stock interest in Tobin Construction for all of the common stock of Three Central. On the same day, Three Central purchased all of Joseph's stock in Tobin Construction for $ 2.9 million in cash. As a result of those two transactions, Patricia became the sole shareholder of Three Central, and Three Central became the sole shareholder and parent of 1007 Tobin Construction. On December 10 17, 1975, the name of Three Central was changed to O'Rourke Bros.The corporate history of Three Central (i.e., O'Rourke Bros.) prior to its utilization to acquire the stock of Tobin Construction is important in this case. Prior to late 1975, Three Central had been a "shelf" corporation. It was incorporated by a Kansas City law firm on July 15, 1974, as a Missouri corporation. Members of the law firm were designated as the shareholders, officers, and directors of Three Central solely to comply with Missouri corporation law. No business was conducted by Three Central, and its corporate status simply was maintained by the law firm in good standing until and if a client of the law firm needed a new corporate vehicle for the transaction of business being handled by the law firm. Three Central had conducted no economic activity and had total assets of $ 1.As mentioned, in December of 1975, Three Central was utilized by Patricia to acquire all of her stock and all of Joseph's stock in Tobin Construction. To make Three Central a suitable corporate vehicle for the acquisition of Tobin Construction, a number of changes were necessary in its corporate structure shortly prior to the contemplated 11 stock acquisition. On November 19, 1975, Three Central applied to the State of Missouri to change its name to O'Rourke Bros, Inc. It opened a bank account and applied for a bank loan of $ 2.9 million in order to fund the purchase of Joseph's stock in Tobin Construction.On November 28, 1975, the three outstanding shares of common stock of Three Central were redeemed, and 100 shares of common stock were issued to Patricia in exchange for all of her stock in Tobin Construction. A new board of directors was elected, and Patricia and members of her family were elected to the board. Patricia also was elected president and treasurer of the corporation. As mentioned, the name of Three Central was changed to O'Rourke Bros., Inc. (O'Rourke), on December 17, 1975.On December 31, 1975, O'Rourke declared a stock dividend pursuant to which Patricia received 4 shares of common stock for each share she owned. Thus, on December 31, 1975, Patricia was the sole shareholder of O'Rourke with 500 shares 1008 of its common stock, and O'Rourke was the sole shareholder of Tobin Construction.On March 9, 1976, there was filed on behalf of O'Rourke and Tobin Construction a joint application for an automatic 12 extension of time to file a consolidated Federal corporate income tax return for 1975. On June 14, 1976, however, there was filed on behalf of O'Rourke and Tobin Construction, separate Federal corporate income tax returns for 1975. On Tobin Construction's 1975 return, the statement was made that, "Taxpayer and its parent subsequently decided against filing a consolidated Federal income tax return for 1975." That decision apparently was made because petitioner's representatives thought that the filing of a consolidated return for 1975 would have required the preparation of a separate return for Tobin Construction for the period January 1, 1975, to December 8, 1975, due to the acquisition of Tobin Construction on December 9, 1975. Since O'Rourke realized a net operating loss for 1975 of only $ 13,918, which could be carried forward to 1976, the representatives of O'Rourke and Tobin Construction decided against filing a consolidated return for 1975.On its 1975 separate corporate Federal income tax return, Tobin Construction reflected taxable income of $ 1,869,307. Rosedale, on its 1975 separate corporate Federal income tax return, reflected a net operating loss of $ 171,730.In 1976, 13 O'Rourke acquired ownership of two additional corporations, P.M. Divide Mining Co. (Divide) and Rosedale. Divide was incorporated on June 3, 1976, as a Missouri corporation to engage in a coal mining venture. On June 27, 1976, O'Rourke acquired all 125 shares of the common stock of Divide for the total amount of $ 125.On December 31, 1976, O'Rourke acquired all of the stock of Rosedale by exchanging 81 shares of the common stock of O'Rourke for all of the outstanding shares of Rosedale owned by Patricia and by exchanging 13,000 shares of preferred stock of Rosedale for all of the outstanding stock of Rosedale owned by Mrs. F.M. Tobin.For 1976, Tobin Construction, O'Rourke, and Divide filed a consolidated Federal corporate income tax return and reflected thereon the following separate income and loss figures and consolidated taxable income as indicated: 1009 1976Taxable income or lossTobin Construction$ 1,564,588 O'Rourke(244,003)Divide0 1976 Consolidated taxable income1,320,585 Rosedale filed a separate Federal corporate income tax return for 1976, reflecting a taxable income of $ 79,929.For 1977 and 1978, Tobin Construction, O'Rourke, Divide, and Rosedale filed consolidated Federal 14 corporate income tax returns reflecting the following separate income and loss figures and consolidated net operating losses:19771978Taxable incomeTaxable incomeor lossor lossTobin Construction($ 256,431)($ 923,729)O'Rourke(195,891)(200,660)Divide(107,220)(78)Rosedale20,581 14,785 Consolidated net operating losses(538,961)(1,109,682)The consolidated net operating losses, as reported on the consolidated Federal corporate income tax returns filed by Tobin Construction, O'Rourke, Divide, and Rosedale for 1977 and 1978, were carried back to the separate return of Tobin Construction for 1975 and to the consolidated return of Tobin Construction, O'Rourke, and Divide for 1976 as follows:Carrybacks of NOLs Claimed on the Consolidated1977 and 1978 Federal Income Tax ReturnsNOLsCARRIED BACK TO:1975 Separate1976 Consolidated return1977 Consolidated1978 Consolidatedreturn ofof Tobin Construction,NOL carrybackNOL carrybackTobin ConstructionO'Rourke and Divide$ 538,961($ 254,260)($ 284,701)2 $ 1,109,681(917,773) (191,908) Rosedale claimed 15 a net operating loss of $ 171,730 on its separate Federal corporate income tax return for 1975. That net operating loss for 1975 was carried forward by Rosedale to 1010 its separate return for 1976 and to the separate taxable income of Rosedale for 1977 as reflected on the 1977 consolidated Federal income tax return of Tobin Construction, O'Rourke, Divide, and Rosedale as follows:NOLCARRIED FORWARD TO:Separate income of Rosedaleon 1977 consolidated return1976 Separateof Tobin Construction,1975 Separate NOLreturn ofO'Rourke, Divide,of RosedaleRosedaleand Rosedale($ 171,730)$ 79,929$ 91,801During the years 1975, 1976, 1977, and 1978, Tobin Construction transferred funds to O'Rourke on a monthly basis which funds O'Rourke used to pay operating expenses and to make payments on the $ 2.9-million bank loan that O'Rourke had obtained to purchase Joseph's stock in Tobin Construction. The transfers to O'Rourke were reflected on Tobin Construction's books and financial statements as loans to O'Rourke.O'Rourke made no repayment of any of the funds transferred to it by Tobin Construction except that two tax refunds (that apparently were attributable to O'Rourke's losses as reflected on the consolidated 16 returns) were treated on the intercompany books as payments to Tobin Construction in partial repayment by O'Rourke of some of the funds O'Rourke had received from Tobin Construction. Typically, the balance of the receivable account on Tobin Construction's books with respect to funds it had transferred to O'Rourke was reduced by the declaration of cash dividends by Tobin Construction in favor of O'Rourke. No actual payment of dividends occurred. In order to fulfill its obligation to pay dividends declared, Tobin Construction simply would debit its dividends payable account reflecting dividends owed to O'Rourke and credit its receivable account reflecting amounts that previously had been transferred to O'Rourke and that had been accounted for by Tobin Construction as loans to O'Rourke.Reflected below are the amount of funds transferred each year in this manner by Tobin Construction to O'Rourke, the tax refunds attributable to O'Rourke that were treated as having been transferred by O'Rourke to Tobin Construction, the cash dividends declared each year by Tobin Construction 1011 (which were used to reduce the receivable account of O'Rourke in favor of Tobin Construction), and the balance 17 at the end of each year of the funds transferred by Tobin Construction to O'Rourke:Tax refundsdebited toYearendFundsTobinDividendsbalance oftransferredConstructiondeclaredfunds transferred1975not in the record1976$ 872,274$ 122,0000$ 750,2741977612,0930$ 750,000612,367 1978579,93372,500600,000519,800 The funds transferred by Tobin Construction to O'Rourke were not evidenced by written promissory notes. No interest was due on the funds. No repayment or maturity dates were fixed. In a footnote to petitioner's financial statements during the years in issue, the following statement was made with respect to the funds transferred:Tobin Construction is a wholly-owned subsidiary of O'Rourke which has required cash advances from Tobin Construction in order to fund certain operations and service its debt. Such advances are shown in the balance sheet as a receivable due from the parent. Further advances may be required in the future for these purposes. It is Tobin Construction's intention to declare cash dividends during [the years in question] to the parent, if the parent is unable to meet its obligations.OPINIONCarryback of O'Rourke's Portion of the 1977 and 1978 Consolidated NOLs 18 to Tobin Construction's 1975 Separate ReturnPetitioner seeks to carry back the portion of the consolidated net operating losses for 1977 and 1978 attributable to O'Rourke to offset Tobin Construction's 1975 taxable income. Petitioner asserts that even though a consolidated return was not filed for 1975 by Tobin Construction and O'Rourke, it was intended for those two companies to file a consolidated return, and they failed to do so only because of a mistake of law or fact, or inadvertence. Under any of those circumstances, petitioner contends that a consolidated return will be deemed 1012 to have been filed for 1975 by Tobin Construction and O'Rourke. Petitioner cites section 1.1502-75(b)(3), Income Tax Regs., as authority. In the alternative, petitioner contends that O'Rourke was a member of the consolidated group "immediately after its organization" and that therefore, under section 1.1502-79(a)(2), Income Tax Regs., O'Rourke's net operating losses from 1977 and 1978 can be carried back to separate return years of other members of the consolidated group.Respondent disagrees with petitioner's arguments primarily on factual grounds. Respondent contends that petitioner's failure to join 19 in the filing of a consolidated return with O'Rourke for 1975 was intentional and was not due to a mistake of law or fact, or inadvertence. With regard to petitioner's alternative argument, respondent contends that O'Rourke was not a member of the consolidated group immediately after its organization and that since O'Rourke filed a separate return for 1975, its net operating losses for 1977 and 1978 cannot be carried back to Tobin Construction's 1975 separate return year. For the reasons explained below, we agree with respondent on both arguments.With regard to petitioner's first argument, section 1.1502-75(b)(3), Income Tax Regs., does provide that where the failure to join in the filing of a consolidated return is due to a mistake of law or fact, or inadvertence, a consolidated return will be deemed to have been filed. 321 Petitioner asserts that its accountants were under the misapprehension that the acquisition by Patricia of O'Rourke and the acquisition by O'Rourke of Tobin Construction did not qualify as a reverse acquisition. Had the accountants realized that the reorganization did qualify as a reverse acquisition, petitioner argues that a consolidated return would have been 20 filed under the authority of section 1.1502-75(d), Income Tax Regs. This argument fails because even if the acquisition of O'Rourke did not qualify as a 1013 reverse acquisition, a consolidated return still could have been filed by Tobin Construction and O'Rourke for part of 1975 under the consolidated return rules. See secs. 1501 and 1502 and the regulations thereunder. Thus, any mistake as to whether the acquisition qualified as a reverse acquisition was not a reason for not filing a consolidated return for at least part of 1975.Petitioner argues that a mistake of fact occurred that was responsible for a consolidated return not being filed. The only mistake of fact that occurred was the failure of petitioner's representatives to predict more accurately the future income and loss picture of the consolidated group. Errors in tax planning with respect to subsequent years' earnings and profits and tax liabilities arising therefrom surely do not rise to the level of a mistake of fact as contemplated by section 1.1502-75(b)(3), Income Tax Regs. See Grynberg v. Commissioner, 83 T.C. 255">83 T.C. 255, 262-263 (1984); Estate of Stamos v. Commissioner, 55 T.C. 468">55 T.C. 468, 474 (1970).Petitioner also argues that the failure to file a consolidated return for 1975 was due to inadvertence. The testimony in this case is quite clear that petitioner's representatives considered filing a consolidated return for 1975 but affirmatively chose not to do so. The separate return for O'Rourke for 1975 was filed consciously and intentionally, and without inadvertence.Although not entirely clear from petitioner's briefs, petitioner also apparently argues that 22 a mistake of law occurred due to the failure of petitioner's representatives to realize that under section 1.1502-75(d), Income Tax Regs., Tobin Construction and O'Rourke could have filed a consolidated return for the entire 12 months of 1975 which, petitioner contends, would have been done if the representatives had realized that the acquisition of O'Rourke and its acquisition of the stock of Tobin Construction qualified as a reverse acquisition. To the extent petitioner does make that argument, it also must be rejected. Even if a mistake of fact or law, or inadvertence occurred, by its express terms the relief provision of section 1.1502-75(b)(3), Income Tax Regs., applies only to the situation where a consolidated return is filed by some members of the consolidated group (for the year for which relief is sought -- namely, 1975 herein) and where the mistake causes one or more of the other members of the group to fail to join in the 1014 consolidated return that was filed. See Lion Associates, Inc. v. United States, 515 F. Supp. 550">515 F. Supp. 550 (E.D. Pa. 1981). Here, no consolidated return was filed by any member of the consolidated group for any portion of 1975, and section 1.1502-75(b)(3), Income Tax Regs., 23 is not applicable.Petitioner makes the alternative argument that if O'Rourke is not deemed to have filed a consolidated return with Tobin Construction for 1975 under section 1.1502-75(b)(3), Income Tax Regs., the portion of the 1977 and 1978 consolidated net operating losses attributable to O'Rourke can be carried back to Tobin Construction's separate return for 1975 under the authority of section 1.1502-79(a)(2), Income Tax Regs. That regulation provides, among other things, that the portion of a consolidated net operating loss attributable to a particular corporation will be allowed as a carryback to a separate return of another member of the affiliated group if the corporation to whom the net operating loss in question is attributable was not yet organized in the separate return year in question and if that corporation became a member of the group immediately after its organization. 425 As part of its argument, petitioner asserts that during the period from July 15, 1974, to December 9, 1975, O'Rourke was an inactive "shelf" corporation and that O'Rourke should not be considered to have been in existence during that period. Also, petitioner cites section 1.1502-76(b)(5), Income Tax Regs., 24 and argues that any period of time less than 30 days (namely, the 23 days from December 9, 1975, through December 31, 1975) may be ignored for purposes of the consolidated return regulations. 5 Based on the 1015 above arguments, petitioner asserts that O'Rourke should not be considered to have been organized and in existence until January 1, 1976, by which date it had become a part of the affiliated group. If correct, that argument would allow O'Rourke to carry back its portion of the 1977 and 1978 consolidated net operating losses to the 1975 separate return year of Tobin Construction.Again, we must reject petitioner's argument. An inactive corporation is considered to be in existence for purposes of section 1.1502-79(a)(2), Income Tax Regs., from the date of its incorporation. Braswell Motor Freight Lines, Inc. v. United States, 26 an unreported case ( N.D. Tex. 1972, 30 AFTR 2d 72-5608, 72-2 USTC par. 9675), affd. 477 F.2d 594">477 F.2d 594 (5th Cir. 1973), cert. denied 414 U.S. 1143">414 U.S. 1143 (1974). 6 Thus, O'Rourke (under its prior name of Three Central United) is considered to have been in existence from July 15, 1974. Because it was not a member of the affiliated group immediately after its organization, the portion of the 1977 and 1978 consolidated net operating losses attributable to O'Rourke cannot be carried back to the separate return of Tobin Construction for 1975. With regard to petitioner's argument that the 23 days in December of 1975, during which O'Rourke was active, can be disregarded, we note that section 1.1502-76(b)(5), Income Tax Regs., expressly applies only to days that occur during a year for which a consolidated return 27 is filed. Since Tobin Construction and O'Rourke filed separate returns for 1975, petitioner's reliance on that regulation is misplaced.The facts of Electronic Sensing Products, Inc. v. Commissioner, 69 T.C. 276">69 T.C. 276 (1977), are very similar to the facts of this case on this issue. A subsidiary was organized on October 6, 1972. The parent corporation and the subsidiary filed separate returns for their taxable periods ended October 31, 1972. Because the subsidiary was in existence in 1972 and because it filed a separate return for its short taxable year ended October 31, 1972, the portion of the consolidated net operating losses in 1016 a subsequent year that was attributable to the subsidiary could not be carried back to the separate return of the parent corporation ended October 31, 1972. Electronic Sensing Products, Inc. v. Commissioner, supra at 282-283; see also sec. 1.1502-79(a)(4), example (1), Income Tax Regs.; Jim Burch & Associates, Inc. v. Commissioner, 76 T.C. 202 (1981). The fact that O'Rourke existed in 1975 and filed a separate return for 1975 is fatal to petitioner's argument that section 1.1502-79(a)(2), Income Tax Regs., authorizes the portion of the 1977 and 1978 consolidated 28 net operating losses attributable to O'Rourke to be carried back to Tobin Construction's separate return for 1975.The Carryback of Divide's Portion of the 1977 and 1978 Consolidated NOLs to Tobin Construction's 1975 Separate ReturnSince Divide was a member of the affiliated group immediately after its organization in 1976, petitioner argues that Divide's portion of the 1977 and 1978 consolidated net operating losses can be carried back to Tobin Construction's 1975 separate return.As we have previously discussed, section 1.1502-79(a)(2), Income Tax Regs., provides, among other things, that if a loss member of an affiliated group was a member of the group immediately after its organization, the portion of a consolidated net operating loss attributable to that member can be carried back to a separate return of other members of the group. The regulation, however, is silent as to which member of the affiliated group is entitled to the carryback in the separate return year.Petitioner asserts that Divide's portion of the 1977 and 1978 consolidated net operating losses should be carried back to Tobin Construction's 1975 separate return. Tobin Construction is, of course, a sister corporation 29 of Divide. Respondent counters that Divide's portion of that consolidated net operating loss only can be carried back against O'Rourke's 1975 separate return. O'Rourke, of course, is the parent of Divide.There is limited authority discussing this issue. In Rev. Rul. 74-610, 2 C.B. 288">1974-2 C.B. 288, respondent states that the portion of a consolidated net operating loss attributable to a second tier subsidiary should be carried back to the separate return of the 1017 immediate parent corporation, not to the separate return of the common parent. The rationale for that holding was that the assets of the second tier subsidiary (i.e., the loss member) previously had been owned by the immediate parent corporation and but for the formation of the second tier subsidiary, the immediate parent (i.e., the first tier subsidiary) would have sustained the losses in the consolidated return year and the losses would have been carried back to the separate return of the immediate parent.References to this issue in 8A J. Mertens, Law of Federal Income Taxation, sec. 46.104, at 131 (1985 rev.), and in J. Crestol, K. Hennessey & A. Rua, Consolidated Tax Return, par. 5.02 (iv), at 5-51 (3d ed. 1980), state that 30 the immediate parent corporation will be allowed the carryback loss and no reference is made to a "but-for" test. In F. Peel, Consolidated Tax Returns, sec. 9:06, at 9-30 (3d ed. 1984), it is stated that ordinarily the carryback will be to the separate return year of the immediate parent corporation and the further explanation is given that --The principle that has developed is that the carryback is to the member that would have sustained the loss if the loss subsidiary had not been incorporated.Petitioner argues that Tobin Construction, not O'Rourke, funded the operations and the acquisition of Divide and that, but for the existence of Divide, Tobin Construction would have incurred the net operating losses Divide incurred in 1977 and 1978. Petitioner therefore argues that those losses should be carried back to the 1975 separate return of Tobin Construction.It is our opinion that in most situations involving this issue, a subsidiary corporation's portion of a consolidated net operating loss should be carried back to the separate return of the subsidiary's immediate parent corporation. We will not attempt to describe potential exceptions to that rule for we are not faced with an 31 exception here. Although O'Rourke did receive some funds from Tobin Construction that were lent by O'Rourke to Divide, that fact does not establish an adequate basis to allocate the loss carryback in question to the 1975 separate return of Tobin Construction. O'Rourke was a viable corporate entity that was formed for valid business purposes. 1018 It formed a new corporation (namely, Divide). It acquired two corporations (namely, Tobin Construction and Rosedale), and it filed a separate tax return for 1975. On the facts presented to us, there is no basis to allow a carryback of Divide's portion of the 1977 and 1978 consolidated net operating losses to the 1975 separate return of Tobin Construction.The Carryforward of Rosedale's 1975 Separate Return Loss To Reduce Its Separate Taxable Income in 1977Petitioner seeks to carry forward a loss of $ 91,801 from Rosedale's 1975 separate return to Rosedale's 1977 separate taxable income computation, thereby increasing the 1977 consolidated net operating loss that is available as a carryback to the 1975 separate return of Tobin Construction. Section 1.1502-21(c)(2), Income Tax Regs., allows a carryforward of a loss from a separate return 32 limitation year (i.e., Rosedale's 1975 separate return year) to a consolidated return year where, among other things, there exists consolidated net taxable income in the carryforward year before the loss carryforward in question is applied. That regulation provides as follows:(c) Limitation on net operating loss carryovers and carrybacks from separate return limitation years --* * * (2) Computation of limitation. The amount referred to in subparagraph (1) of this paragraph with respect to a member of the group is the excess, if any, of --(i) Consolidated taxable income (computed without regard to the consolidated net operating loss deduction), minus such consolidated taxable income recomputed by excluding the items of income and deduction of such member, over(ii) The net operating losses attributable to such member which may be carried to the consolidated return year arising in taxable years ending prior to the particular separate return limitation year.Section 1.1502-21(c), Income Tax Regs., was promulgated under the specific authority of section 1502. Furthermore, the regulation has been upheld by each court that has considered its validity or its application. See Wolter Construction Co. v. Commissioner, 68 T.C. 39">68 T.C. 39, 48 (1977), 33 affd. 634 F.2d 1029">634 F.2d 1029 (6th 1019 Cir. 1980). Addressing the predecessor regulation in Foster v. Commissioner, T.C. Memo. 1966-273, remanded on another issue sub nom. Likins-Foster Honolulu Corp. v. Commissioner, 417 F.2d 285">417 F.2d 285 (10th Cir. 1969), cert. denied 397 U.S. 987">397 U.S. 987 (1970), we rejected the same argument made herein and stated that --Unless there is consolidated net income prior to the use of any net operating loss carryover, there is no income of the consolidated group against which to apply a carryover and therefore no reason for application of a carryover. * * [25 TCM 1390, at 1413, 35 P-H Memo T.C. par. 66,273, at 66-1581.]See also Phinney v. Houston Oil Field Material Co., 252 F.2d 357">252 F.2d 357 (5th Cir. 1958); Likins-Foster Honolulu Corp. v. Commissioner, supra.For the reasons set forth above, Rosedale cannot carry forward its 1975 net operating loss of $ 91,801 to reduce its 1977 separate taxable income computation.Imputed Interest Income Adjustment Under Section 482In his statutory notice of deficiency for 1977 and 1978, respondent determined that the funds transferred by Tobin Construction to O'Rourke constituted loans, not corporate distributions. Since Tobin Construction had not 34 charged O'Rourke interest on the loans, under the authority of section 482, respondent imputed interest income in the amount of $ 69,303 for 1977 and $ 53,697 for 1978 to Tobin Construction with respect to the funds that respondent determined had been loaned to O'Rourke. Imputed interest expenses in the same amounts were allowed to O'Rourke for 1977 and 1978, as correlative adjustments required under section 1.482-1(d)(2), Income Tax Regs.The imputed interest income was computed on the average balances throughout 1977 and 1978 of the funds transferred from Tobin Construction to O'Rourke. The interest rate used was 7 percent. Respondent's imputed interest income adjustments resulted in additional income of $ 990,044 and $ 767,101 being charged to Tobin Construction for 1977 and 1978.Respondent relies primarily on section 1.482-2(a)(1), Income Tax Regs., which provides as follows:Sec. 1.482-2. Determination of taxable income in specific situations. --1020 (a) Loans or advances -- (1) In general. Where one member of a group of controlled entities makes a loan or advance directly or indirectly to, or otherwise becomes a creditor of, another member of such group, and charges no interest, 35 or charges interest at a rate which is not equal to an arm's length rate as defined in subparagraph (2) of this paragraph, the district director may make appropriate allocations to reflect an arm's length interest rate for the use of such loan or advance.Petitioner argues that the above regulation applies only to valid indebtedness and not to payments between related entities that, for accounting purposes only, were reflected on the books of the related entities as loans, but that, in substance, were corporate distributions. Petitioner cites section 1.482-2(a)(3), Income Tax Regs., which provides as follows:(3) Loans or advances to which subparagraph (1) applies. Subparagraph (1) of this paragraph applies to all forms of bona fide indebtedness and includes:(i) Loans or advances of money or other consideration (whether or not evidenced by a written instrument), and(ii) Indebtedness arising in the ordinary course of business out of sales, leases, or the rendition of services by or between members of the group, or any other similar extension of credit.Subparagraph (1) of this paragraph does not apply to alleged indebtedness which was in fact a contribution of capital or a distribution 36 by a corporation with respect to its shares. * * [Emphasis added.]Petitioner and respondent each cite numerous cases in support of their respective characterizations of the funds transferred as loans or corporate distributions.In the typical case involving the characterization of funds transferred between related entities as loans or distributions, the positions of the parties are reversed from what they are herein. Taxpayers typically seek to treat the funds as loans and respondent seeks to treat the funds as dividend distributions. 7 Herein, however, petitioner is seeking distribution treatment for the funds transferred, and respondent is seeking loan treatment therefor in order to support his adjustment for imputed interest income under section 482.1021 Section 48237 adjustments made by respondent carry with them a heavy presumption of correctness and petitioner has the burden of proof as to the character of the funds transferred to O'Rourke. Commissioner v. Transport Mfg. & Equip. Co., 478 F.2d 731">478 F.2d 731, 734-736 (8th Cir. 1973), affg. Riss v. Commissioner, 56 T.C. 388">56 T.C. 388 (1971), and 57 T.C. 469 (1971) (supplemental opinion); Foster v. Commissioner, 80 T.C. 34">80 T.C. 34, 142-144 (1983), affd. on this issue 756 F.2d 1430">756 F.2d 1430 (9th Cir. 1985).We also note that a taxpayer generally is not allowed to argue that the substance of a transaction was other than the form he chose. The substance-over-form argument is always available to respondent, but it is available to taxpayers only on a limited basis. The rationale has been stated as follows:As a general rule, the government may indeed bind a taxpayer to the form in which he has factually cast a transaction. The rule exists because to permit a taxpayer at will to challenge his own forms in favor of what he subsequently asserts to be true "substance" would encourage post-transactional tax-planning and unwarranted litigation on the part of many taxpayers and raise a monumental administrative burden and substantial problems 38 of proof on the part of the government. [Citations omitted.]In re Steen v. United States, 509 F.2d 1398">509 F.2d 1398, 1402-1403 n. 4 (9th Cir. 1975). That rule, however, is not absolute, 8 and section 1.482-2(a)(3), Income Tax Regs., previously cited herein, states that interest income adjustments under section 482 are not to be made by respondent where the underlying transaction was not a bona fide loan. The regulation places no express restriction on a taxpayer's (as distinguished from respondent's) ability to challenge the bona fide nature of the loan and nothing in the regulation suggests that only respondent can make that argument. Furthermore, in this case, respondent does not argue that petitioner, as a matter of law, is held to the form of the transaction. We also note that although certain aspects (namely, the accounting entries) of the transfers in question took the form of loans, 39 other aspects of the transfers do not support a finding that the form of the transfers was that of a loan. In other 1022 words, both the form and substance of the transfers in question are in dispute.On the facts of this case, it is appropriate to consider all of the facts and circumstances pertinent to the transfers in order to decide whether these transfers, in substance, were loans or corporate distributions to petitioner's sole shareholder. That is a factual issue and depends primarily upon the good-faith intention of the shareholder to repay the amounts received and the intention of the corporation to require repayment. Williams v. Commissioner, 627 F.2d 1032">627 F.2d 1032, 1034 (10th Cir. 1980), affg. a Memorandum Opinion of this Court; Pierce v. Commissioner, 61 T.C. 424">61 T.C. 424, 430 (1974). In the case of a closely held corporation, special scrutiny is required because of the unfettered control exercised by a limited number of shareholders. Roschuni v. Commissioner, 29 T.C. 1193">29 T.C. 1193, 1201-1202 (1958), affd. per curiam 271 F.2d 267">271 F.2d 267 (5th Cir. 1959).Mere declarations by a shareholder that he intended a transaction to constitute a loan is insufficient if the transaction fails to meet more reliable indicia 40 of debt which indicate the "intrinsic economic nature of the transaction." Williams v. Commissioner, supra at 1034; Fin Hay Realty Co. v. United States, 398 F.2d 694">398 F.2d 694, 697 (3d Cir. 1968). In making the necessary factual determination, courts have looked to a number of objective factors including the following:(1) the extent to which the shareholder controlled the corporation;(2) the earnings and dividend history of the corporation;(3) the magnitude of the payments;(4) whether a ceiling existed to limit the amount of the corporate payments;(5) whether or not security was given for the payments;(6) whether there was a set maturity date;(7) whether the corporation ever undertook to force repayment;(8) whether the shareholder was financially able to repay the payments; and(9) whether there was any indication the shareholder attempted to repay the amounts received.Dolese v. United States, 605 F.2d 1146">605 F.2d 1146, 1153 (10th Cir. 1979), cert. denied 445 U.S. 961">445 U.S. 961 (1980); Alterman Foods, Inc. v. United States, 505 F.2d 873">505 F.2d 873, 877 n. 7 (5th Cir. 1974). Also relevant are the treatment of the funds on the books of the corporation, the substantiality of any repayments made by the shareholder, and the existence 41 of corporate earnings and profits at the time 1023 the funds were transferred. Pierce v. Commissioner, 61 T.C. at 430-431.As stated, the funds in question lacked much of the form of loans and very little of the substance. No promissory notes were issued. No interest payments were due. No maturity dates were set. No security was established. What repayments occurred were in effect little more than bookkeeping entries with respect to the respective contributions of the related entities to the consolidated tax liabilities of the group. No cash repayments occurred.The record does not indicate that any formal dividends were declared by Tobin Construction other than the dividend declarations that were necessary to enable petitioner to reverse accounting entries that had been made reflecting the balance of the intercompany receivable account. No cash dividends were paid to O'Rourke in connection with the dividends declared. The funds that had been transferred prior to the declaration of the dividends (namely, the funds in question herein) simply were treated as satisfying the obligation of Tobin Construction to pay the dividends declared. Such accounting entries appear to have been intended 42 from the outset. In other words, the ultimate form and substance of the transfers in question from Tobin Construction to O'Rourke were dividends.O'Rourke had no intention of repaying the funds transferred, and Tobin Construction had no intention of being repaid by O'Rourke. The footnote references in Tobin Construction's financial statements, although they mention repayment as a possibility, are more significant in their acknowledgement that the funds transferred likely were to be recharacterized as dividends even for accounting purposes, which is what occurred.For the reasons set forth above, we conclude that the funds in question were not loans, but were corporate distributions from Tobin Construction to O'Rourke, its sole shareholder. Accordingly, we find for petitioner on this issue.Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect during the year in issue.↩2. The record herein does not explain the $ 1 discrepancy between the 1978 consolidated net operating loss ($ 1,109,682) and the amount carried back ($ 1,109,681).↩3. Sec. 1.1502-75(b)(3), Income Tax Regs., provides as follows:(3) Failure to consent due to mistake. If any member has failed to join in the making of a consolidated return under either subparagraph (1) or (2) of this paragraph, then the tax liability of each member of the group shall be determined on the basis of separate returns unless the common parent corporation establishes to the satisfaction of the Commissioner that the failure of such member to join in the making of the consolidated return was due to a mistake of law or fact, or to inadvertence. In such case, such member shall be treated as if it had filed a Form 1122 for such year for purposes of paragraph (h)(2) of this section, and thus joined in the making of the consolidated return for such year.4. Sec. 1.1502-79(a)(2), Income Tax Regs., provides --(2) Nonapportionment to certain members not in existence. Notwithstanding subparagraph (1) of this paragraph, the portion of a consolidated net operating loss attributable to a member shall not be apportioned to a prior separate return year for which such member was not in existence and shall be included in the consolidated net operating loss carrybacks to the equivalent consolidated return year of the group (or, if such equivalent year is a separate return year, then to such separate return year), provided that such member was a member of the group immediately after its organization.5. Sec. 1.1502-76(b)(5), Income Tax Regs., provides --(5) Period of 30 days or less may be disregard. For purposes of the regulations under section 1502 --(i) If within a period of 30 days after the beginning of a corporation's taxable year (determined without regard to the required change to the parent's taxable year) it becomes a member of a group which files a consolidated return for a taxable year which includes such period, then such corporation may at its option be considered to have become a member of the group as of the beginning of the first day of such corporation's taxable year, or(ii) If, during a consolidated return year of a group, a corporation (other than a corporation created or organized in such year by a member of the group) has been a member of such group for a period of 30 days or less, then such corporation may at its option be considered as not having been a member of the group during such year.↩6. For purposes of sec. 1.1502-79(a)(2), Income Tax Regs., respondent apparently will not count a period of corporate inactivity immediately following incorporation if a request under sec. 1.6012-2(a)(2), Income Tax Regs.↩, is filed for permission not to file corporate income tax returns for the period of inactivity. See Crestol, Hennessy & Rua, The Consolidated Tax Return, par 5.02 at 5-52 (1983).7. See, for example, Williams v. Commissioner, 627 F.2d 1032">627 F.2d 1032 (10th Cir. 1980), affg. a Memorandum Opinion of this Court; Dolese v. United States, 605 F.2d 1146">605 F.2d 1146 (10th Cir. 1979), cert. denied 445 U.S. 961">445 U.S. 961 (1980); Road Materials, Inc. v. Commissioner, 407 F.2d 1121">407 F.2d 1121 (4th Cir. 1969), affg. a Memorandum Opinion of this Court; Ludwig Baumann & Co. v. Commissioner, 312 F.2d 557">312 F.2d 557↩ (2d Cir. 1963), affg. a Memorandum Opinion of this Court.8. See, e.g., Hoffman Motors Corp. v. United States, 473 F.2d 254">473 F.2d 254, 257 (2d Cir. 1973); Swan v. Commissioner, 355 F.2d 795">355 F.2d 795, 797-798 (6th Cir. 1966), affg. 42 T.C. 291">42 T.C. 291 (1964); Frelbro Corp. v. Commissioner, 315 F.2d 784">315 F.2d 784, 786 (2d Cir. 1963), revg. 36 T.C. 864">36 T.C. 864 (1961); Ciaio v. Commissioner, 47 T.C. 447">47 T.C. 447, 457↩ (1967).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623220/	Madeleine Feiks v. Commissioner.Feiks v. CommissionerDocket No. 64793.United States Tax CourtT.C. Memo 1958-120; 1958 Tax Ct. Memo LEXIS 109; 17 T.C.M. (CCH) 642; T.C.M. (RIA) 58120; June 26, 1958109 Nicholas R. Doman, Esq., 521 Fifth Avenue, New York, N. Y., for the petitioner. Colin C. Macdonald, Jr., Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The respondent determined a deficiency in income tax for the calendar year 1953 in the amount of $906. The issue raised in the petition concerns the disallowance of a net operating loss deduction claimed on the return as a carry-over of a loss for the taxable year 1952 resulting from a nationalization of the petitioner's property in Budapest, Hungary, by the Hungarian Government in 1952. The petitioner filed her return with the collector of internal revenue at Brooklyn, New York. Findings of Fact The petitioner is a citizen of the United States, naturalized in 1953 and is a resident of New York City. Her husband died in 1953. Prior to 1948 she was a resident of Budapest, Hungary. In 1940 the petitioner and an associate, Mrs. Gyula Szasz, purchased an apartment building and adjoining grounds at 116 Gizella Ut, in Budapest. The purchase price was 122,500 pengos. A translation of the land record shows: "On the basis of the purchase contract dated February 14, 1940 ownership110 is recorded in equal parts "Alfred Feiks and wife, nee Magda Bacskar "Mrs. Gyula Szasz, nee Aranka Fenyvesi, Budapest residence." In 1940 the pengo was valued at 0.1977 dollars. The property included a large vegetable garden and was improved by a T-shaped stone building of several stories containing 36 apartments. The petitioner did not live on the property. She managed the property until 1948 and during the war grew vegetables in the garden for sale. In May 1948 the petitioner left Hungary and came to the United States. She authorized a friend, Dr. Vigyazo, to manage the property and had a caretaker on the premises. She corresponded with Dr. Vigyazo about the property. In 1949 a Hungarian decree provided for management by the Hungarian Municipal Realty Property Management Enterprise of properties owned by persons who lived outside Hungary. The proceeds of such properties were kept in a blocked account and could not be withdrawn from Hungary without permission, but could be used within Hungary for purposes of the owner. Pursuant to this decree the petitioner's property was subject to the management of this Hungarian agency from April 1951. In February 1952 the Hungarian111 Government by Decree #4 of 1952 nationalized all privately-owned buildings, including apartment houses. The petitioner learned of the nationalization of her property by letter from Dr. Vigyazo in April 1952. Such letter stated, as translated: "I am advising you that your property interest in the realty located at Budapest XIV Hungaria Boulevard 116, with an act in the month of April, 1951, of the National Bank, Fe. 85/4/1950, was turned over to the Municipal Realty Property Management Enterprise pursuant to order No. 1310/1949. "I am also advising you that pursuant to subdivision la of paragraph 1 of Edict No. 4 of the year 1952, published on February 17, 1952, the above managed realty interest was nationalized. This was due to the fact that the realty in question was utilized for rental in its entirety." The Decree #4 of 1952 provided, in part, as translated: "Article 1 "1) The following shall be nationalized on the strength of the present statute Decree together with their component parts and appurtenances: "a) all privately owned buildings (apartment-houses, villas, business houses, factories, stores, etc.) which, or certain parts of which, are being utilized under112 lease; "b) buildings owned by capitalists, other exploiting elements and the elements belonging to the overthrown social order who oppressed the people, including cases where the building is not leased." The petitioner sustained a loss in 1952 of $5,900 from the nationalization of the property in Budapest. Opinion The petitioner reported an adjusted gross income of $4,180 for 1952 and claimed a deduction of $12,000 from the loss of her property in Budapest by nationalization. On her 1953 return she reported income of $4,955 and claimed a net operating loss deduction of $4,070 as a carryover. In a computation attached to the return the loss was claimed to be $12,000 with $4,150 as a deduction for 1952; $3,780 as a carryback to 1951 and $4,070 remaining as a carryover to 1953. The respondent contends that the petitioner has not proved the extent of her ownership interest, that a loss occurred, the amount of the loss or that the loss was attributable to the operation of a trade or business. In Peter S. Elek, 30 T.C. - (June 26, 1958) we allowed a loss carryover claimed by a former Hungarian owner of an apartment property in Budapest which was nationalized by the same decree113 of 1952. We follow that decision here. This property was managed by the petitioner until 1948 and thereafter by her appointed agent until the management was taken over by the Hungarian Municipal Realty Property Management Enterprise. This agency managed it keeping proceeds in a blocked account usable in Hungary but not withdrawable from that country. To some extent, at least, it was for benefit of the owner as in making repairs to maintain the property. Thus the petitioner was in the business of operating this property until it was nationalized in 1952. Even if she was no longer in the business at the time of the nationalization the loss is still a business loss if proximately related to a business previously engaged in. Adolph Schwarcz, 24 T.C. 733">24 T.C. 733 (1955) Acq. C.B. 1956-1, 5. The total investment in the building was 122,500 pengos. At the rate of exchange in 1940, the pengo equalled 0.1977 United States dollars (Internal Revenue Cum. Bulletin 1941, page 236). The total investment measured in dollars was about $24,000. The petitioner testified that she paid two-thirds of the price and owned a two-thirds interest. The respondent argues that this is contradicted by the114 Hungarian land register showing equal interests in petitioner, her husband and the other investor, and citing the Schwarcz case, supra, where we held that the taxpayer's uncorroborated statement to the contrary was not to be preferred to the land register. The petitioner testified that her husband was shown as having an interest for the purpose of reducing taxes but that she supplied two-thirds of the purchase price. A witness, familiar with Hungarian law in the 1940's, testified that the register was conclusive against anyone who in good faith acquired rights based upon the title as registered, but that facts to the contrary could be proved. However, we are unwilling to accept the petitioner's testimony as sufficient proof that the register does not correctly show the interests. We conclude that her interest was one-third. The petitioner did not know the age of the property at the time she acquired her interest. The building was of stone and mortar construction. The petitioner did not know the cost of repairs or upkeep after 1948, but says that it was in good physical condition at that time. The depreciation on such a structure for 12 years, 1940 to 1952, could not well have exceeded*115 30 per cent of the investment in the building in 1940. The petitioner had a one-third interest in the land and building which cost her about $8,000. We allocate $1,000 to the land, $7,000 to the building in the absence of better proof and compute depreciation for 12 years at 30 per cent or $2,100. Her basis in the property when confiscated was $5,900. That is the amount of her loss and it is attributable to the operation of a trade or business. The amount of loss carryover in 1953 can be determined in a computation under Rule 50. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623222/	American-LaFrance-Foamite Corporation v. Commissioner.American-LaFrance v. CommissionerDocket No. 62520.United States Tax CourtT.C. Memo 1959-101; 1959 Tax Ct. Memo LEXIS 148; 18 T.C.M. (CCH) 447; May 19, 1959Lawrence A. Baker, Esq., 40 Wall Street, New York, N. Y., for the petitioner. Robert S. Bevan, Esq., for the respondent. RAUMMemorandum Findings of Fact and Opinion The respondent determined deficiencies in income tax of petitioner for the years 1951 and 1952 in the respective amounts of $266,685.74 and $6,935.01. The sole issue in controversy is whether advances made by petitioner to International Meters, Inc. aggregating $506,887.06 represent contributions to the capital of that corporation or an indebtedness. If they represent an indebtedness, the respondent concedes that petitioner is entitled to149 deduct the amount of the advances in 1951 as a bad debt. One issue relating to the amounts petitioner is entitled to deduct in 1951 and 1952 on account of liability for New York franchise taxes has been left open by the parties for disposition under Rule 50. Two other issues were raised by the pleadings, one of which, involving $9,630 received by petitioner in 1952 on the cancellation of a lease, has been conceded by the respondent and the other, involving a claimed bad debt of $9,000, has been conceded by the petitioner. Findings of Fact Some of the facts have been stipulated and are incorporated herein by reference. Petitioner is a corporation organized under the laws of the State of New York. Its offices are located at 100 East LaFrance Street, Elmira, New York. It filed its income tax returns for the calendar years 1951 and 1952 with the collector of internal revenue at Buffalo, New York. Louis F. Fink was employed as sales manager by the Standard Meter Company of Hartford, Connecticut, from 1936 to 1941. At that time all parking meters in use controlled a single parking space. While employed by the Standard Meter Company, Fink conceived the idea of using two meters on150 one head and base to control two parking spaces, and applied for a patent covering the "plural parking space meter" (hereinafter referred to as the "twin meter"). In December 1941, Fink caused International Meters, Inc. (hereinafter referred to as "I.M.I.") to be incorporated under the laws of the State of New York with an authorized capital stock of 400 shares of no par value convertible preferred and 1,400 shares of no par value common. The Certificate of Incorporation was subsequently amended to eliminate the conversion privilege in the preferred stock but no change was made in the voting rights which entitled the holder of each share of preferred or common stock to one vote. On February 10, 1942, I.M.I. issued 600 shares of its common stock to Fink in consideration of the assignment by him to I.M.I. of the patent application covering the twin meter. On that date directors previously elected met and elected, as officers of I.M.I., Louis F. Fink, president, William F. Bleakley, secretary, and Walter G. Brown, treasurer. During the period February 10, 1942 to February 6, 1947, the directors and officers of I.M.I. were selected and controlled by Fink. During the early part of this151 period, the application for patent on the twin meter was being prosecuted under the direction of Fink with financial assistance from the personal associates selected by him. The patents applied for were issued in October, 1944. In 1945 I.M.I. needed capital to organize and to begin to "tool up" and produce the twin meter. During that year Edward E. O'Neill (then president of petitioner) was introduced to Fink and became interested in the twin meter. At a meeting of the board of directors of petitioner held on January 16, 1946, O'Neill reported that he had been in touch with I.M.I. during the preceding eight months; that he had received satisfactory opinions from counsel on the twin meter patent; that petitioner could buy a 51 per cent interest in the stock of I.M.I., free and clear of any incumbrances, for $50,00; that this money would partly reimburse Fink for funds he had expended to advance his patent and business to that point; that the plan was to have I.M.I. operate the selling end of the business but under control of petitioner which would manufacture the twin meter; that petitioner would have to advance I.M.I. its operating expenses to start with, in an amount approximating152 $60,000 to $70,000 per year; and that petitioner could advance this money to I.M.I. with interest or have I.M.I. issue to petitioner five per cent preferred stock, as needed, up to $100,000. O'Neill also reported on manufacturing costs, selling prices, and profits per unit and estimated that, on a conservative basis, petitioner should produce 20,000 units per year, making a profit of $160,000. On this volume he estimated that I.M.I., as the selling organization, should gross about $490,000 profit per year, less operating expenses. He further reported petitioner had been working on an experimental model of the twin meter and that it could be made to work satisfactorily with necessary changes of a minor nature. The balance sheet of I.M.I. as of December 31, 1946, showed the following assets and liabilities: AssetsCash$ 121.31Accounts Receivable673.00Total Current Assets$ 794.31Fixed AssetsMachinery and Equipment$ 864.69Furniture and Fixtures1,367.96Automobile2,035.63$ 4,268.28Less Reserve for depreciation1,558.992,709.29Deferred Charges888.44PatentsCost$119,591.76Less Amortization10,854.98108,736.78$113,128.82LiabilitiesNotes Payable$ 9,000.00Advances from American-LaFrance-FoamiteCorporation53,983.80Total Current Liabilities$ 62,983.80Deferred Credits to Income20,000.00Capital and SurplusPreferred Stock (400 Shares)$40,000.00Common Stock (1400 Shares)1,000.00$41,000.00Deficit(10,854.98)30,145.02$113,128.82153 On February 6, 1947, an agreement was concluded between petitioner and Fink, whereby Fink agreed to sell and deliver and petitioner agreed to purchase for the amount of $50,000, (1) 400 shares of preferred stock of I.M.I., (2) 714 shares, being 51 per cent, of the common stock of I.M.I., and (3) a note of I.M.I. for $9,000 payable to Fink. Fink also agreed to grant an option to petitioner upon the exercise of which he would be required to transfer to petitioner 343 shares of common stock of I.M.I. at the end of six years from February 6, 1947, the date of the agreement, provided either of the following contingencies had occurred: (a) The death of Fink or (b) the termination of employment of Fink by I.M.I. Such option was to continue and be exercisable at any time after six years, upon the happening of either of these contingencies, upon the payment by petitioner to Fink of the book value of the stock. Fink further agreed that 343 shares of common stock held by him would be stamped to give notice of the option so granted. On February 15, 1947, the board of directors of I.M.I. authorized the issuance of additional stock and its note for $9,000, without interest, to Fink in consideration154 for his agreement to pay all of the debts of I.M.I. in the amount of $57,140.81, making it possible for him to complete delivery required by the agreement between him and petitioner dated February 6, 1947. At the same meeting the directors elected Edward E. O'Neill, then president of petitioner, and Clarence A. Pettyjohn, then vice-president and treasurer of petitioner, as directors of I.M.I. in place of Walter G. Brown and William Nardo. On February 21, 1947, the board of directors of I.M.I. elected Edward E. O'Neill, president, and Clarence A. Pettyjohn, secretary and treasurer of I.M.I. O'Neill and Pettyjohn received no salary from I.M.I.On February 21, 1947, petitioner entered into an agreement with I.M.I. wherein I.M.I. agreed to pay petitioner $53,983.80, the total amount of money spent by petitioner during 1946 for maintenance of the office of I.M.I., for engineering and development services on the twin meter rendered by petitioner and others, for patent and legal expenses, and for the purchase of the Clausen Patent. The agreement also provided that petitioner would "loan" to I.M.I. without interest sufficient funds to take care of the operating expenses of I.M.I. during155 1947, such as rent, light, telephone, salaries, advertising, traveling and kindred expenses necessary in conducting its business for that year; and that I.M.I. would assign to petitioner the obligations of purchasers of the meters as collateral for sums "owed" by I.M.I. to petitioner. On February 22, 1947, the stock of I.M.I. was held as follows: Petitioner, 400 shares of preferred stock, the entire amount of such stock outstanding, and 714 shares of common stock, being 51 per cent of such stock outstanding; Edward E. O'Neill, 140 shares of common stock and Louis F. Fink, 546 shares of common stock. Although the agreement of February 21, 1947 contained no promise by petitioner to make advances to I.M.I. subsequent to December 31, 1947, the petitioner continued to advance I.M.I. all funds necessary for it to do business during the year 1948 and the first seven months of 1949. Under date of August 4, 1949, petitioner and I.M.I. entered into an agreement wherein petitioner agreed to "loan" to I.M.I., without interest, sufficient funds to take care of I.M.I.'s expenditures during the years 1948 and 1949 for "tools, dies, patterns, engineering and development work, rent, light, telephone, 156 salaries, advertising, legal, traveling and other expenses necessary in conducting its business for those years". Petitioner continued to make advances to meet the financial requirements of I.M.I. during the year 1950, which was not covered by the 1949 agreement. Under date of January 17, 1951, petitioner and I.M.I. entered into an agreement wherein petitioner agreed to "loan" to I.M.I., without interest, sufficient funds to take care of its operating and other business expenses during 1950 and 1951. In both the 1949 and 1951 agreements I.M.I. agreed to assign to petitioner its accounts receivable in payment of petitioner's advances. The 1951 agreement differed from the 1949 agreement in that each party had the right to terminate it on 30 days notice. The 1951 agreement was terminated effective August 12, 1951. However, petitioner continued after August 12, 1951, to make advances to I.M.I. The agreements between petitioner and I.M.I. required petitioner to manufacture for I.M.I. twin meters at prices ranging from 33 1/3 per cent to 20 per cent over cost. Pursuant to the agreement of February 21, 1947, petitioner made advances to I.M.I. in the amount of $53,983.80 to cover its 1946157 expenditures and in the amount of $98,717.20 to cover its 1947 expenditures, which resulted in total advances as of December 31, 1947, of $152,701. No accounts receivable were assigned by I.M.I. to petitioner during 1946 and 1947 since no twin meters were sold. The advances were made for the following: 19461947Operating expenses$ 9,202.32$33,387.17Engineering and develop-ment31,366.2847,235.28Patent and legal expenses12,581.358,762.97Tools, dies and patterns7,602.45Miscellaneous833.851,729.33During the years 1948, 1949, 1950 and 1951, the advances included "Cost of meters shipped" in addition to the five items listed above. The advances during those years were as follows: YearAmount1948$427,814.991949667,181.401950713,468.171951569,233.50The books of petitioner treat the following amounts as having been repaid by I.M.I. on the advances: YearAmount1948$215,517.421949497,431.731950712,636.311951597,926.54 The amounts treated as having been repaid in 1948, 1949 and 1950, and $422,123.68158 of the $597,926.54 treated as repaid during 1951, represented the amount of meter accounts receivable assigned by I.M.I. to petitioner during those years. The books of petitioner show balances of unpaid advances of petitioner to I.M.I. at the end of each year to be as follows: YearBalance1946$ 53,983.80194798,717.201948364,998.571949534,748.241950535,580.101951 575,987.08 *During the years 1948, 1949 and 1950, and the period January 1 to October 15, 1951, I.M.I. sustained net losses of $111,676.91, $122,535.40, $42,819.15, and $6,815.65, respectively. Its balance sheets show the following assets, liabilities, and deficits: YearEndedAssetsLiabilitiesDeficit12/31/48$322,292.22$443,097.66$120,805.4412/31/49368,274.74611,615.58243,340.8412/31/50365,403.93651,563.92286,159.9910/15/51 313,849.06586,824.70272,975.64159 Prior to 1947, some handmade models of the twin meter were made by I.M.I. for experimental and testing purposes. In the latter part of 1946, tests by the engineering department of petitioner revealed that some improvements had to be made in the twin meter before it could be marketed. During 1947, I.M.I. was engaged in the improvement, development and promotion of the twin meter and was receiving assistance from petitioner in these activities. Production and delivery of meters by petitioner to I.M.I., for sale by the latter, began in 1948. I.M.I. marketed the meters through representatives with whom it had contracts. These selling representatives made contracts with customers which became effective when they were approved by the Elmira office of I.M.I. As to each contract, the amount receivable by I.M.I. was assigned to petitioner and the assignment was attached to the original contract. Purchasers of meters were billed for the contract price on I.M.I. invoices. These invoices reflected notice of assignment. Payments by the customers were received at Elmira by petitioner and deposited in the bank account of petitioner. Upon receipt160 of such payments, the amounts thereof were applied to reduce the balance of petitioner's advances to I.M.I., and so recorded in the intercompany accounts. The petitioner experienced difficulty in reaching a profitable production level of parking meters and in 1951 initiated steps to bring about the liquidation and dissolution of I.M.I. The operating contract between petitioner and I.M.I. was cancelled by letter of July 12, 1951, effective August 12, 1951. At a special meeting of the board of directors of I.M.I. on August 6, 1951, a resolution recommending dissolution and notice to stockholders was adopted and at a meeting of the stockholders on August 20, 1951, on record vote, approval was given to the filing of a certificate of dissolution which was filed on August 28, 1951. Subsequent to the termination of the contract between petitioner and I.M.I. on August 12, 1951, and during the liquidation of I.M.I., petitioner caused all of I.M.I.'s known debts to be paid. In some instances petitioner made advances to I.M.I. to enable it to pay creditors, and in others it paid I.M.I.'s creditors directly and treated such payments as advances to I.M.I.At a meeting of the board of directors161 of I.M.I. on December 4, 1951, George R. Hanks, who had been elected president of petitioner on October 24, 1951, was elected president of I.M.I. Hanks reported that petitioner had assumed liability for all commissions due to sales representatives. At a special meeting of the board of directors of I.M.I. on December 5, 1951, Hanks reported on bids which had been received for the assets of I.M.I., one from The Michaels Art Bronze Co., Inc., of Covington, Kentucky, in the amount of $57,000, 50 per cent to be paid in cash and terms to be arranged for the balance, and the other a bid from petitioner in the amount of $60,000, all cash. The directors authorized acceptance of the offer of petitioner. The treasurer reported that as of December 15, 1951, all known liabilities of I.M.I. had been paid with the exception of the amount due petitioner. The treasurer was thereupon authorized and directed to pay to petitioner all the cash in the hands of I.M.I. including the $60,000 paid by petitioner as the purchase price of I.M.I. assets. Immediately prior to this payment to petitioner, the balance of advances made by petitioner to I.M.I. was $568,656.63. Application to this balance of the amount162 of $61,769.57, which was paid to and taken from I.M.I. by petitioner, left a balance of $506,887.06 of advances made by petitioner to I.M.I. Petitioner deducted on its income tax return for the year 1951 this balance of $506,887.06 as a bad debt. The $506,887.06 balance of petitioner's advances to I.M.I. represented capital contributions and not a bona fide debt. Opinion RAUM, Judge: The petitioner contends that the unpaid balance of its advances to I.M.I. totaling $506,887.06 represented a bad debt which it is entitled to deduct under Section 23(k), Internal Revenue Code of 1939. Respondent contends that it represented capital contributions the deduction of which is limited by Sections 23(g) and 117. The question presented is essentially one of fact. Petitioner became interested in the twin meter patent owned by I.M.I. in 1946. At that time I.M.I. had only a few assets, which included the twin meter patent, some handmade models of the meter, debts, and no liquid capital. Its stock was owned by Fink, the inventor of the twin meter. It needed capital to develop, produce and market the meter. Petitioner was aware of this when, on February 6, 1947, it purchased a controlling interest163 in the stock of I.M.I. from Fink for $50,000. In agreements between petitioner and I.M.I. dated February 21, 1947, August 4, 1949 and January 17, 1951, petitioner agreed to advance to I.M.I. sufficient funds to meet its operating and other expenses for the years 1946 through 1951, and I.M.I. agreed to assign to petitioner the obligations of purchasers of meters as collateral for amounts "owed" by I.M.I. to petitioner. No meters were sold and no assignments were made during the years 1946 and 1947. Assignments made during the years 1948, 1949, 1950 and 1951 did not equal the amount of the advances made by petitioner in those years. In 1951, when I.M.I. was liquidated, the unpaid balance of advances amounted to $506,887.06. Petitioner stresses the fact that in its books and financial statements and also in those of I.M.I. the advances were treated as loans; that they were not made in proportion to stockholdings; and that they were partially repaid. Certainly these are factors to be considered in determining whether the real intention of the parties was to create a debtor-creditor relationship. But they are not conclusive and that intention must be gleaned from the entire record. It164 shows that the purpose of the advances was to get the business of I.M.I. established and to keep it in operation; that they were not evidenced by notes or other evidence of indebtedness; that no time was fixed for their repayment and no interest charged; that repayment was contingent upon the success of the business of I.M.I. and the possibility that the amount of its contracts assigned to petitioner would eventually equal the amount of the advances; and that I.M.I. sustained net losses and had mounting deficits during the period covered by the advances. We think that the advances made by petitioner were intended to be subject to the risks of the business and not repayable in any event. Although the matter may not be completely free from doubt, it is our best judgment on the entire record that the advances were capital in nature and did not create debts. Accordingly, the deduction for worthlessness of petitioner's investment must be governed by the provisions relating to capital assets rather than by the bad debt provisions. Decision will be entered under Rule 50. Footnotes. Includes amount of $60,000 received upon dissolution of I.M.I.↩. October 15, 1951. ↩*. This balance at October 15, 1951, was subsequently adjusted between October 15 and December 17 so that immediately prior to complete liquidation the balance was $568,656.63. Application of cash, the sole remaining asset, amounting to $61,769.57 reduced the balance to $506,887.06.↩. Period January 1 to October 15, 1951.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623223/	The Homer Laughlin China Company, Petitioner, v. Commissioner of Internal Revenue, RespondentHomer Laughlin China Co. v. CommissionerDocket No. 5364United States Tax Court7 T.C. 1325; 1946 U.S. Tax Ct. LEXIS 15; December 12, 1946, Promulgated 15 Decision will be entered that the petitioner is not entitled to relief under section 722, and that there is a deficiency in the amount determined by the Commissioner. In the petitioner's claim for relief under section 722, Internal Revenue Code, the constructive average base period net income was computed by the use of the formula or rule set forth in section 713 (f). Held, that the petitioner failed to establish that the tax computed without benefit of section 722 resulted in an excessive and discriminatory tax, or to establish what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income, and claim for refund was properly denied. M. L. Aaron (an officer), for the petitioner.Jacquin Bierman, Esq., for the respondent. Disney, Judge. DISNEY1325 This proceeding arises from the Commissioner's rejection of the petitioner's application for excess profits tax relief under section 722, Internal Revenue Code. The Commissioner sent petitioner a deficiency notice asserting deficiencies in income tax for 1940 and excess profits tax for 1941 in the respective amounts of $ 12,815.56 and $ 67,246.77. The deficiency notice states 16 that petitioner's application for excess profits tax relief under section 722 for 1941 in the amount of $ 65,031.12 has been disallowed.Petitioner's claim for relief under section 722 is based solely upon the ground that alleged excessive depreciation deductions were taken in its income tax returns for the base period years 1936 to 1939, inclusive. The question has been submitted to us on a written stipulation of facts, which we adopt and incorporate herein by reference. The following findings contain all of the stipulated facts substantially as set forth in the stipulation, together with such additional material facts as are shown by the exhibits.FINDINGS OF FACT.Petitioner is a Delaware corporation, organized in the year 1927, having its principal office and place of business at Newell, West Virginia. It filed its income tax returns for the years 1937, 1938, 1939, 1940, and 1941 and its excess profits tax returns for the years 1940 and 1941 with the collector of internal revenue for the district of West Virginia, at Parkersburg.From its organization in 1927 to December 1, 1936, the petitioner acted as a holding corporation only.On December 1, 1936, the petitioner succeeded through 17 the liquidation of its wholly owned subsidiary, the Homer Laughlin China Co. (West Virginia), to the business of that corporation, and has at all 1326 times since that date engaged in the manufacture of earthenware.On December 18, 1936, petitioner succeeded through the liquidation of another wholly owned subsidiary, the North American Manufacturing Co. (West Virginia), to the business of that corporation.Petitioner and its subsidiaries, the Homer Laughlin China Co. (West Virginia) and the North American Manufacturing Co. (West Virginia), filed separate income tax returns for the year 1936 with the collector of internal revenue for the district of West Virginia, at Parkersburg.In its excess profits tax returns for 1940 and 1941 petitioner elected not to compute average base period net income under section 742 of the Internal Revenue Code.The adjustments made by the Commissioner in the case of petitioner's wholly owned subsidiary, the Homer Laughlin China Co. (West Virginia), which decreased its depreciation by $ 916.67 and increased its capital gain by $ 220.28 for the taxable year 1936, have been accepted both by the subsidiary and by the petitioner.Depreciation claimed by the petitioner 18 on its properties for the years 1936 to 1939, inclusive, and approved by the Commissioner, was as follows:1936, December only$ 16,442.051937, entire year205,324.701938, entire year189,532.891939, entire year184,226.12Depreciation claimed by the petitioner for 1940 and 1941, calculated at the rates and upon the basis approved by the Commissioner for the prior years 1936-1939, depreciation allowed by the Commissioner, and the difference between depreciation claimed and allowed were as follows:YearDepreciation claimedDepreciationDifferenceallowed1940(corrected) $ 184,745.92$ 133,934.62$ 50,811.301941183,545.66132,349.0851,196.58Average184,145.791 133,141.852 51,003.94The properties of the petitioner were subject to normal physical depreciation in each of the years of the base period 1936-1939 and in each of the taxable years 1940 and 1941. Neither the petitioner nor the Commissioner claims that abnormal usage of the properties occurred in any of the base period years or in 1940 or 1941.The disallowance of depreciation by the Commissioner for the years 1327 1940 and 1941 was based on a revised estimate of the remaining useful life of various assets (buildings 19 and kilns) of the petitioner from December 31, 1939. The method of disallowance was to spread the unrecovered cost over the newly determined remaining useful life and to limit current depreciation to an amount so ascertained.Depreciation on buildings installed prior to December 31, 1937, at petitioner's plant #4 was claimed by petitioner for 1936 and 1937 on a life limit of 7 years from December 31, 1931. Depreciation on the same account for 1938 and 1939 was claimed on a life limit of 5 years from December 31, 1937, with 3 per cent straight line depreciation on 1938 and subsequent additions. The life limit of these buildings as redetermined by the Commissioner for 1940 and 1941 is 7 years from December 31, 1939, with 3 per cent straight line depreciation on 1938 and subsequent additions.Depreciation on buildings installed from 1915 to 1939, inclusive, at petitioner's plant #5 was calculated for 1936 to 1939, inclusive, at 3 per cent straight line. The life limit of these buildings as redetermined by the Commissioner for 1940 and 1941 is 12 years from December 31, 1939.Depreciation on kilns at petitioner's plant #4 for 1936 to 1939, inclusive, was calculated at 7 1/2 per cent straight 20 line. The life limit of these kilns as redetermined by the Commissioner for 1940 and 1941 is a 25-year life from installation.Depreciation on kilns at petitioner's other plants for 1936 to 1939, inclusive, was calculated on the basis of a 15-year life from installation. The life limit of these kilns as redetermined by the Commissioner for 1940 and 1941 is a 25-year life from installation.The petitioner accepts as correct for the purpose of income tax calculation the adjustment in depreciation made by the Commissioner for 1940 and 1941.Net sales of the petitioner in each of the base period years, as disclosed by its income tax returns, were as follows:1936, December only$ 445,159.011937, entire year5,135,405.141938, entire year5,762,106.981939, entire year5,866,300.83The December 1936 net sales of $ 445,159.01 were for the period following petitioner's absorption of its two subsidiary companies. The net sales of the petitioner and its subsidiaries for the entire year 1936 amounted to $ 5,034,140.47.On May 10, 1943, petitioner filed with the Commissioner its application for relief under section 722 of the Internal Revenue Code from 1328 the excess profits tax which would result for 1941 21 from the disallowance of depreciation for that year and from the reduction in carry-over of unused excess profits credit from the disallowance of depreciation for the year 1940. It was stated in the claim in material part, in answer to questions and otherwise, as follows:YearAmount4. Excess profits net income or deficit in excess profits1936$ 32,006.90net income for each taxable year in the base period,1937264,223.06computed without regard to section 722.1938409,623.771939336,483.59Total$ 1,042,337.325. Average base period net income determined without regardto section 722409,623.77(a) Is the benefit of section 713 (e) (1) (relating to exclusion of deficit or to increase in lowest yearin base period) claimed? No.(b) Is the benefit of section 713 (f) (relating to increased earnings in last half of base period) claimed? Yes.(c) If answer to (a) or (b) is "yes," furnish computation.Year 1938 used.6. Amount of constructive average base period net income claimed for use in computing excess profits tax for taxable year. (Furnish particulars supporting amount claimed and detailsinvolved in computation)$ 466,466.787. Has Supplement A been availed of in determining average baseperiod net income? No. * The 22 use of the excess profits credit based upon income would result in an excessive and discriminatory tax, because of the drastic alteration in depreciation schedules proposed in the Revenue Agent's report for 1940 and 1941. The Agent has proposed to reduce depreciation for 1940 from $ 185,975.05 to $ 133,934.62 and for 1941 from $ 183,545.66 to $ 132,349.08 -- an average reduction of $ 51,618.51. Such radical alteration of depreciation destroys all basis of comparison between base period and current years. With current income rated up by the sharp curtailment of depreciation and with base period allowed to remain as it was, average base period net income becomes an inadequate standard of normal earnings. Section 722 (b) (5).Two substitute calculations are appended hereto:(1) Based on the application of uniform depreciation to base period and current years.(2) Based on the addition to average base period net income per return of the average differential applied by the Revenue Agent in reduction of depreciation allowances for 1940 and 1941.The basis for these calculations is more fully stated in a protest of even date filed with the Internal Revenue Agent in Charge, Huntington, West 23 Virginia.Respectfully submitted,The Homer Laughlin China Company[Signed] M. L. AaronM. L. Aaron1329 EXHIBIT A -- CALCULATION OF CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME BASED ON THE APPLICATION OF UNIFORM DEPRECIATION TO BASE PERIOD AND CURRENT YEARS.DepreciationDepreciationAdditionalclaimed or allowedcorrectedincome1936$ 16,442.05$ 10,662.83$ 5,779.221937205,324.70129,244.5976,080.111938189,532.89132,689.8856,843.011939184,226.12135,911.2148,314.911940185,975.05146,567.8739,407.181941183,545.66145,368.8238,176.84Excess profits netAdditionalCorrected excessincome per returnincomeprofits net income1936$ 32,006.90$ 5,779.22$ 37,786.121937264,223.0676,080.11340,303.171938409,623.7756,843.01466,466.781939336,483.5948,314.91384,798.50Aggregate$ 1,229,354.57Average307,338.64Constructive average base period net income -- growth formula Year 1938 used466,466.78EXHIBIT B -- CALCULATION OF CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME BASED ON THE ADDITION TO AVERAGE BASE PERIOD NET INCOME PER RETURN OF THE AVERAGE DIFFERENTIAL APPLIED BY THE REVENUE AGENT IN REDUCTION OF DEPRECIATION ALLOWANCES FOR 1940 AND 1941.Average base period net income per return (year 1938 used)$ 409,623.77Add average reduction in current depreciation allowances51,618.51Constructive average base period net income$ 461,242.2824 The Commissioner in the deficiency notice allowed the petitioner a 95 per cent excess profits tax credit of $ 389,142.58 -- which is 95 per cent of $ 409,623.77, average base period net income computed by applying section 713 (f) to actual income as reported in the base period.OPINION.Is the petitioner, in the light of the facts above found, entitled to relief under section 722 (a), (b) (5) of the Internal Revenue Code, 126 27 as contended? Briefly stated, the petitioner's position 1330 is that the reductions in depreciation deductions in the years 1940 and 1941 by the Commissioner, because of use of a revised rate, show that excessive depreciation had been claimed, and allowed, for the base period years 1936 to 1939; that such excessive depreciation depressed earnings below a normal standard and was thus a "factor affecting the taxpayer's business * * * resulting in an inadequate standard of normal earnings," within the language of section 722 (b) (5); and that "a fair and just amount representing normal earnings to be used as a constructive average base period net income" is to be determined by using the figures for the base period years which it computes by increasing the income of such 25 years (by decreasing depreciation deductions in accordance with its theory of applying the same rates used by the Commissioner in 1940-1941) and on such figures making a computation under section 713 (f), the "growth formula," as shown in the application for section 722 relief, shown above in our findings of fact. However, since that method produces $ 466,466.78, a result slightly greater than merely adding to the growth formula computation (under the original income figures for 1936-1939, inclusive) the $ 51,003.94, the average decrease of depreciation under the Commissioner's rates in 1940-1941, the petitioner is willing to limit its result to $ 460,627.71 (the $ 51,003.94 plus $ 409,623.77, the result of growth formula computation on the original actual income figures for 1936-1939) instead of $ 466,466.78. 2The petitioner has the right, under section 722 (b) (5), to show that its average base period net income is an inadequate standard of normal earnings because of some "factor affecting the taxpayer's business 1331 which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period," provided the application of section 72228 is consistent with the principles, conditions, and limitations of section 722 (b). If an inadequate standard for the base period is so proved, thereupon the excess profits tax (computed without benefit of section 722) shall be considered excessive and discriminatory. Having so demonstrated, the petitioner may then secure the benefits of section 722 (a) by further establishing a constructive average base period net income, consisting of "a fair and just amount representing normal earnings." East Texas Motor Freight Lines, 7 T.C. 579">7 T. C. 579.The question therefore arises here as to whether computation under section 713 (f) may be utilized to raise the figures for base period net income so as to demonstrate the "inadequate standard of normal earnings" required by section 722 (b) and to establish constructive average base period net income under section 722 (a).In Stimson Mill Co., 7 T. C. 1065, we had a situation where it was admitted that due to a strike in 1937 the corporate income was affected by "events unusual and peculiar in the experience of such taxpayer," within the language of section 722 (b) (1); nevertheless, we denied relief to the taxpayer for the reason that, in computing the 29 "fair and just amount representing normal earnings to be used as a constructive average base period net income," it did not merely use the actual base period net income, adding thereto the effect of section 713 (e), but first raised the income for 1937, under section 722, because of the strike, and then computed under section 713 (e) upon the amount so obtained.Here, the petitioner contends that, having shown that in the taxable years the respondent calculated depreciation by using a lower rate than had been used in the base period years, it has shown that depreciation deductions were excessive in the base period years and, therefore, that it has established a factor demonstrating that its "average base period net income is an inadequate standard of normal earnings."In the Stimson case it was not denied, in fact was agreed, that the proof necessary for section 722 relief up to that point had been produced, that is, that in one year, due to a strike, income would, in a computation under section 722, be raised; yet, relief under section 722 was denied for the reasons to which we have above adverted. There is, therefore, a complete parallel between the stipulated proof in the Stimson30 case (of a strike adversely affecting petitioner's business) and the alleged, but denied, proof here (of change in depreciation rate in the taxable years, indicating excessive rate in the base period years). Here, just as in the Stimson case, the petitioner goes forward and attempts to establish a constructive average base period net income. It does so in precisely the same way as was done in the Stimson case, 1332 except that here section 713 (f) is used to raise the base period income average, instead of section 713 (e). Here, just as in the Stimson case, after giving effect in the computation of average base period net income to the factor affecting business (admitted by the respondent in the Stimson case, but vigorously denied in this), the petitioner utilizes one of the two formulae of section 713 to raise the amount of the computation, and calls the result constructive average base period net income. Since, as in the Stimson case and for the reasons set forth therein, such a showing is not sufficient to establish a "fair and just amount representing normal earnings to be used as a constructive average base period net income," within the language of section 722 (a), the petitioner 31 here also, as in that case, has failed to show a right to further relief than it was originally granted in the deficiency notice. Therein the Commissioner allowed an excess profits credit of 95 per cent of $ 409,623.77, which is the section 713 (f) average base period net income based on the actual and reported income in the base period. Moreover, as was true of the amount of relief allowed in the Stimson case, $ 409,623.77 is more than an average base period net income computed upon the petitioner's theory, but without application of section 713 (f); that is, computed upon the figures resulting from raising the net income actually determined by the taxpayer and reported by it, to the extent of the effect of application of petitioner's theory of decreasing depreciation deductions in the base period years, because they were decreased in the taxable years. Such changed and increased figures on petitioner's theory are as follows:1936$ 37,786.121937340,303.171938466,466.781939384,798.50Average307,338.64The average, $ 307,338.64, is the average base period net income, on petitioner's theory, up to the point of applying section 713 (f). Therefore, we see, since this figure is less than 32 $ 409,623.77, that, just as in the Stimson case, the petitioner has shown no right to relief under section 722, because without the further assistance of section 713 (f) to raise the "actual" base period average, such average is less than already allowed by the Commissioner, who has allowed, as he must, the benefit of section 713 (f) to be added to the original income figures. Even if we assume then, without deciding, that petitioner has proven a right to use in the base period the depreciation rate used by the Commissioner in the taxable period, it has shown no right to relief; for it is apparent that a showing that average base period net income is an "inadequate standard of normal earnings," resulting in excessive discriminatory 1333 tax, is not made by the alleged "factor affecting the taxpayer's business," introduced by the petitioner, when, without adding the effect of section 713 (f) the result is less relief than already allowed. Such a factor is not one "reasonably to be considered as resulting in an inadequate standard of normal earnings during the base period," within the words of section 722 (b) (5). It is apparent also, for the reasons set forth in the Stimson case, that 33 such use of section 713 (f) sets up no "fair and just amount representing normal earnings," which is, under section 722 (a), to be used as a constructive average base period net income, but sets up only a statutory computation. It is immaterial that the petitioner does reduce, by a small amount, the full effect of applying section 713 (f) to its increased base period average, for as above seen, the petitioner is not entitled to use that section at all upon figures already increased upon its theory, and without such use the relief already afforded, in the deficiency notice and after applying section 713 (f) to the actual income, is far greater, for 95 per cent credit is based upon $ 409,623.77, while petitioner's theory, without the assistance of section 713 (f), produces only $ 307,338.64. We hold, therefore, that the petitioner has not shown itself entitled to relief under section 722.This conclusion renders it unnecessary to consider the respondent's contentions that petitioner's relief should be based upon section 734, that in relying upon the change in depreciation rates in the taxable years the petitioner, contrary to the provisions of section 722 (a), was relying upon an event 34 or condition after December 31, 1939, and that the fact that depreciation rates were lowered in the taxable years is no proof that they were improper, either in those years or in the base period years.Reviewed by the Special Division.Decision will be entered that the petitioner is not entitled to relief under section 722, and that there is a deficiency in the amount determined by the Commissioner. Footnotes1. Average allowed.↩2. Average disallowed.↩1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in the cases described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.(b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * *(5) of any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.↩2. The $ 466,466.78 is the figure used in the petitioner's application for relief. The figure used on brief is $ 464,475.92 due apparently to a correction. The figure $ 51,003.94 is corrected on brief from $ 51,618.51 used in the application, as appears above in the findings of fact.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623224/	MACO STEWART, EXECUTOR, ESTATE OF RAYMOND A. PERRY, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Stewart v. CommissionerDocket No. 63645.United States Board of Tax Appeals32 B.T.A. 442; 1935 BTA LEXIS 948; April 18, 1935, Promulgated 948 The respondent having determined the value of stock on the basis of value of corporate assets, and that method being advocated by both parties, the value is redetermined in the same way in accordance with the evidence of asset values. Eugene Meacham, Esq., Knox B. Phagan, C.P.A., and Raymond M. White, Esq., for the petitioner. Mason B. Leming, Esq., for the respondent. ARUNDELL442 OPINION. ARUNDELL: This proceeding contests a deficiency in income tax for the year 1929 in the amount of $132,712.50. The only issue is the March 1, 1913, value of stock of the Standard Dredging Co.In 1929 petitioner's decedent, Raymond A. Perry, sold 67,248 shares of stock of the dredging company at $29.89 per share, receiving a total of $2,010,042.72. The company was incorporated in 1905 and Perry acquired this stock prior to March 1, 1913. In determining the gain on the sale the respondent fixed the March 1, 1913, value at $4.21098 per share. Perry was the sole owner of the stock of the dredging company, and prior to his sale of 67,248 shares in 1929, none of the stock had been sold on any exchange or otherwise. It was not listed on any stock949 exchange. In fixing the March 1, 1913, value of the stock the respondent determined the average capital, surplus, and earnings for the five-year period 1908 to 1912, inclusive. Computing a 10 percent return on the average capital and surplus as attributable to tangibles, he capitalized the average excess earnings at 20 percent and thus reached a value for good will of $578,450.75. Adding to this good will figure a so-called "balance sheet value" of the dredging company of $673,449.41 and a "balance sheet value" of the North American Dredging Co. of Texas of $262,162, a total value of $1,514,062.16 was reached. The North American Co.'s stock was wholly owned by the Standard Dredging Co. Dividing the $1,514,062.16 value by 359,550-50/89, the number of shares outstanding, gave respondent a per share value of $4.21098. In the petition filed a March 1, 1913, value of at least $19.80 per share was claimed. Petitioner in his brief claims a value of $45.04369 per share. Petitioner's evidence was directed to showing the values of the Standard Dredging Co.'s assets at March 1, 1913. There was no evidence of any kind directly to the point of the value of the stock 443 itself. 950 The assets are separated by petitioner into four groups, namely, plant and equipment, Mexican contracts, sand deposits, and good will. The plant and equipment concerning which there is evidence consisted of mobile facilities - dredges, tugs, barges, scows, and accessories therefor. The March 1, 1913, values of these facilities were given by men who in some instances were familiar with the equipment at the basic date and in others were qualified by their experience to express values upon being furnished descriptions and photographs. Based on the testimony of the witnesses we find the March 1, 1913, value of the items comprising "plant and equipment" to be $1,500,000. The respondent's calculation as set forth in the deficiency notice does not assign a value to plant and equipment separately from other assets. It does appear, however, that the figures used by the respondent are book values. According to information in the income tax returns placed in evidence by the respondent, plant and equipment were carried at cost. According to the returns, plant and equipment owned in 1912 cost $584,853 and that owned in 1913 cost $784,100. We do not know when the increase occurred, 951 whether before or after March 1, 1913, and in the absence of any showing by the petitioner as to the time of acquisition or the amount allowed by the respondent for plant and equipment, we must assume that the respondent used the larger figure, $784,100. The petitioner has the burden of proving that the respondent used too low a figure, and where there is doubt as to which of two figures was used the doubt must be resolved against the petitioner. Consequently, we must assume that the respondent used the 1913 cost figure of $784,100 for plant and equipment in reaching the figure of $673,449.41 which he calls "Standard Dredging Company balance sheet value" in the computation set forth in the deficiency notice. We have found above the March 1, 1913, value of plant and equipment to be $1,500,000. It follows that the difference between $784,100 and $1,500,000, that is, $715,900, should be added to the $673,449.41 found by the respondent as "balance sheet value." This will result in an increase of the same amount, $715,900, in the total of $1,514,062.16 used by the respondent as the dividend in his calculation of the per share value. The Mexican contracts consisted of contracts with952 the Government of Mexico for harbor construction and dredging at Frontera, Tampico, and Salina Cruz. The Frontera contract was entered into on November 30, 1911, between an official of the Mexican Government and the North American Dredging Co. of Texas, and provided for the performance of certain work in the port of Frontera. A part of the work was to be completed within two years from the 444 date of the contract. Payment was to be made as the work progressed on what may be termed a piece-work basis, that is, at certain stipulated prices per cubic meter or ton of materials dredged or construction work performed. The Tampico contract was entered into on May 30, 1913, between the Secretary of State of Mexico and Edwin R. Davis, an employee of the Standard Dredging Co. By assignment of July 10, 1913, Davis transferred the contract to the United Dredging Co. which was a wholly owned subsidiary of the Standard Dredging Co. This contract called for the dredging of the Panuco River for a length of 13 kilometers. It was estimated that the material to be removed would amount to 10,000,000 cubic meters. The contractor was to receive an advance payment of 500,000 pesos at the953 time of delivery of machinery and equipment on location, and thereafter payment was to be made monthly on the basis of 56 cents per cubic meter of materials dredged, less a deduction of 12 percent until the advance payment was recovered. The Salina Cruz contract was entered into on November 23, 1912, between an official of the Mexican Government and the North American Dredging Co. of Texas, called therein the contractor. Under it the contractor was to dredge the harbor and the entrance canal to the dike of the port of Salina Cruz. The minimum of material to be removed was 250,000 cubic meters and the maximum was 300,000 cubic meters. The contractor was to be paid "at the rate of one peso and sixty (1.60) per cubic meter of material dredged and deposited" at specified places. The contractor was to begin work within 60 days after the date of the promulgation of the contract and complete the work within 150 days from that date. Work was started on this project in March 1913. The contractors on the Frontera and Salina Cruz projects were hampered in their work by reason of the unsettled political situation in Mexico in 1913. On both projects some of the contractors' property954 was seized and its employees harassed. On the Salina Cruz project the contractor received payments in April and May aggregating $191,010.56. Other amounts owing for dredging completed were not paid and the North American Dredging Co. filed a claim therefor in the amount of $245,308.64 with the Claims Commission, United States and Mexico. In an affidavit in support of that claim Perry stated, "As a result of the losses of the claimant company at Frontera and Salina Cruz, it became and was, wholly insolvent for a number of years." A claim was also filed with the Claims Commission on behalf of the North American Dredging Co., claiming $383,526.42 for damages and losses on the Frontera project alleged to have resulted from the acts of Mexican Government troops and revolutionary forces. The Salina Cruz claim was dismissed by the Claims Commission445 for want of jurisdiction. The disposition of the other claim is not shown. The above mentioned contracts were the first ever obtained by any American firm for dredging in Mexican waters. Prior thereto the dredging had been done by an English concern which withdrew from the Mexican field upon entry of the American companies. 955 When dredging contracts were entered into it was contemplated by the Mexican officials and the contractors that extensions of the operations would subsequently be performed by the same contractors. The contemplated extensions were omitted from the original contracts in order to keep the price as low as possible and thus avoid the appearance of expenditures by the Government of unduly large sums. In the case of the Standard Dredging Co. and its subsidiaries, contracts were subsequently executed for extensions and the removal of silt from channels. These companies also performed considerable work for private concerns in Mexico, consisting of dredging channels from private docks to the Government channels. Petitioner claims a March 1, 1913, value for the Mexican contracts of $8,000,000. This is based in the testimony of Perry and the other officers of the companies as to the amount of profits they expected to realize from the original contracts plus the expected extensions. We cannot agree with the conclusion of the witnesses. The Tampico contract was not in existence on March 1, 1913. There is testimony that an oral agreement for the performance of the work had been made prior956 to that date and all that remained to be done at March 1 was its reduction to writing. It is hard to see wherein the company whose stock we are valuing had any property or property right at March 1 which is susceptible of valuation. It had no contract, and it is scarcely possible that the oral agreement could be assigned. All that the company had at the basic date was the possibility of securing a contract which has not been shown to be susceptible of valuation. The Frontera contract called for performance of a part of the work within two years of its date, which was November 30, 1911. In the absence of a contrary showing, we must assume a compliance with the terms. There is no showing how much the contractor was to receive for the work remaining to be done at March 1, 1913. Undoubtedly a willing buyer of the contracts, if such could be found, would have heavily discounted the prospective receipts from the Frontera and Salina Cruz contracts. It is a matter of history that as early as 1912 Mexico was beset with serious political disturbances and that condition continued throughout 1913. In February 1913 Francisco I. Madero was forced from the presidency and executed. The United957 States did not recognize the government organized by his successor, Victoriano Huerta, who held office until July 1914. No doubt a prospective purchaser would have taken the political situation 446 into consideration in making any bid for the contracts. According to the claims filed with the Claims Commission, the companies here involved were adversely affected by the unsettled political conditions. The estimates of profits given by petitioner's witnesses are based on the original contracts plus the extensions. At March 1, 1913, there were no agreements for extensions sufficiently definite to be susceptible of valuation. Perry's statements to the Claims Commission indicate that the original contracts themselves resulted in losses rather than profits. Considering all the evidence, it does not convince us that the Mexican contracts had any value at March 1, 1913, substantial enough to affect the fair market value of the Standard Dredging Co. stock at that date. At March 1, 1913, the operation of raising the grade of the city of Galveston, Texas, was under way. The city had been flooded in 1900 and thereafter sea walls had been built and the plan was to fill in sand958 back of the walls and raise the grade of the city. There were two deposits of sand available for this purpose. One was in Offatt's Bayou. About 1906 Perry acquired approximately 250 acres in the bayou, which acreage was so located as to prevent the dredging of sand from any other part of the deposit for use in grade raising at Galveston. This 250-acre tract was turned over to the North American Dredging Co. of Texas upon its organization and, with other land, the total being about 407 acres, was listed as having a value of $100,000 in the certificate of incorporation. The other sand deposit was on Galveston Island, east of the city of Galveston. This land, comprising some 1,500 acres, was owned by Maco Stewart, who was Perry's friend and business associate. Stewart, prior to March 1, 1913, had orally given Perry the exclusive right to remove sand from his acreage. Others attempted to secure from Stewart the privilege of dredging sand from his acreage, but he refused, saying that that had been promised to Perry. Filling operations were started by a foreign company, but it was forced to discontinue prior to March 1, 1913, because of the lack of available sand. The contract959 for filling was taken over by the North American Dredging Co. of Texas in 1910, under an agreement whereby the North American Co. was to receive 18 1/2 cents per cubic yard of filling material. By reason of these deposits being privately owned they were exempt from the state tax imposed on the removal of material from public waters. Petitioner claims a value of $5,300,000 for the sand deposits. This is based upon the dredging company's claimed ownership or control of over 1,500 acres of sand deposits containing an estimated 53,000,000 cubic yards of sand worth 10 cents per yard. Perry's testimony, by deposition, was that he or his companies owned 1,570 acres of sand deposit in Offatt's Bayou. This was disproved, proved, 447 Stewart's testimony being that there was not that much land in the bayou, and it was developed that the total amount owned by Perry or his companies in the bayou was 250 acres. The claim now is that by reason of Perry's exclusive right to dredge from Stewart's property the value of the sand deposit on the property should be treated as an asset of the Standard Dredging Co. There are several manifest weaknesses in petitioner's claim to a value of960 $5,300,000. The testimony of two other witnesses on this subject, like that of Perry's, was based on ownership of some 1,500 acres of sand deposit in Offatt's Bayou. Perry's conclusion of value was based in part on the notion that the dredging company received "from 30 to 31 cents per cubic yard, sometimes more" for the fill at Galveston. The parties subsequently stipulated that under the contract of 1910 the company received 18 1/2 cents per yard. Perry also testified that the net profits from filling operations in the vicinity of Galveston down to 1928 were $1,895,952.61. There is no segregation of this into amounts realized before and after March 1, 1913, so we have no way of knowing whether the anticipated profits at March 1, 1913, have been realized. There is evidence that the dredging of sand from Offatt's Bayou was started in 1906, and it is entirely possible that a substantial part of the profits were made between then and 1913. It is obvious that the 1,500 or more acres of land owned by Stewart can not be treated as dredging company land merely because of oral permission given to Perry to remove sand. This was a privilege that, as far as the record shows, Stewart961 could have terminated at any time. But even assuming an indefeasible right in the dredging company to remove sand, there is no showing of how much sand would be needed to complete the Galveston filling operations, nor is there any showing that the sand was of any value for any other purpose. For all we know, it is quite possible that only a fraction of the sand deposits would be necessary after March 1, 1913, in the filling operations then in view. Considering all the evidence, we are not convinced that the dredging company's sand deposits and its right to dredge from Stewart's land had a value at March 1, 1913, in excess of $100,000. According to counsel for the respondent, in stating the issues, and not questioned by counsel for petitioner, the amount of $100,000 has been included by the respondent in tangible assets for the purpose of figuring the value of the stock. Good will is claimed to have had a value of $1,500,000. The testimony of the witnesses ranged all the way from $1,000,000 to $5,000,000 for the value of good will. Upon analysis, the testimony does not support the conclusions expressed. The only witness who explained his method of computation appears to962 have had in mind 448 the value of all properties, tangible and intangible. The respondent in determining the value of the stock included good will as an element in the amount of $578,450.75. The evidence is not convincing that good will had any greater value. The items which we have so far considered, being those to which the evidence was directed, are only some of the elements which, in the absence of sales of stock, usually go into a determination of stock value. The other elements are entirely missing except as some few are shown in the computation upon which the Commissioner based his determination. Net income is not shown except as it appears in returns placed in evidence by the respondent. These returns for the five calendar years 1909 to 1913, inclusive, show an average annual net income of a little over $49,000. The Commissioner used $142,454.40 as "average total earnings" for the five years 1908 to 1912 in figuring good will. There is no evidence of either total assets or liabilities, consequently we do not know the amount of surplus except as shown by the respondent's computation. This computation shows a deficit for each of the years 1908 and 1909, a surplus963 of $15,206.94 for 1910, $513,447.61 for 1911, and $576,135.99 for 1912; an average of $217,642 for the five-year period. We have indicated above that the evidence does not establish the value of the sand deposits as being greater than allowed by the respondent. We have also set forth our conclusion as to the value of the plant and equipment. Ordinarily proof of value of a particular asset, or even proof of value of all assets, without more, is insufficient to establish the market value of stock. But in this case it is shown that the respondent has based his computation of stock value on asset values, and neither party now questions that method. The petitioner's evidence is directed entirely toward showing a higher value for the corporate assets, and the respondent's is directed toward sustaining the valuation he has used. In this situation, where the taxpayer establishes an asset value higher than that used by the respondent, we feel warranted in holding that the increase shown should be added to the amount used by the respondent. In this case the increase, as set out above, is $715,900 applicable to plant and equipment. The evidence as to the other items being insufficient964 to convince us of error in the respondent's determination, the other items will remain unchanged. Adding the increase of $715,900 to the value of $1,514,062.16 used by respondent as net asset value, and dividing the sum by the number of shares of stock outstanding, gives a per share value of $6.20207. This figure should be used as the basis to determine gain on the sale of stock instead of the figure of $4.21098 used by the respondent. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623225/	L. E. Carpenter & Company, Petitioner, v. Commissioner of Internal Revenue, RespondentL. E. Carpenter & Co. v. CommissionerDocket No. 54678United States Tax Court29 T.C. 562; 1957 U.S. Tax Ct. LEXIS 6; December 30, 1957, Filed 6 Decision will be entered for the respondent. Prior to 1941, the petitioner was a producer of book cloth, a chemically coated or impregnated fabric. In 1941 petitioner converted to the production of tent material for the Government. Held, under the record presented, the petitioner has not shown that any part of the income received from the production of tent material for the Government can be attributed to research and development in prior years within the meaning of section 721 (a) (2) (C), I. R. C. 1939. Jacquin D. Bierman, Esq., Edward Pesin, Esq., and Mortimer Berl, Esq., for the petitioner.Stanley W. Herzfeld, Esq., for the respondent. Mulroney, Judge. MULRONEY 562 This is a proceeding involving deficiencies asserted by the respondent and refunds claimed by the petitioner as follows:YearTaxDeficiencyRefundclaimed1942Excess profits1 $ 242,596.761943Excess profits94,342.341944Income$ 34,650.33Excess profits47,395.671945Excess profits19,308.2647,841.177 The sole issue presented for our determination is whether petitioner derived abnormal income during the taxable years 1942 through 1945 which can be attributed to its prewar research and development extending over a period of more than 12 months within the meaning of section 721 (a) (2) (C) of the Internal Revenue Code of 1939.563 FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.L. E. Carpenter & Company, hereinafter referred to as the petitioner, was incorporated in New Jersey in 1925 and maintained its principal offices in Wharton, New Jersey. Its corporation income and excess profits tax returns for the period here involved were filed with the then collector of internal revenue, Newark, New Jersey.Petitioner filed its excess profits tax return for 1942 on May 15, 1943. Payments were made thereon on the following dates and in the following amounts:1942Mar. 15, 1943$ 79,770.00June 26, 194376,724.46Sept. 15, 194378,247.23Jan. 1, 194478,247.23Mar. 1, 194623,127.40Total336,116.328 On January 28, 1948, the petitioner filed a claim for relief under section 721, I. R. C. 1939, asking for a refund of excess profits tax in the amount of $ 242,596.76 paid for 1942. Petitioner now admits that such claim was not timely except insofar as it includes the March 1, 1946, payment of $ 23,127.40.The petitioner filed timely claims for relief and refund under section 721 for the years 1943, 1944, and 1945. In the petition filed herein the petitioner claimed refunds in the amounts of $ 94,342.34, $ 47,395.67, and $ 47,841.17 for the years 1943 through 1945, respectively, which claims were disallowed in full by the respondent.The petitioner began its operations in 1925 as a manufacturer of what is commonly called imitation leather. The essential nature of the operation was to lay successive coats of a pyroxylin solution on top of a fabric base with as little penetration as possible to reach a desired thickness. The machine used in this operation to coat the fabric was a standard-type coating machine. The principal user of petitioner's product was the bookbinding trade which used it as book cloth.The Holliston Mills, Inc., hereinafter referred to as Holliston, was a major9 manufacturer of a starch-filled water-soluble book cloth and also acted as distributors of petitioner's product to the bookbinding industry. On February 1, 1932, petitioner and Holliston entered into a contract by which petitioner sold to Holliston that part of its business consisting of the manufacture and sale of pyroxylin-coated fabrics for the bookbinding and window shade trades. By this contract petitioner transferred machinery and equipment to Holliston for two complete coating units and agreed to furnish the pyroxylin 564 solution for the successful production of "Sturdite," the trade name of petitioner's product.The contract provided that petitioner would not manufacture or sell pyroxylin-coated fabrics to the bookbinding or window shade trade for 5 years and that for the same period Holliston would produce such fabrics only for such trade. The agreement also provided that L. E. Carpenter, who was one of petitioner's incorporators and will hereinafter be referred to as Carpenter, would work for Holliston for 1 year. He was to devote his efforts "to directing, supervising and assisting in the work of installing the necessary machinery as aforesaid, the attainment10 of successful commercial production of the Sturdite bookbinding and shade cloth products in said Norwood and the development of a new type or types of fabric now contemplated by the parties hereto as may be necessary to those ends." The new fabric mentioned was a pyroxylin-impregnated book cloth which at least two other companies had been producing commercially since 1930 or early 1931.One of petitioner's foremen, Levi B. Cushman, was sent by petitioner to help install the machinery and get production started at Holliston. Petitioner had not, prior to this time, commercially produced an impregnated fabric. Within 2 or 3 months, with the help of Carpenter and Cushman, Holliston produced a commercially acceptable pyroxylin-impregnated fabric.A coated fabric such as Sturdite is obtained by laying a continuous film of solution on top of the fabric. An impregnated fabric is obtained by driving the compound or solution into the fibers of the fabric by the use of pressure blades or doctor knives. There are two principal methods of applying the solution. The "puddle method" called for a puddle of solution to be applied separately to each side of the fabric in front of the blades which11 forced the solution into the fabric, one side at a time. Another method was the so-called bath method whereby the fabric passed through a solution-filled trough after which the solution would be driven into both sides of the fabric in the same operation by the pressure exerted by the doctor knives. The puddle method was superior for book cloth production as only one side of the fabric was impregnated. The bath method was superior for impregnating duck fabric to be used by the Army for tent purposes as thorough impregnation was required.The basic components of the solution or compound, commonly referred to as dope, which is used to coat or impregnate fabric to gain certain characteristics, are essentially the same as in paint or any other coating material. They are (1) a film former or binder, which binds together the other components of the solution; (2) a 565 plasticizer, which lends pliability to the treated fabric; (3) pigments, which color the fabric; and (4) solvents, which regulate the viscosity of the compound. The formula and nature of the chemicals used in making up these components determine the characteristics of the fabric as to flameproofness, weather resistance, 12 pliability, etc.Petitioner's principal business after the sale to Holliston was the manufacture and sale of artificial leather or pyroxylin-coated fabrics other than book cloth. Most of these fabrics were treated with a solution containing nitrocellulose which is highly inflammable. In 1935 petitioner was released from its agreement not to deal in the bookbinding and window shade trade and reentered that business, producing pyroxylin-impregnated book cloth.In mid-1941, petitioner learned that the Government was seeking processors who could render duck flameproof, waterproof, and weatherproof for tent purposes. Petitioner decided that it could qualify as a processor, presented an acceptable sample of treated duck, and thereafter received its first Government order for processing duck in 1941. From that date through the taxable years before us petitioner devoted most of its time and equipment to the production of treated duck for the Government. Prior to 1941 petitioner had never attempted to produce any fabric treated to the specifications required by the Government.Because petitioner had been approved as a processor of duck, petitioner was asked to bring in other companies13 which could be converted to produce the treated fabric. In March 1942 petitioner entered into contracts with Holliston, Weymouth Art Leather Company, Suntex, Inc., and Coated Textiles, Inc. Under the contracts petitioner was required to give the other companies full information as to chemical formulation of the solution which was to be used to meet the Army specifications. Petitioner was also obligated to instruct these companies as to methods of application and the procurement of raw materials.The machinery used by petitioner was not developed by petitioner but was in common usage prior to the existence of petitioner. Standard coating machines were used not only for coating fabrics but for impregnating fabrics after certain adjustments were made. These adjustments required manipulative skills which could be made on the foreman level in a shop and compared technically with the adjustments made by a lathe operator. Petitioner was not the first to convert a standard coating machine to one used in impregnating fabrics.The bath method of impregnating fabric was not developed by petitioner. This method is very old and is generally used in the dyeing industry and waterproofing 14 industry. Petitioner began its 566 Army duck operation using the standard coating machine with a coating head to impregnate the duck. The method was determined to be unsatisfactory as to waterproofness and in December 1942, petitioner suggested to Holliston and to petitioner's other subcontractors that they adopt the bath method of impregnation which was being used by one of petitioner's subcontractors, Weymouth Art Leather Company, hereinafter referred to as Weymouth. Thereafter the bath method of impregnating fabric was used.The chemical formula for flameproofing wartime duck and that used for producing pyroxylin-coated or -impregnated book cloth are fundamentally different formulas for fundamentally different products, even though both contain (1) a film binder or former, (2) a plasticizer or softener, (3) a pigment, and (4) a solvent. Prior to 1941 only three firms were commercially producing flameproof fabrics. Flameproofing was a comparatively new process and petitioner had never commercially produced such goods prior to 1941.In 1938 Gustave E. Landt, a pioneer in the field of flameproofing fabrics, developed, after years of work, the most effective flameproofing15 combination of elements known. This solution contained a combination of antimony oxide and chlorinated hydrocarbons. Calcium carbonate was also a vital ingredient in this formula. This combination satisfied the required specifications of the Army duck program during the taxable years. Prior to 1941 petitioner had never used antimony oxide in combination with a chlorinated hydrocarbon but did use this formula in producing treated duck for the Army tent program during the taxable years. By the end of 1941 most companies attempting to flameproof fabrics were using the combination of agents developed by Landt.Most of petitioner's products prior to 1941 were coated or impregnated with a nitrocellulose solution which is highly inflammable. Efforts were made on some of these products to make them fire resistant by adding such flameproofing agents as tricresol phosphate and boric acid. The use of nitrocellulose in a solution defeats the purpose of adding a flameproofing agent.None of the flameproofing agents used by petitioner prior to 1941 and none of the fireproofing agents known in the early 1930's was used as such an agent in Army tent production during the war. These agents16 were not used because they were too water soluble or they would not give the extended resistance to wear and tear that was required.The chlorinated hydrocarbon used with antimony oxide was changed several times during wartime production because of scarcities. Each time a change was made, new proportions of antimony oxide to chlorinate hydrocarbons had to be worked out to achieve the same 567 results. Eight or ten changes in formula were made by petitioner during the years in question and each change required a period of experimentation and testing.No part of petitioner's income during the years 1942 through 1945 resulted from exploration, discovery, prospecting, research, or development by petitioner of tangible property, patents, formulas, or processes, or any combination of the foregoing extending over a period of more than 12 months.OPINION.Petitioner has filed a claim for refund of excess profits tax under the provisions of section 721, I. R. C. 1939. 1 The issue before us is to determine whether or not petitioner received net abnormal income in the years before us which is attributable to prior years within the meaning of the cited sections of the Internal Revenue17 Code of 1939.18 The petitioner contends that it did receive such income of the class set out in section 721 (a) (2) (C), I. R. C. 1939, which is set out in the margin. This income, petitioner asserts, resulted from its research and development in the field of fabric impregnation over a period extending from 1927 through 1939. The respondent, on the other hand, contends that no part of the tremendous income received by petitioner in the years before us resulted from any research or development carried on by the petitioner. Upon the record presented, we agree with the respondent.568 The petitioner, since its incorporation in 1925, has been in the business of treating fabrics with chemical solutions to achieve certain desired characteristics. The principal product of petitioner in the beginning was a coated fabric commonly known as imitation leather. Petitioner's principal market for the product was the bookbinding trade. At first petitioner coated the fabric with the solution, laying a film of the solution on top of the fabric. Later petitioner saturated or impregnated the fabric with the solution. Impregnation was achieved by two methods, i. e., the puddle method, whereby only one side19 of the fabric was treated at a time, and the trough method, whereby the fabric was immersed in the solution and impregnated through and through by the pressure applied by knives, bars, or rollers to each side of the fabric. The puddle method was best for book cloth as only one side of the fabric was impregnated. The bath method was superior for the duck program as more thorough saturation was necessary for waterproofing purposes. Both methods were well known in the trade.The machines used by petitioner for both coating and impregnation and for both book cloth and Army duck, were standard coating machines. The machines required some modifications when used for impregnating fabrics.The solution used by petitioner generally in its book cloth production was a pyroxylin formulation which contains nitrocellulose, a highly inflammable agent. Generally the principal agents of the solution used for the duck program were chlorinated hydrocarbons, antimony oxide, and calcium carbonate.There is no argument but that the great profits of petitioner were derived for the most part from the processing of a fabric known as duck for the Armed Forces. The petitioner's efforts were devoted toward20 the impregnation of the duck with a chemical compound or solution so as to render the fabric flameproof, waterproof, and generally weather resistant so that it might be suitable for tent purposes.Petitioner's argument is not that its research and development were carried on over the years looking to the production of flameproof, waterproof, etc., duck, the product from which its profits were derived. Its argument is that because of its research and development in the fabric impregnation field in general and its development of an impregnation process, it was able efficiently and quickly to produce the required duck for the Armed Forces. Petitioner's problem therefore is to prove that its research and development in the fabric impregnation field extending over a period exceeding 12 months so affected its production of treated duck that its increase in income during the years before us, at least in part, can be attributed to that research and development.569 Petitioner contends that it developed, through its own research and development, the process, which includes the machinery, the formulation, and the technique for impregnating fabric of all types, including duck, to meet21 required specifications. We do not think that the record supports the contention.Let us first consider the machinery used by the petitioner. It is admitted by petitioner that none of the coating machines used were invented by petitioner. The machines used from the beginning were standard coating machines which had been in use long before petitioner was incorporated. There was evidence that the machines were in use as far back as 1915.What petitioner does contend is that the modifications necessary to be made on the standard coating machine to convert it from a coating machine to an impregnating machine were developed by petitioner. While petitioner's witness, L. E. Carpenter, one of petitioner's incorporators and present chairman of the board, made this contention in his direct testimony, he seemed to admit on cross-examination that petitioner did not develop the modifications. He testified that the major changes necessary to be made in converting the machines were: Altering the sharpness and angle of the knives which are used to drive the compound into the fabric, and altering the speed and tension at which the fabric is passed through the machine. Carpenter then admitted22 that petitioner was not the originator of the changes made in the angle of knives, sharpness of knives, tension and speed of fabric passed through the machine.There was also evidence that the changes described by Carpenter were made, usually on the foreman level, in the shops. Gustave E. Landt testified that a degree of manipulative skill similar to that of a lathe operator was necessary to make the adjustments on the standard coating machine, and that scientific knowledge was not necessary.There is also evidence in the record to the effect that if these modifications were developed by anyone connected with petitioner, the development came while these employees were working for Holliston and did not extend over a period exceeding a year as required by the statute. The sales agreement between petitioner and Holliston not only provided for the sale of coating machines and a pyroxylin-coating process, but provided that L. E. Carpenter would work for Holliston and devote himself, among other things, to the "development of a new type or types of fabric now contemplated by the parties." It is obvious from the record that the new fabric contemplated, but yet to be commercially developed, 23 was a pyroxylin-impregnated book cloth.Levi B. Cushman, an employee of petitioner from 1925 to 1932, was sent to Holliston by petitioner in 1932 as a foreman to aid in the 570 installation of machinery and getting production started. He testified that petitioner had never commercially produced an impregnated fabric prior to the sale to Holliston and that such a fabric was developed at Holliston and commercially produced, using the puddle method of application, within 2 or 3 months after the sale. It thus appears that the modifications made on the standard coating machines may have been developed by Holliston, if at all, within a few months in 1932. In any event, petitioner has not proven that it, by its own research and development, developed any of the machinery used in the impregnation of duck for the Armed Forces.Petitioner contends that it developed the bath method or technique of impregnation. The fact is that petitioner's own witness, Thomas D. Lewis, stated that the bath method of immersing fabric and the use of knives or bars to impregnate fabric was as old as "Omar and the first beeswax." L. E. Carpenter stated that he developed the bath process on June 10, 1932. 24 On this date Carpenter was supposed to be under contract to Holliston, devoting time and effort toward the development of a new type (impregnated) fabric. Also on this date Carpenter wrote a letter to Holliston in which he related the fact that he had run an experiment at a firm by the name of Goodlatte's, using their saturating machine. A rough sketch of Goodlatte's saturating machine, which employed the bath method, was enclosed.First of all, if Carpenter developed the bath method or process of impregnation to any extent at all, it is not clear whether he did so while working for petitioner or for Holliston. Second, if he developed the process on or prior to June 10, 1932, we wonder why he found it necessary to run experiments, obviously for Holliston, on a bath assembly of another firm. We also wonder why Carpenter enclosed a sketch of Goodlatte's saturating machine when petitioner had allegedly already developed such a machine.Another oddity in petitioner's evidence is that, although petitioner contended that it developed the bath method of impregnation and determined that such method was superior to the puddle method, the petitioner began the duck program using the puddle25 method instead of the bath process. From the allegations made in petitioner's claim for relief and memorandum of additional information, one would gather that only the bath method of impregnation was used in the duck program. On trial it was disclosed that as late as December 1942 petitioner was using the puddle method and only changed to the bath method when complaints of poor impregnation were received. Petitioner then recommended that its subcontractors adopt a bath assembly process, not the bath assembly that petitioner had allegedly developed, but an assembly already in use by one of petitioner's subcontractors.571 We think all this evidence strongly indicates that petitioner did not, through its own research, develop the bath method of impregnating fabrics which was used during most of the years before us for the production of duck. There can be little doubt that petitioner had an experienced, efficient book cloth impregnating plant by 1941. No doubt its personnel were well qualified and skilled in the art of coating and impregnating book cloth. We think, however, that petitioner has mistaken such skill and efficiency for research and development. Just because 26 petitioner had the personnel skills and the machinery which could be converted to the efficient production of duck does not necessarily mean that petitioner had developed anything within the meaning of section 721 (a) (2) (C), I. R. C. 1939.We come now to petitioner's contention as to the development of the formulation used in the duck program. Petitioner did not originally contend in its refund claim and memorandum of additional information, that the chemical formula used in the duck program was a result of its research and development in the flameproofing field. There, as we have stated, petitioner's principal claim of development was a "process" of impregnating fabrics by immersing the fabric in a bath and forcing the solution into the fabric with knives. It was only at the trial of this case that petitioner attempted to prove some connection between the fireproofing formula used in the duck program and its research.We think that petitioner has failed to prove that its independent research and development in chemical formulations effected any increase in petitioner's income in the years before us. The most important elements in the formula approved by the Armed Forces and 27 used for the duck program were antimony oxide, a chlorinated hydrocarbon, and calcium carbonate. We have found as a fact that petitioner, prior to 1941, had never used these elements together. In fact, petitioner did not attempt to prove that it, prior to 1941, had even experimented with these elements.Petitioner's chemical development argument therefore is not directed toward the particular, specific formula used in the duck program. The argument is that because of its development of chemical formulation to achieve given characteristics, in general, that it could and did come up with this particular formula within 2 weeks after receiving the specifications.In the light of the testimony of Gustave E. Landt, an eminent personality in the field of chemical research, especially in the flameproofing field, the argument by petitioner appears doubtful. Landt testified that the chemical formulas used by petitioner prior to 1941 and the formula used in the duck program were fundamentally different, even though both of these formulas and all coating-type 572 solutions contain a film former or coater, a plasticizer, a pigment, and a solvent. Landt further testified that he developed28 the use of antimony oxide, in combination with the other elements mentioned, in 1938 after about 5 years of intensive research. We simply do not believe that petitioner could have come up with the same formula within 2 weeks as a result of its general research and development in pyroxylin impregnation of book cloth prior to 1941.We think that petitioner was selected as a processor of duck for the Armed Forces, not because it had developed anything, but because it had the machinery, experience, and skill in the impregnation field which could be easily converted to the wartime program. There were only three firms which were in the flameproofing field prior to 1941 and petitioner was not one of them. Waterproofing firms were chosen, leather firms were chosen, along with book cloth firms, not because these firms had developed machinery, formulas, or anthing else. They were chosen because they could convert to the production of impregnated duck with the least amount of confusion.Because petitioner was skilled in the field and got in the duck program early, the Government asked petitioner, as a prime contractor, to bring in other firms. Petitioner brought in several firms which began29 as subcontractors under petitioner and which paid petitioner a certain amount per yard of fabric treated for the Government. At the trial of this case, petitioner argued that these firms were licensees and the sums paid were royalties for the use of petitioner's formulation or process which, of course, it had developed. This argument is directly contradictory to contentions made by petitioner to officials of the Quartermaster Corps when petitioner's dealings with its subcontractors came under examination for possible renegotiation under the Royalty Adjustment Act of 1942. At that time petitioner contended that the payments it received were not royalties for the use of an exclusive process but were payments largely for technical services rendered.It is not necessary for us to determine whether or not the payments received from firms such as Holliston and Weymouth were royalties for the use of a process or were fees for technical services, as we have already determined that petitioner did not develop the machinery, the formula, nor the technique for processing duck. We might state in passing, however, that we fail to understand what "process" Holliston would have been licensing30 from petitioner. Petitioner had, in 1932, sold Holliston machines and had sent Levi Cushman and L. E. Carpenter to work with Holliston to install the impregnation process at Holliston. As far as we know, Holliston had the same machinery and skills for impregnating fabric as did petitioner in the years before us. The only thing Holliston would have needed to license from 573 petitioner would have been the flameproof formula, which petitioner developed in 2 weeks, if at all.Certainly Weymouth would not have found it necessary to license the bath method of saturating fabric from petitioner as petitioner in 1942 suggested that other contractors adopt the bath method already in use by Weymouth.Since our problem here is completely factual, it would be useless to cite authorities as we have found no case with similar facts. Pantasote Leather Co., 12 T. C. 635, which petitioner cites as having "virtually identical circumstances," is no aid to us. In that case it seemed to be agreed that the taxpayer had spent many years developing the very product which brought in the agreed abnormal income. The only issue in the case was whether the abnormal income31 was attributable to that development of prior years, or to other criteria in the years in which the income was received. Here we have determined that the research and development of petitioner, if any, in producing pyroxylin book cloth had no bearing on its wartime income from flameproof, waterproof, and weather-resistant duck for the Armed Forces.Reviewed by the Special Division.Decision will be entered for the respondent. Footnotes1. The petitioner now concedes that $ 219,469.36 of its claimed refund for the taxable year 1942 is barred by the statute of limitations, leaving a claimed refund of $ 23,127.40 for 1942.↩1. SEC. 721. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.(a) Definitions. -- For the purposes of this section -- (1) Abnormal income. -- The term "abnormal income" means income of any class includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years, or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence.(2) Separate classes of income. -- Each of the following subparagraphs shall be held to describe a separate class of income: * * * (C) Income resulting from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months; or * * *(3) Net abnormal income. -- The term "net abnormal income" means the amount of the abnormal income less, under regulations prescribed by the Commissioner with the approval of the Secretary, (A) 125 per centum of the average amount of the gross income of the same class determined under paragraph (1), and (B) an amount which bears the same ratio to the amount of any direct costs or expenses, deductible in determining the normal-tax net income of the taxable year, through the expenditure of which such abnormal income was in whole or in part derived as the excess of the amount of such abnormal income over 125 per centum of such average amount bears to the amount of such abnormal income.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623227/	Estate of Robert Poletti, Deceased, LaBarbara T. Poletti, Personal Representative & LaBarbara T. Poletti, Petitioners v. Commissioner of Internal Revenue, RespondentEstate of Poletti v. CommissionerDocket No. 11500-90United States Tax Court99 T.C. 554; 1992 U.S. Tax Ct. LEXIS 83; 99 T.C. No. 29; November 9, 1992, Filed 83 Decision will be entered for respondent. The Ute Partition Act of 1954 (UPA), now codified as amended in 25 U.S.C. secs. 677-677aa, was one of a series of statutes enacted during the 1950s to reduce Federal involvement in Indian affairs. In response to the desires of a majority of the full-bloods and the mixed-bloods of the Ute Tribe, respectively, UPA provided for the termination of Federal supervision of the property of the mixed-bloods, which was distributed to them individually. However, as to tribal property not susceptible of equitable and practicable distribution (primarily oil rights under lease to oil companies), such nondivisible property was retained and placed in a corporation, Ute Distribution Corp. (UDC), organized pursuant to UPA. The UDC shares were distributed proportionately to the mixed-bloods individually, and the remaining shares were kept undistributed for the benefit of the full-bloods. Each mixed-blood received 10 shares, which were freely transferable, by sale or otherwise, even to non-Indians. T, a mixed-blood, received her 10 shares. UDC managed the nondivisible tribal assets for the benefit of the mixed-bloods84 and the full-bloods jointly; it collected the income generated by those assets which it distributed accordingly. In 1983, T received distributions from UDC aggregating $ 7,000. Held, distributions from UDC were taxable income in T's hands. 25 U.S.C. sec. 677p (1982); Ute Distribution Corp. v. United States,721 F. Supp. 1202">721 F. Supp. 1202 (D. Utah 1989), affd. on this issue 938 F.2d 1157">938 F.2d 1157 (10th Cir. 1991). Held, further, the result herein is not limited to prospective operation from the date or year of this opinion. D. James Manning and Kent Arthur Higgins, for petitioners.Joel A. Lopata, for respondent. Raum, Judge. RAUM555 OPINIONRaum, Judge:The Commissioner determined a deficiency of $ 1,538 in petitioners' income tax for the year 1983. Petitioners are LaBarbara T. Poletti and the estate of her late husband. She and her husband had filed a joint income tax return for 1983. At issue is whether distributions in the aggregate of $ 7,000 made by Ute Distribution Corp. (UDC) to Mrs. Poletti (petitioner) in 1983 were exempt from taxation by reason of 25 U.S.C. section 677p85 (1982). The facts were stipulated.Petitioner resided "near" Pocatello, Idaho, at the time the petition herein was filed. She is the duly appointed and acting personal representative of her husband's estate, which is being administered in Idaho.UDC was created pursuant to the Ute Partition Act of 1954 (also the Act or UPA), 1 now codified as amended in 25 U.S.C. secs. 677-677aa (1982). 286 The Act was one of a series of statutes enacted by Congress during the 1950s to reduce Federal involvement in Indian affairs. 3 The stated purposes of the Act were: (1) To provide for the partition and distribution of the assets of the Ute Indian Tribe of the Uintah and Ouray Reservation in Utah between the mixed-blood and full-blood members thereof; (2) to terminate Federal supervision over the mixed-blood members' property; and (3) to assist the full-blood members to prepare for termination of Federal supervision of their property. Sec. 677. One of the problems that the Act sought to address was the difference in attitudes of the full-blood and mixed-blood members, respectively, about their readiness for termination. "[T]he majority of the mixed-blood group [felt] that they [were] ready for a termination of Federal supervision over their property and the fullblood Indians [believed] that they [were] not ready for such action." H. Rept. 2493, 83d Cong., 2d. Sess. (1954); S. Rept. 1632, 83d Cong., 2d Sess. (1954). 556 The Act dealt with the situation by providing for the partition of tribal assets between the mixed-bloods and the full-bloods, followed by the distribution to the mixed-bloods of the assets allocable to them.The partition was accomplished by first preparing rolls of the full-bloods and the mixed-bloods. Sec. 677g. The assets that were readily susceptible of division were then divided between the respective groups of full-bloods and mixed-bloods based upon the relative number of persons in the membership roll of each group. Sec. 677i. Provision87 was then made for the distribution to the individual members of the mixed-blood group of the divisible assets allocated to that group. Secs. 677l and 677m. Federal supervision over the mixed-bloods with respect to those assets was ended. Sec. 677o.Federal supervision over each mixed-blood member and his property was, however, not terminated "as to his remaining interest in [certain] tribal property" such as unadjudicated claims against the United States, oil and mineral rights, and "other tribal assets not susceptible to equitable and practicable distribution." Sec. 677o. The nondivisible assets, which in large part consisted of subsurface oil, gas, and other mineral rights, were to be managed jointly by the Tribal Business Committee (TBC) on behalf of the full-bloods and by the authorized representative of the mixed-blood group, and the proceeds therefrom were to be "divided between the full-blood and mixed-blood groups in direct proportion to the number of persons comprising the final membership roll of each group". Sec. 677i. Pursuant to section 677i, the mixed-bloods organized the Affiliated Ute Citizens (AUC) and empowered AUC's board of directors to act as their authorized88 representative. The mixed-bloods thereafter approved a plan for dividing the tribal assets that was adopted by the TBC and the AUC. Under the plan, the mixed-bloods' share of the divisible assets was directly transferred to the mixed-bloods. With respect to the nondivisible assets, however, the plan provided for the formation of a corporation (UDC) that was jointly to manage the assets with the Tribal Business Committee, receive the income therefrom that represented the share of the mixed-blood group, and distribute that income to its shareholders. 489 557 Upon removal of Federal restrictions on the distributable property of each individual member of the mixed-bloods, section 677v required the Secretary of Interior to publish in the Federal Register a proclamation stating that the trust relationship of the United States to each such person was terminated. 5 That proclamation was published by the Secretary effective August 27, 1961. 26 Fed. Reg. 8042.90 As part of the distribution plan, each mixed-blood was to receive 10 shares of UDC stock, which entitled the holder to vote for mixed-blood delegates and to share in the proceeds of the jointly managed assets. However, when a mixed-blood sold his or her shares, that person no longer would have a voice in management of the undivided assets or any rights therein.Mrs. Poletti is a mixed-blood Ute Indian who received her shares in UDC as part of the original distribution of shares to mixed-blood Ute Indians.UDC receives trust funds collected by the Bureau of Indian Affairs, Department of the Interior, on lease and royalty agreements with oil companies, which funds are periodically distributed to the UDC shareholders. During 1983, Mrs. Poletti received distributions from UDC aggregating $ 7,000 which consisted of her share of the revenues collected by UDC pursuant to the agreements just described, and which were paid to her by reason of her ownership of stock in UDC.The Commissioner determined that the $ 7,000 distributions to petitioner represented "taxable income" that should have been reported in the 1983 joint return filed by petitioner and her husband. We sustain the Commissioner. 91 Preliminarily, we note first that in our income tax law Congress intended to exert "the full measure of its taxing 558 power." HCSC-Laundry v. United States,450 U.S. 1">450 U.S. 1, 5 (1981); Helvering v. Clifford,309 U.S. 331">309 U.S. 331, 334 (1940). Second, Indians are citizens and are liable for the payment of Federal income taxes, unless exempted by applicable treaties or remedial legislation. Squire v. Capoeman,351 U.S. 1">351 U.S. 1, 6 (1956); Estate of Shelton v. Commissioner,68 T.C. 15">68 T.C. 15, 21 (1977). However, as stated by the Court in Estate of Shelton v. Commissioner, supra at 21: "While the general rule requires tax exemptions to be clearly expressed, statutes affecting Indians are liberally construed, with all doubtful expressions resolved in their favor." Nevertheless, as explained hereinafter, we conclude that the statute leaves no room for doubt that the distributions received by petitioner from UDC are taxable.The taxability of distributions of Ute tribal assets and related income among the tribe members is not mentioned anywhere in the 92 Internal Revenue Code. It is, however, dealt with in the Ute Partition Act of 1954, which, as noted above, is now codified as amended in 25 U.S.C. secs. 677-677aa (1982). At issue here is the effect of section 677p, pertinent parts of which are as follows:Sec. 677p. Tax exemption; exceptions and time limits; valuation for income tax on gains or lossesNo distribution of the assets made under the provisions of this subchapter shall be subject to any Federal or State income tax * * * Property distributed to the mixed-blood group pursuant to the terms of this subchapter shall be exempt from property taxes for a period of seven years from August 27, 1954, unless the original distributee parts with title thereto, * * . After seven years from August 27, 1954, all property distributed to the mixed-blood members of the tribe under the provisions of this subchapter, and all income derived therefrom by the individual, corporation, or other legal entity, shall be subject to the same taxes, State and Federal, as in the case of non-Indians; except that any corporation organized by the mixed-blood members for the purpose of aiding in the joint management93 with the tribe and in the distribution of unadjudicated or unliquidated claims against United States, all gas, oil, and mineral rights of every kind, and all other assets not susceptible to equitable and practicable distribution shall not be subject to corporate income taxes. * * * [Emphasis supplied.]It is quite true that the first sentence of section 677p does provide for tax exemption. But subsequent qualifying language unambiguously states that after 7 years from August 27, 1954, "all property distributed to the mixed-blood[s]559 * * and all income derived therefrom * * , shall be subject to the same taxes, State and Federal, as in the case of non-Indians". This language explicitly covers the 1983 distributions to petitioner with respect to her shares of stock in UDC. We reject petitioners' strained and unnatural interpretation of the statute -- an interpretation that would authorize taxation after August 27, 1961, only of "property which has in fact been distributed to mixed-blood members and the income derived therefrom," petitioners' opening brief, at 10, and that "no tax was intended by Congress on distributions." Petitioners' reply brief at 9. This unnatural94 interpretation of the statutory language is particularly unpersuasive here, since the UDC shares had already been distributed to the mixed-bloods, and what is involved in this case is the income derived from those shares which is reflected in the distributions made with respect to such shares.In sharp contrast to the provision authorizing taxation after 7 years from August 27, 1954, is the exception thereto, immediately following in the same sentence. That exception explicitly exempts from income tax any corporation organized by the mixed-bloods to aid "in the joint management with the tribe [i.e., the full-bloods as a group] and in the distribution of * * * all gas, oil, * * * and all other assets not susceptible to equitable and practicable distribution". Sec. 677p. Such exemption was obviously appropriate in view of the fact that the full-bloods, who were still wards of the United States, had a stake in the management of the assets jointly owned with the emancipated mixed-bloods. But the status of the mixed-bloods as individuals was an entirely different matter. And the status of the property of the mixed-bloods, as well as the nature of UDC stock itself, was described by95 the Supreme Court in Affiliated Ute Citizens v. United States,406 U.S. 128">406 U.S. 128, 149-150 (1972), as follows:The proclamation of August 26, 1961, was contemplated by sec. 23 of the Act, 25 U.S.C. sec. 677v. To the extent the nature of the property so permitted, this marked the fulfillment of the purpose set forth in sec. 1 of the Act, 25 U.S.C. sec. 677, namely, the termination of federal supervision over the trust and restricted property of the mixed-bloods. It stated specifically that the mixed-blood thereupon "shall not be entitled to any of the services performed for Indians because of his status as an Indian." This broad reference obviously included the shares of UDC although the undivided 560 interests in turn held by UDC and shared with the full-bloods remained subject to restrictions after the proclamation. Sec. 16(a), 25 U.S.C. sec. 677o(a). The UDC stock itself, however, was free of restriction; as to it, federal termination was complete. Each mixed-blood could sell his shares as he wished and to whom he pleased, subject96 thereafter only to the restrictions imposed by UDC's own articles. * * [Emphasis supplied.]Surely, Congress could hardly have intended distributions to the non-Indian purchaser of UDC shares of stock to be subject to tax while at the same time exempting from tax the distributions to a mixed-blood in respect of his retained shares. Both the non-Indian owner and the mixed-blood owner of shares of stock stand on the same footing with respect to their relationship to UDC. To differentiate between them in these circumstances would indeed be inappropriate in view of the general objective of the statutes enacted during the 1950s looking towards the integration of the Indians in our society.The result that we reach here is in accord with Ute Distribution Corp. v. United States,721 F. Supp. 1202">721 F. Supp. 1202 (D. Utah 1989), affd. on this issue 938 F.2d 1157">938 F.2d 1157 (10th Cir. 1991), where the precise question was considered in exhaustive opinions by both the District Court and the Court of Appeals. Among the parties in that case were four stockholders seeking refunds of taxes paid with respect to distributions by UDC. Two of them were original97 mixed-blood stockholders, another was a full-blood who elected to be terminated pursuant to the Act and had acquired additional shares by inheritance, and the fourth was a non-Indian who had purchased his shares. It was held in that case that the distributions to all of these stockholders were taxable in accord with section 677p. Petitioners do not argue that the case is not in point, but they urge us to reach the opposite result. We decline to do so. Here, as in that case, petitioner received her distributions not because of her status as a mixed-blood Ute Indian but because of her shareholdings in UDC. It should be remembered that, like other Indian termination statutes, the Ute Partition Act reflects a broader congressional policy of making Indians "as rapidly as possible * * subject to the same laws and entitled to the same privileges and responsibilities" as non-Indian citizens and thereby "end[ing] their status as 561 wards of the United States." H. Con. Res. 108, 83d Cong., 1st Sess. (1953); see also Cohen, Handbook of Federal Indian Law 171-175 (1982 ed.).Although the District Court in the Ute Distribution Corp. case held that the distributions were taxable98 to the stockholders, it held further that it would apply its decision prospectively only; i.e., to distributions "[commencing] with the tax year 1989." 721 F. Supp. at 1208. The Court of Appeals reversed as to this aspect of the District Court's opinion. The parties herein do not seem to address this point. We decline to limit our holding to make it prospective only. The Supreme Court in United States v. Estate of Donnelly,397 U.S. 286">397 U.S. 286, 294-295 (1970), stated:Acts of Congress are generally to be applied * * * from the date of their effectiveness onward. Generally, the United States, like other parties, is entitled to adhere to what it believes to be the correct interpretation of a statute, and to reap the benefits of that adherence if it proves to be correct, * * . In rare cases, decisions construing federal statutes might be denied full retroactive effect, as for instance where this Court overrules its own construction of a statute * . [Emphasis supplied.]See also Benedict Oil Co. v. United States,582 F.2d 544">582 F.2d 544, 549 (10th Cir. 1978); C. Blake McDowell, Inc. v. Commissioner,71 T.C. 71">71 T.C. 71, 73-74 (1978),99 affd. 652 F.2d 606">652 F.2d 606 (6th Cir. 1980).Decision will be entered for respondent. Footnotes1. Ute Partition Act of 1954, ch. 1009, secs. 1-28, 68 Stat. 868.↩2. Except as otherwise indicated, section references herein are to the Ute Partition Act, as codified in 25 U.S.C.↩3. See Cohen, Handbook of Federal Indian Law 152-180 (1982 ed.).↩4. The purposes of UDC are set forth in Art. IV of its Articles of Incorporation, as follows:to manage jointly with the Tribal Business Committee * * * all unadjudicated or unliquidated claims against the United States, all income from oil gas and mineral rights of every kind, and all other assets not susceptible to equitable and practicable distribution to which the mixed-blood members * * * may hereafter become entitled * * * and to receive the proceeds therefrom and to distribute the same to the stockholders of this corporation as herein provided.↩5. Sec. 677v provided:Upon removal of Federal restrictions on the property of each individual mixed-blood member of the tribe, the Secretary shall publish in the Federal Register a proclamation declaring that the Federal trust relationship to such individual is terminated. Thereafter, such individual shall not be entitled to any of the services performed for Indians because of his status as an Indian. All statutes of the United States which affect Indians because of their status as Indians shall no longer be applicable to such member over which supervision has been terminated, and the laws of the several States shall apply to such member in the same manner as they apply to other citizens within their jurisdiction.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623228/	Arthur R. Ivey and Karen L. Ivey, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentIvey v. CommissionerDocket Nos. 198-67, 199-67, 200-67United States Tax Court52 T.C. 76; 1969 U.S. Tax Ct. LEXIS 153; April 16, 1969, Filed 153 Decision will be entered for the respondent in each docket. Petitioners, stockholders in a corporation, acquired improved realty in a sec. 333 liquidation with intent to demolish the improvement (a multiple-dwelling house) and erect an office building. The building was demolished within a month after petitioners acquired title. Held, the partnership petitioners had formed to handle the property could not take a demolition deduction. It was the intention of petitioners to demolish at the time they acquired the property that precludes taking the deduction. The intention of the corporation when it bought the property some years before is immaterial. Tobias Weiss, for the petitioners.John K. Antholis and William T. Hayes, for the respondent. Mulroney, Judge. MULRONEY 76 Respondent determined deficiencies in these consolidated cases in the petitioners' income tax for 1963 as follows: 77 DocketAddition toPetitionernumberDeficiencytax, sec. 6653(a),I.R.C. 1954Arthur R. Ivey and Karen L. Ivey198-67$ 2,380.14$ 119.01Rober C. Barnum, Jr., and Marion M.Barnum199-673,991.51Edwin J. O'Mara, Jr., and Helen E.O'Mara200-673,118.11155 The deficiencies are in issue only with respect to a demolition deduction of $ 31,617.73 taken in 1963 by a partnership, the Mason Co., of which the petitioners were partners. The amount of distributable partnership loss or income was affected by this deduction.FINDINGS OF FACTSome of the facts have been stipulated and they are found accordingly.At the time the petitions in these proceedings were filed petitioners Arthur R. Ivey and Karen L. Ivey, husband and wife, lived in Greenwich, Conn.; Robert C. Barnum, Jr., and Marion M. Barnum, husband and wife, lived in Greenwich, Conn.; and Edwin J. O'Mara, Jr., and Helen E. O'Mara, husband and wife, lived in Old Greenwich, Conn. All of the petitioners filed joint income tax returns for 1963 with the district director of internal revenue, Hartford, Conn. Hereinafter the word "petitioners" will refer only to the husbands since the wives are parties only by reason of the filing of joint income tax returns.The 168 Mason Corp. was organized in 1952 under the laws of the State of Connecticut. It owned real estate located at 168 Mason Street, Greenwich, Conn., which was purchased and remodeled into a law office prior to 1959. Its total156 outstanding and issued 100 shares of stock were owned by petitioners and another person, Robert E. Nickerson, who is not involved in these proceedings. Each stockholder owned 25 shares of stock. The petitioners and Nickerson were lawyers and partners in the practice of law and the law partnership rented office space at 168 Mason Street from 168 Mason Corp.The Greenwich Title Co. Inc. was organized January 21, 1959, under the laws of the State of Connecticut for the purpose of purchasing and taking title to Greenwich property. Throughout the entire existence of this corporation, its 3,000 outstanding and issued shares of stock were owned by petitioners and Nickerson. Each stockholder owned 750 shares. On March 16, 1959, it purchased and took title to improved real property at 170-172 Mason Street for a purchase price of $ 55,000, and it was stipulated that $ 36,300 was allocated by Greenwich Title Co. Inc. to the improvements. This is the only real property owned by Greenwich and it is adjacent to the above described property of 168 Mason Corp. The improvements on this property consisted of a multifamily residence and a garage. At the time the property was purchased it was157 zoned for business use.78 The purchase of the property at 170-172 Mason Street was financed by a mortgage taken out on the property at 168 Mason Street which was owned by 168 Mason Corp. The mortgage payments relating to the 168 Mason Street mortgage were made jointly by separate checks in unequal amounts drawn by Greenwich Title Co. Inc. and 168 Mason Corp.From the date of purchase until sometime in May 1963 the property at 170-172 Mason Street was used for rental purposes.On July 14, 1959, the 168 Mason Corp. acquired the real property located at 174 Mason Street with a frame building on it for the purchase price of $ 40,000. The building was rented out by 168 Mason Corp. as a two-family residence.On June 10, 1960, Joseph Weir, architect, completed a plan at the request of petitioners and Nickerson that was captioned "Proposed Addition to Building -- The 168 Mason Corporation -- June 10, 1960." That plan showed a three-floor building which ran from the northern boundary of the property at 168 Mason Street to the southern boundary line of the property located at 170-172 Mason Street.Petitioners, prior to May 16, 1961, contacted Robert Felson, an architect, whose office158 was in New York, and requested that he submit a proposal for a new construction which would cover the property at 170-172 Mason Street. That proposal was made in a letter dated May 16, 1961. In a letter dated June 13, 1961, signed by one of the petitioners as president of 168 Mason Corp., Felson's services were retained. In July of 1962 Felson was authorized to prepare working drawings and specifications for new construction on property which included 170-172 Mason Street.On December 3, 1962, Felson completed the plans for the new construction on the property that included 170-172 Mason Street. On March 25, 1963, George L. O'Brien, Inc., submitted the successful construction bid. In March of 1963 these site plans were filed with the chief building inspector, Greenwich, Conn., and on April 26, 1963, the Department of Public Works of Greenwich, Conn., recommended to the inspector that the plan be approved. A building permit was issued on July 2, 1963.On June 5, 1963, both the 168 Mason Corp. and the Greenwich Title Co. Inc. adopted resolutions for complete liquidation and dissolution. That same day the Greenwich Title Co. Inc. conveyed by deed the real property which it owned159 at 170-172 Mason Street to petitioners and Nickerson as tenants in common, who managed the property as partners in a partnership known as the Mason Co. The 168 Mason Corp. likewise conveyed the real property which it owned at 168 and 174 Mason Street to the petitioners and Nickerson as tenants in common.79 Greenwich Title Co. Inc. was dissolved on June 26, 1963. The 168 Mason Corp. was also dissolved in June of 1963. The dissolution and liquidation of Greenwich Title Co. Inc. met the requirements of section 333, I.R.C. 1954.Sometime after June 18, 1963, and before July 2, 1963, the demolition of the building located at 170-172 Mason Street was begun and within a few days after July 21, 1963, it was completely demolished. The property at 170-172 Mason Street was owned by petitioners and Nickerson as the Mason Co., a partnership, at the time demolition was started and finished. The value of the building located at 170-172 Mason Street was stipulated by the parties to be $ 31,617.73 at the time of the demolition.As a result of the demolition of the building in 1963 the Mason Co. on its partnership return deducted $ 31,617.73 as a loss sustained on demolition of the building, 160 one-fourth of which ($ 7,904.43) was used by each petitioner in computing his partnership distributable loss of $ 6,913.65. Respondent disallowed the demolition loss of $ 31,617.73 "because it has not been established that the partnership is entitled to such a deduction." This determination by respondent is the only assigned error in the three petitions.OPINIONSection 165, I.R.C. 1954, 2 allows "as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise." It is under this law that a taxpayer may receive what is called a demolition deduction when the improvement on his realty is demolished. The deductible loss, if he is entitled to a demolition deduction, will be that portion of his purchase price of the improved realty that is allocable to the improvement.The rule is well established that if the intent to demolish the building exists at the time the property on which161 it is located is purchased or acquired, no loss, in fact, occurs for which a deduction may be taken. The determining factor is the intention of the taxpayer on the date of acquisition, Liberty Baking Co. v. Heiner, 37 F.2d 703">37 F.2d 703 (C.A. 3, 1930); Lynchburg National Bank & Trust Co., 20 T.C. 670 (1953), affd. 208 F.2d 757">208 F.2d 757 (C.A. 4, 1953). Also see section 1.165-3, Income Tax Regs.3 The rationale for this rule was stated in Lynchburg National 80 , as follows:Where, as here, there is a purchase of land with the intent to demolish a building situated thereon and erect a new one, no part of the price paid is allocable to the building, since it is deemed that the building has no value to the purchaser and it is the land which is purchased and which alone has value. The entire purchase price, therefore, represents the cost of the land and becomes the purchaser's basis. * *162 Petitioners acquired title to the property at 172 Mason Street by the deed of Greenwich Title Co. Inc. dated June 5, 1963. Petitioners were stockholders of Greenwich Title Co. Inc. and the deed they received was executed and delivered to them pursuant to a section 333 liquidation of the said corporation. In general, and insofar as applicable here, the cited statute provides for the nonrecognition of gain realized by electing stockholders in certain liquidations when the "property distributed in complete liquidation" is "made in pursuance of a plan of liquidation" and "the distribution is in complete cancellation or redemption of all the stock."Petitioners admit that at the time they acquired title to the property at 172 Mason Street in June of 1963 they intended to demolish the building. In their petitions they alleged: "In the summer of 1963, the stockholders therefore decided to demolish the apartment building at 172 Mason Street. That demolition was completed on July 31, 1963." Petitioners do not argue that they would be entitled to the demolition deduction under the statute and regulations if their intent at the time they acquired title in June of 1963 is to be the determining163 factor. In effect petitioners argue that they are entitled to a loss deduction for the demolition of a building located on realty that they acquired with intent to demolish the building. All of the evidence clearly shows the demolition occurred pursuant to petitioners' intent formed prior to their receipt of deed to the property. As stated petitioners do not allege or argue otherwise and in fact they affirmatively allege they had the intent to demolish the building while they were still stockholders and before they received their deed.Petitioners' position as stated on brief is as follows:I. There was no intent or plan to demolish the building at the time the property was purchased on March 16, 1959.II. Section 334(c) of the Code prescribes the basis for the building to be allocated to the taxpayers upon the Section 333 liquidation, and a loss to that extent was incurred when the building thereafter was demolished by the taxpayers.We need not decide the corporate intent of petitioners' predecessor in title, the Greenwich Title Co. Inc., at the time it purchased the property in March of 1959. We need only consider the second part of petitioners' contention.81 As we understand164 petitioners' arguments they seem to contend that when improved property is acquired by stockholders in a nontaxable section 333 liquidation, the controlling intent with respect to demolition of the improvement is not their intent at the time they surrendered their stock and took the corporation's deed but the corporation's intent with respect to demolishing the improvement when the corporation bought the property some years earlier.Petitioners' argument is not supported by any reason or authority. It consists almost entirely of stating the conclusion that the demolition loss is available to them because this is the natural result from an acquisition in a section 333 liquidation when the corporation did not acquire the property with intent to demolish the improvement. The argument does not give any reason or explain why taxpayers who acquire property admittedly with intent to demolish the improvement should receive a demolition deduction merely because the property was acquired in a section 333 liquidation.The rule as stated earlier is that the purchaser who intends to demolish is not entitled to a demolition deduction and the entire basis should be allocated to the realty. We165 pointed out that the rationale for this rule is that the existence of the purchaser's intent to demolish means the building has no value to the purchaser. He suffers no loss when the building is demolished for it is the land alone that has value to him. The acquisition of property by a stockholder in liquidation amounts to a "purchase" within the meaning of section 1.165-3(a)(1), Income Tax Regs. Petitioners do not argue otherwise. Section 331 provides that "Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock." Ordinarily this would be a fully taxable event. All that section 333 does is provide that under certain circumstances the shareholders' gain can go unrecognized. But the character of the liquidation is still one of sale or exchange of stock for assets. In substance the shareholder purchases his share of the corporate assets in exchange for his stock.As stated petitioners give no reason why the deduction should be made available to them without regard to their intent merely because they acquired the property in a section 333 liquidation. The only case cited by petitioners is N. W. Ayer & Son, Inc., 17 T.C. 631.166 The case is not applicable. There, a partnership business was incorporated and the business property transferred to the corporation in a tax-free exchange. The partnership's basis carried over to the corporation and the opinion holds the carryover basis included the partnership's intent to demolish the building at the time it purchased the building and paid the purchase price. Actually the partnership only bought land since it intended to demolish the building. This case is not at all like the instant case. It did not involve an acquisition in liquidation. In a transfer of assets 82 under an incorporation of a business statute providing for a tax-free exchange (such as section 351) the assets keep the basis they had in the hands of the transferor. Thus the transferor's intent at the time he bought the asset can be said to control. In a section 333 liquidation, the basis of a distributed asset does not carry over to the stockholder. The asset acquires a new basis in the hands of the stockholder. His stock basis is allocated to the distributed assets pro rata in accordance with the value on the date of liquidation of the assets liquidated. Sec. 334(c); sec. 1.334-2, 167 Income Tax Regs.We find no merit in petitioners' contention. The corporate intent of Greenwich Title Co. Inc. in 1959 when it purchased the property with respect to demolishing the building is immaterial. The guiding consideration is petitioners' intent in June of 1963 when they surrendered their stock for the deed to the property. As pointed out earlier their intent at the time they acquired the property was to demolish the building. Under section 1.165-3, Income Tax Regs., they and their partnership are precluded from any demolition loss deduction. On the date of the liquidation and the date of their deeds the building had no value to petitioners. They suffered no loss when it was demolished. Respondent was right in disallowing the demolition deduction to the partnership and in determining the deficiencies in issue based on such disallowance.Decision will be entered for the respondent in each docket. Footnotes1. Cases of the following petitioners are consolidated herewith: Robert C. Barnum, Jr., and Marion M. Barnum, docket No. 199-67; Edwin J. O'Mara, Jr., and Helen E. O'Mara, docket No. 200-67.↩2. All section references are to the Internal Revenue Code, as amended unless otherwise indicated.↩3. Sec. 1.165-3. Demolition of buildings.(a) Intent to demolish formed at time of purchase. (1) Except as provided in subparagraph (2) of this paragraph, the following rule shall apply when, in the course of a trade or business or in a transaction entered into for profit, real property is purchased with the intention of demolishing either immediately or subsequently the buildings situated thereon: No deduction shall be allowed under section 165(a)↩ on account of the demolition of the old buildings even though any demolition originally planned is subsequently deferred or abandoned. The entire basis of the property so purchased shall, notwithstanding the provisions of § 1.167(a)-5, be allocated to the land only. Such basis shall be increased by the net cost of demolition or decreased by the net proceeds from demolition.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623230/	Dorothy LaPoint, Petitioner v. Commissioner of Internal Revenue, RespondentLaPoint v. CommissionerDocket No. 8797-87United States Tax Court94 T.C. 733; 1990 U.S. Tax Ct. LEXIS 50; 94 T.C. No. 45; May 23, 1990, Filed 50 Decision will be entered under Rule 155. P owned 13 rental properties. In 1983, P purchased a new BMW which she used to inspect and maintain said properties. P claimed entitlement to an investment tax credit with respect to her acquisition of the BMW. Held, because the BMW was used in connection with the furnishing of lodging, it is not sec. 38 property; hence, P is not entitled to the claimed investment tax credit. Dorothy LaPoint, pro se.Ann Murphy, for the respondent. Jacobs, Judge. JACOBS733 Respondent determined a deficiency of $ 8,214.58 in petitioner's 1983 income tax.After concessions, the issues for decision are: (1) The characterization of certain renovations which petitioner made to 3 of her 13 rental properties (i.e., whether said renovations constituted repairs or capital improvements); (2) whether petitioner is entitled to an investment tax credit with respect to an automobile used in connection with her 734 rental activities; and (3) whether petitioner is liable for the alternative minimum tax under section 55. 151 FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated herein by this reference.Petitioner resided in Castro Valley, California, at the time she filed her petition. She was employed by the Department of Housing and Urban Development in its San Francisco office.Petitioner owned 13 rental properties located in the Bay area. She made the following renovations to three of these properties in 1983:PropertyItemCostNewton StreetReplaced furnace$ 997Newton StreetErected fence234Newton StreetReplaced roof3,697Dixon StreetFixtures for bathroom and kitchen778Dixon StreetInstalled drapes152LaPorteInstallation of garage door, greenhouse,window, sink and counter, flooring, andcarpeting2,780Total2 8,63852 Petitioner deducted these expenditures on her 1983 tax return as repairs; respondent determined that said expenditures constituted capital improvements which should be depreciated rather than expensed.Petitioner made the renovations to her Dixon Street and LaPorte properties in anticipation of selling said properties, which she in fact did in 1983. The sale of these two properties resulted in a long-term gain in the approximate amount of $ 145,000. Primarily as a result of the capital gain deduction taken by petitioner on her 1983 return, respondent determined that petitioner was liable for the alternative minimum tax which she failed to compute in calculating her 1983 tax obligation.735 On October 16, 1983, petitioner purchased a 1983 BMW to replace her 1975 Buick. Claiming that the BMW was used in connection with her rental activities (specifically, to inspect and maintain the properties), petitioner deducted automobile expenses and depreciation and claimed entitlement to an investment tax credit. At trial, the parties agreed that the BMW was used by petitioner 85 percent of the time for business; thus, respondent concedes petitioner's entitlement to the claimed deductions53 for automobile expenses and depreciation. However, respondent still disputes petitioner's entitlement to the investment tax credit.OPINIONWe first decide the proper characterization of the renovations made in 1983 by petitioner, i.e., whether the expenditures were for repairs deductible as ordinary and necessary business expenses under section 162 or capital expenditures which must be depreciated.Capital expenditures are those expenses which add to the value or substantially prolong the useful life of the property. Sec. 1.263(a)-1(b), Income Tax Regs. Expenses for incidental repairs or maintenance are currently deductible (and are not capital expenditures) if they neither materially add to the value of the property nor appreciably prolong the property's useful life. Sec. 1.162-4, Income Tax Regs.The renovations made to the Dixon Street and LaPorte properties are capital expenditures made in connection with the sale of said properties. As such, the expenditures, while not currently deductible, increase petitioner's basis in the properties and reduce the amount of gain petitioner realized from the sale of said properties. The expenses incurred in connection with renovations54 to the Newton Street property are capital expenditures.Petitioner contends that the expenditures are deductible under section 179. (Section 263(a)(1)(H) provides an exception to the general rule which otherwise denies a deduction for capital expenditures for which a deduction is allowed under section 179.)Section 179 permits a taxpayer to elect to treat the cost of section 179 property as an expense, within certain dollar limitations. To avail himself/herself of the benefits of 736 section 179, the taxpayer must make an irrevocable election on his/her income tax return. Sec. 179(a) and (c). Petitioner did not make the requisite election; therefore, the renovation expenditures are not deductible under section 179.We next decide whether petitioner is entitled to an investment tax credit with respect to the BMW purchased in 1983. An investment tax credit is allowed for qualified investment in section 38 property. See sec. 46. Section 38 property generally includes depreciable tangible personal property. Sec. 48(a)(1). Section 48(a)(3) provides, with exceptions not relevant here, that "Property which is used predominantly to furnish lodging or in connection with 55 the furnishing of lodging shall not be treated as section 38 property."Respondent contends that petitioner used the BMW in connection with the furnishing of lodging, and therefore, the BMW is not section 38 property. See Rev. Rul. 78-439, 2 C.B. 11">1978-2 C.B. 11. We agree.The investment tax credit enacted in 1962 contained the lodging exception found in section 48(a)(3). Revenue Act of 1962, sec. 2(b), Pub. L. 87-834, 76 Stat. 960, 963-970. The rationale for the lodging exception was stated in the Joint Committee on Taxation's General Explanation of the Revenue Act of 1961: "Lodging, or residential real estate, * * * [is] excluded on the grounds that this property for the most part is used by consumers rather than in production." Staff of Joint Comm. on Taxation, General Explanation of Committee Discussion Draft of Revenue Bill of 1961, 87th Cong., 1st Sess. 9 (J. Comm. Print 1961). 356 The regulations under section 48 provide that property which is used predominantly in the operation of a lodging facility or in serving tenants shall be considered used in connection with the furnishing of lodging. Sec. 1.48-1(h)(1)(ii), Income Tax Regs. As examples of property used in connection with the furnishing of lodging, section 1.48-1(h)(1)(ii) lists lobby furniture, office equipment, and laundry and swimming pool facilities used in the operation of an apartment house or in serving tenants.Tax credits, like deductions, are a matter of legislative 737 grace. Segel v. Commissioner, 89 T.C. 816">89 T.C. 816, 842 (1987). Petitioner used her BMW to inspect and maintain her rental properties. The rental properties were lodging facilities. Sec. 1.48-1(h)(1)(i), Income Tax Regs.The statutory language "Property * * * used * * * in connection with the furnishing of lodging" is more encompassing than property used or available for use by a tenant; it includes property used in connection with the operations of rental property, such as an automobile used by a landlord to inspect and repair rental property. Accordingly, in the instant case, the BMW is not57 section 38 property; hence, petitioner is not entitled to the claimed investment tax credit.Finally, we decide whether petitioner is liable for the alternative minimum tax under section 55. In 1983, petitioner recognized a net long-term capital gain as a result of the sale of the La Porte and Dixon Street properties. The net long-term capital gain entitled petitioner to take the 60-percent deduction for capital gains provided in section 1202.Section 55 imposes an alternative minimum tax on noncorporate taxpayers to the extent that 20 percent of the excess of the taxpayer's "alternative minimum taxable income" over an exemption amount exceeds the taxpayer's regular tax. In general, a taxpayer's "alternative minimum taxable income" is calculated using the taxpayer's adjusted gross income as a base figure. Sec. 55(b). Items of tax preference under section 57 are then added to the base figure. Sec. 55(b)(2). In the case of a noncorporate taxpayer (such as petitioner), the amount of the section 1202 net capital gain deduction is a tax preference item. Sec. 57(a)(9).In the instant case, to the extent that 20 percent of the excess of petitioner's alternative minimum taxable income58 over her exemption amount exceeds her regular tax, petitioner will be liable for the alternative minimum tax. The precise amount of petitioner's liability under section 55, if any, can be determined in the parties' Rule 155 computation.To reflect the foregoing and the concessions of the parties,Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the tax year in issue.↩2. Respondent disallowed deductions for "replacements" in the aggregate amount of $ 8,611, whereas the actual costs for the renovations total $ 8,638. No explanation was given as to the $ 27 discrepancy.↩3. That draft contained language identical to that which was eventually enacted in the Revenue Act of 1962. See Revenue Act of 1961, sec. 2(b), Discussion Draft 12 (J. Comm. Print 1961).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623233/	PRISCILLA M. LIPPINCOTT ADAMS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAdams v. CommissionerTax Ct. Dkt. No. 15535-96, Docket No. 3437-97United States Tax Court110 T.C. 137; 1998 U.S. Tax Ct. LEXIS 12; 110 T.C. No. 13; March 3, 1998, Filed 12 Decisions will be entered for respondent. P contends that, pursuant to the Religious Freedom Restoration Act of 1993, she is exempt from Federal income taxes. Held: RFRA does not exempt petitioner from Federal income taxes. Peter Goldberger and James H. Feldman, Jr., for petitioner.Linda A. Love, for respondent. FOLEY, JUDGE. FOLEY137 OPINION FOLEY, JUDGE: Respondent determined the following deficiencies in and additions to petitioner's Federal income taxes: Additions to TaxYearDeficiencySec. 6651(a)(1)Sec. 66541988$ 2,111$ 522$ 13419893,091273---19923,364160---19933,489226---19943,54319925Unless otherwise13 indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The issues for decision are as follows: 1. Whether, pursuant to the Religious Freedom Restoration Act of 1993, petitioner is exempt from Federal income taxes. We hold that she is not.2. Whether petitioner is liable for additions to tax for failure to file Federal income tax returns and failure to make estimated tax payments. We hold that she is. 138 The facts have been fully stipulated under Rule 122 and are so found. Petitioner resided in Willingboro, New Jersey, at the time she filed her petition.Petitioner is a devout Quaker and a member of the Religious Society of Friends, a Quaker organization. Petitioner adheres to the fundamental tenets of Quaker theology, including the belief that the Spirit of God is in every person and that it is wrong to kill or otherwise harm another person. Petitioner's faith dictates that she not voluntarily participate, directly or indirectly, in military activities. Because Federal income taxes fund military activities, petitioner believes that her faith prohibits her from14 paying such taxes.Petitioner contends that, pursuant to the Religious Freedom Restoration Act of 1993 (RFRA), Pub. L. 103-141, sec. 2, 107 Stat. 1488, 42 U.S.C. sec. 2000bb to 2000bb-4 (1994), she is exempt from Federal income taxes. RFRA was enacted in response to Employment Div., Dept. of Human Resources v. Smith, 494 U.S. 872">494 U.S. 872, 108 L. Ed. 2d 876">108 L. Ed. 2d 876, 110 S. Ct. 1595">110 S. Ct. 1595 (1990). In Smith, the Supreme Court held that neutral, generally applicable laws may be applied to religious practices even when not supported by a compelling governmental interest. Before Smith, the Government had to demonstrate that the application of such laws to religious practices was "essential to accomplish an overriding governmental interest," or represented "the least restrictive means of achieving some compelling state interest". Employment Div., Dept. of Human Resources v. Smith, supra at 899 (O'Connor, J., concurring in judgment). In City of Boerne v. Flores, 521 U.S. 507">521 U.S. 507, 117 S. Ct. 2157">117 S. Ct. 2157, 138 L. Ed. 2d 624">138 L. Ed. 2d 624 (1997), the Supreme Court held that RFRA was unconstitutional as applied to State and local governments. The Court, however, has not determined, 15 and the parties do not contend, that RFRA is unconstitutional as applied to Federal law.RFRA restores the compelling interest test by prohibiting the Government from imposing a substantial burden on the free exercise of religion unless it demonstrates that application of the burden is the least restrictive means of achieving a compelling governmental interest. RFRA, 42 U.S.C. sec. 2000bb-1(b) (1994); S. Rept. 103-111, at 8, 1993 U.S.C.C.A.N. 1892, 1898. The legislative history accompanying RFRA explicitly states that, in evaluating whether the Government has met the compelling interest test, cases 139 decided prior to Smith are applicable, and the test "should not be construed more stringently or more leniently than it was prior to Smith." S. Rept. 103-111, at 8-9 (1993), 1993 U.S.C.C.A.N. 1892, 1898.Prior to Smith, the Supreme Court repeatedly held that neutral, generally applicable tax laws meet the compelling interest test. See, e.g., Hernandez v. Commissioner, 490 U.S. 680">490 U.S. 680, 699-700, 104 L. Ed. 2d 766">104 L. Ed. 2d 766, 109 S. Ct. 2136">109 S. Ct. 2136 (1989) (stating that the Government had a "broad public interest in maintaining a sound tax system free of myriad exceptions flowing16 from a wide variety of religious beliefs"); United States v. Lee, 455 U.S. 252">455 U.S. 252, 258-259, 71 L. Ed. 2d 127">71 L. Ed. 2d 127, 102 S. Ct. 1051">102 S. Ct. 1051 (1982) (holding that the Government's "very high" interest in maintaining a comprehensive Social Security system justified denying an Amish employer an exemption from Social Security taxes); see also S. Rept. 103-111 at 5 n.5, 1993 U.S.C.C.A.N. at 1895 (citing the aforementioned decisions). In United States v. Lee, the Supreme Court stated: The tax system could not function if denominations were allowed to challenge the tax system because tax payments were spent in a manner that violates their religious belief. Because the broad public interest in maintaining a sound tax system is of such high order, RELIGIOUS BELIEF IN CONFLICT WITH THE PAYMENT OF TAXES AFFORDS NO BASIS FOR RESISTING THE TAX. 455 U.S. at 260; citations omitted; emphasis added. Thus, while petitioner's religious beliefs are substantially burdened by payment of taxes that fund military expenditures, the Supreme Court has established that uniform, mandatory participation in the Federal income tax system, irrespective of religious belief, is a compelling governmental interest. See17 id.; Hernandez v. Commissioner, supra. As a result, requiring petitioner's participation in the Federal income tax system is the only, and thus the least restrictive, means of furthering the Government's interest. Cf. Steckler v. United States, 1998 U.S. Dist. LEXIS 722">1998 U.S. Dist. LEXIS 722, 98-1 U.S. Tax Cas. (CCH) P 50219">98-1 U.S. Tax Cas. (CCH) P50,219, 81 A.F.T.R.2d (RIA) 1049">81 A.F.T.R.2d (RIA) 1049, 1998 WL 28235">1998 WL 28235 (E.D. La., 1998) (relying on United States v. Lee to hold that withholding pursuant to section 3406 was the least restrictive means of furthering the compelling governmental interest of ensuring that all citizens participate in the tax system). Therefore, we hold that RFRA does not exempt petitioner from Federal income taxes. Accordingly, we sustain respondent's determinations. Cf. Babcock v. Commissioner, 140 T.C. Memo 1986-168">T.C. Memo 1986-168 (upholding additions to tax for failure to file and failure to make estimated tax payments where an Amish taxpayer claimed a religious exemption from Federal income taxes).To reflect the foregoing,Decisions will be entered for respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623234/	APPEAL OF GEORGE S. SCOVILLE.Scoville v. CommissionerDocket No. 2443.United States Board of Tax Appeals2 B.T.A. 813; 1925 BTA LEXIS 2255; October 6, 1925, Decided Submitted April 27, 1925. 2255 At March 1, 1913, the taxpayer had a lease which expired December 31, 1923. The taxpayer had made extensive improvements upon the leased property prior to March 1, 1913. Held, that the fair value of the lease at March 1, 1913, was $70,000, and that the unextinguished cost of the lease at January 1, 1919, was $36,762.82. Benjamin Mahler, Esq., for the taxpayer. Laurence Graves, Esq., for the Commissioner. SMITH 814 Before JAMES, SMITH, and TRUSSELL. This appeal is from the determination of a deficiency in income tax for 1919 in the amount of $4,138.45. FINDINGS OF FACT. Under date of December 13, 1907, the taxpayer leased property at Coney Island, New York City, from January 1, 1908, to December 31, 1917, at an annual rental of $6,000 per year for the first five years of the term and of $7,000 per year for the balance of the term. There were located upon the property at the time that it was leased a hotel and certain bathhouses. The size of the lot was approximately 200 feet by 600 or 800 feet. The taxpayer, soon after leasing the property, spent a considerable amount of money in grading and filling in the land and in erecting2256 bathhouses, bungalows, and other buildings. He sublet some of these buildings and derived annually from rentals during the period 1910 to 1913 approximately $9,000. He also derived income from the operation of the hotel and bathhouses. His net income from these operations during the first five years of the term of the lease was from $15,000 to $20,000. In a schedule attached to the taxpayer's 1918 income-tax return the various improvements upon the property are listed and given a total cost and value as of January 1, 1914, of $58,146.17. No exception was taken to the finding of the Commissioner of the value of the improvements at that date of $58,146.17. In 1912 the taxpayer contemplated the erection of additional buildings upon the property and negotiated with the lessor for an extension of the lease. He was granted a six-year extension by an indenture dated April 23, 1912, the rental to be paid during the extended term to be at the rate of $9,000 per annum. The taxpayer had a net income for the year 1913 of approximately $20,000 and the business was operated profitably from that date up to and including the year 1918. The lease of December 13, 1907, contained a provision2257 "that no assignment of this lease made without the written assent of the said party of the first part shall operate in any way to release or exonerate the party of the second part [lessee] of or from any obligation imposed upon him by this instrument." With the consent of the lessor, the taxpayer entered into an agreement for the sale of the lease in the latter part of 1918. The purchasers paid the taxpayer $59,575 for his rights under the lease. They secured from the lessor a new lease under date of January 1, 1919, which new lease was to expire December 31, 1933. The rental to be paid under the new lease was at the rate of $12,000 per annum. 815 In his income-tax return for 1919 the taxpayer reported a profit upon the sale of the lease of $8,283.18. This amount was arrived at in the following manner: Cost of improvements made upon the leased premises to Mar. 1, 1913$58,146.17Value of improvements as of that date in excess of cost20,000.00Value of lease and improvements at Mar. 1, 191378,146.17Depreciation to Dec. 31, 1916$15,138.75Depreciation in 19175,707.80Depreciation in 19186,007.8026,854.35Depreciated cost or value Jan. 1, 191951,291.82Net profit on sale8,283.182258 The fair value of the lease, including improvements made upon the land by the lessee at March 1, 1913, was $70,000. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on consent or on 15 days' notice, in accordance with Rule 50. OPINION. SMITH: In his income-tax return for 1919 the taxpayer reported a net profit of $8,283.18 upon the sale of a lease in 1919 for a net consideration of $59,575. In the determination of the net profit the taxpayer added to the depreciated cost of the improvements upon the leased property at January 1, 1919 ($31,291.82), $20,000. The Commissioner has disallowed this addition to the depreciated cost of the improvements upon the leased premises and has computed the profit from the sale of the lease at $28,283.18. In his appeal the taxpayer alleges errors on the part of the Commissioner in determining a deficiency in tax for 1918 as follows: (1) The failure to allow the March 1, 1913, value of the leasehold for purposes of determining profit on the sale thereof and for the purpose of determing exhaustion accrued thereon. (2) Failure to allow good will value as of2259 March 1, 1913. (3) Failure to allow a discount for notes received in part payent of the consideration for the sale and in valuing these notes at market, and that such market value was equal to the face thereof. The taxpayer's books of account have been lost and it is impossible to determine from any records now in the taxpayer's possession the cost of the improvements to March 1, 1913. The taxpayer had the books of account at the time his return for 1918 was made up, and a schedule attached to that return shows the cost of the improvements at January 1, 1914, as having been $58,146.17. The taxpayer too no exception to the finding of the Commissioner that the cost of the improvements to March 1, 1913, was the same amount. At the hearing 816 counsel for the taxpayer contended, however, that the lease on the property expiring December 31, 1923, had a value on March 1, 1913, of more than $58,146.17, and claimed that the value, inclusive of the improvements, was $70,000. The evidence shows that the taxpayer had a valuable lease. He had made extensive improvements upon the leased premises from the beginning of the term of the lease. Not only were the hotel and bathhouses2260 operated profitably but he derived a large income from subrenting buildings which he had placed upon the property. His income from subrentals by 1912 was approximately $9,000 per year. His net income from the property was from $15,000 to $20,000 per year. By reason of the interest which he had taken in building up the properties the lessor was willing to rent the premises to him at a less amount than he would have rented to any other tenant. From all of the evidence adduced at the hearing, the Board is of the opinion that the market value of the lease at March 1, 1913, inclusive of the improvements, was $70,000, the amount contended for by the taxpayer. It is to be noted, however, that the lease is subject to an exhaustion deduction under the Revenue Act of 1918. . In his income-tax returns prior to 1919 the taxpayer claimed depreciation upon improvements made on the leased premises in the total amount of $26,854.35. This amount does not include anything for exhaustion of the value of the lease in excess of the value of the improvements. The Board finds that the value of the lease was $11,853.83 in excess of March 1, 1913, value2261 of the improvements, and this value is exhaustible over the term of the lease, 10 years and 10 months from March 1, 1913. The remaining value of the improvements and excess value of the lease at January 1, 1919, the date of sale, was $31,291.82 for the improvements and $5,471 for the excess value of the lease, total $36,762.82. The sale price of the lease, including improvements, was $59,575. The taxpayer realized a profit upon the sale of the lease in 1919 of $22,812.18 instead of $8,283.18, the amount shown on taxpayer's original return. The only evidence which the taxpayer submitted with respect to a good-will value as at March 1, 1913, was the net income of the taxpayer from his business operations and the fact that the lessor was willing to rent his property to Scoville at a less rental than he would have rented it to any other tenant. A finding of a good-will will value can not be predicated upon such evidence. In 1919 the taxpayer sold his rights under his lease for $65,000, of which amount $5,425 was commission on the sale. The purchasers paid one-third of the purchase price in cash, the other two-thirds being payable over a period of three years with notes payable2262 817 semiannually. The notes were paid off at maturity. No evidence was introduced that the notes at the time of receipt had a cash value less than their face value. In the opinion of the Board, the Commissioner made no error in holding that the notes were the equivalent of cash to their face value upon receipt by the taxpayer in 1919. ARUNDELL not participating.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623235/	HARVEY A. LUDWIG and BEVERLY LUDWIG, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentLudwig v. CommissionerDocket No. 8088-79.United States Tax CourtT.C. Memo 1983-678; 1983 Tax Ct. Memo LEXIS 113; 47 T.C.M. (CCH) 287; T.C.M. (RIA) 83678; November 10, 1983. Austin J. Doyle, Jr. and Richard H. Champion, for the petitioners. Kathleen E. Whatley, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined the following deficiencies in, and additions to, petitioners' Federal income taxes: Addition to TaxYearDeficiencySec. 6653(b) 11974$55,895.74$28,346.37197538,203.8020,889.40114 By amended answer, respondent redetermined deficiencies 2 and additions to petitioners' Federal income taxes for the years in issue as follows: Addition to TaxYearDeficiencySec. 6653(b)1974$55,065.00$27,931.00197539,066.0021,314.00After concessions, the issues for decision are: (1) Whether the fair market value of bearer bonds received by Harvey A. Ludwig during 1974 and 1975 constitute taxable income to the petitioners for their 1974 and 1975 taxable years; (2) If the bonds are determined to constitute taxable income to petitioners, on what date are the first set of bonds so includable 3; (3) Whether petitioners are liable for the fraud addition to tax under section 6653(b) for the years in issue; and (4) Whether the statute of limitations bars assessment and collection of the deficiencies determined by respondent for petitioners' 1974 taxable year.115 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Harvey A. Ludwig (hereinafter petitioner) and Beverly Ludwig, husband and wife, resided in Shaker Heights, Ohio, when they filed their petition in this case. They filed joint Federal income tax returns for the years in issue with the Internal Revenue Service Center, Cincinnati, Ohio. Thoughout the years in issue petitioner was Chairman of the Board, Chief Executive Officer, and a Director of Tenna Corporation (hereinafter Tenna), an Ohio corporation, which was engaged in the assembly and sale of automotive accessories. Tenna had offices or assembly plants in Alabama, Ohio, Japan, Puerto Rico, Dominican Republic, France, and Canada. Tenna's principal executive office was located in Warrensville Heights, Ohio. On May 3, 1972, petitioner met with William Gohlke, Senior Vice President of Marketing, for Seatrain Lines, Inc. (hereinafter Seatrain), who offered to give Tenna rebates on the established shipping rates if Tenna would utilize Seatrain's ships for its Pacific freight. Petitioner liked Gohlke's proposal, and he instructed Max Kay, Tenna's Traffic Manager, to negotiate an agreement116 with Seatrain. On June 29, 1972, Max Kay and Seatrain's representatives agreed that Tenna would ship all of its Japanese freight on Seatrain vessels in exchange for a rebate of approximately 28 percent of Seatrain's published conference rates. Shortly thereafter, petitioner advised Tenna's Executive Committee that the rebate agreement with Seatrain had been concluded and Tenna began shipping cargo via Seatrain. At approximately this time, petitioner instructed both Max Kay and Donald Vanke, Tenna's Vice President of Finance, to maintain records of Tenna's Seatrain shipments. 4 Between September 1972 and January 1973, copies of Max Kay's records were forwarded to Seatrain as a reminder of the amount it owed Tenna under their agreement, although Seatrain never made any rebate payments throughout this period. In January 1973, petitioner advised Vanke to reflect the unpaid rebates in Tenna's reserves, but Vanke informed petitioner that they could not be reflected in Tenna's reserves and they never were recorded on Tenna's books. In January 1973, petitioner advised Tenna's officers117 that he would personally handle all Seatrain matters, and he directed Max Kay and Donald Vanke to meet with Seatrain's representatives for the purpose of securing the rebate payments that had accrued to date. On May 9, 1973, petitioner, Ronald White (Tenna's President), Donald Vanke, and Stanley Goss met with Seatrain's representatives to discuss the manner in which the rebates could be paid. No agreement was reached during this meeting and at some undetermined point not later than June 1973, 5 petitioner and the other members of Tenna's Board of Directors learned that acceptance of rebates by an American corporation is illegal under the Shipping Act of 1916, 39 Stat. 728, 734 (as amended 10/3/61), Title 46 USC § 815 (hereinafter the Shipping Act of 1916). At approximately the same time that petitioner learned that acceptance of rebates by a U.S. corporation is illegal, Tenna's Japanese counsel advised that Tenna's Japanese subsidiary could legally accept the rebates, and the parties discussed the possibility of paying the rebates to the Japanese subsidiary. Tenna rejected this idea because the rebates could not properly be reflected on the subsidiaries'118 books and, more importantly, Tenna needed the rebates to appear on the books of the U.S. parent corporation to improve its declining corporate earnings and profits. 6119 On June 6, 1973, Tenna's President, Ronald White, aware of the rebate's illegality, advised petitioner in writing that there was no way in which the Seatrain rebates legally could be accepted and that he wanted the matter of the rebates discontinued.On January 22, 1974, Ronald White again advised petitioner in writing not to accept rebates from Seatrain. 7 Notwithstanding White's advice, petitioner continued to seek payment of the rebates, and in subsequent discussions with Arthur Novacek, President of Seatrain's Container Division, petitioner requested that the rebates be paid in the form of bearer bonds. Seatrain agreed to the proposed method of payment and on February 27, 1974, petitioner sent Max Kay to a brokerage firm in New York City where he was given a package containing sixty-five120 $1,000 face value bearer bonds issued by the Florida Power and Light Company (hereinafter the first set of bonds). Kay delivered these bonds to petitioner who placed them in the company safe. Within a few weeks, at some point in March 1974, petitioner removed the bonds from the company safe, took them home, and placed them in a drawer in his dressing room. During this time, no one at Tenna other than Max Kay and petitioner's secretary, Janice Zolnowski, knew that petitioner had received these bonds, and petitioner took no steps to inform any officers or employees of Tenna that he had received the bonds. On June 4, 1974, petitioner moved into a new personal residence that he purchased on November 29, 1973, at a cost of $237,116. The house required extensive renovations and between 1973 and 1976 petitioner sold approximately $700,000 of his stocks and bonds to finance the renovations made to this house although he did not sell any of the bonds he received from Seatrain. On July 23, 1974, petitioner sent Max Kay to Seatrain's Weehawken, New Jersey office where he obtained $77,000 face value AT&T bearer bonds (hereinafter the second set of bearer bonds). Max Kay delivered these121 bonds to petitioner who immediately took them home. Not wishing to keep $142,000 in bearer bonds in his house, petitioner gave the first and second sets of bonds to his wife who deposited them in her personal safety deposit box. 8 When petitioner gave these bonds to his wife he did not tell her that they belonged to Tenna, that he was holding them on behalf of Tenna, or that she was not supposed to clip the interest coupons attached to the bonds which was her normal practice to do. On December 3, 1974, Beverly Ludwig clipped the bond interest coupons on the first set of bonds and deposited the $1,503.45 proceeds in her personal checking account. 9On or about April 14, 1975, petitioners122 filed their joint 1974 Federal income tax return on which they reported income from wages, dividends, and interest in the amount of $55,083. 10 In preparing their returns, it was the petitioners' usual practice to have Mrs. Ludwig go through her checkbook, bills, and receipts to make a list of their expenses. Mrs. Ludwig would then give this list and the attached receipts to petitioner who forwarded it along with their other tax records to their accountant who then prepared petitioners' returns. Petitioners generally maintained accurate and complete tax records throughout the years in issue. Petitioner calculated his income from his Form W-2, and the year-end statements supplied by his banks, brokerage firm, and companies in which he or Mrs. Ludwig owned stock. Although petitioner was aware that the first and second sets of bonds had123 interest coupons attached, he did not provide his accountant with any information pertaining to the $142,000 face value bearer bonds that he received during 1974.Petitioners' original 1974 Federal income tax return did not include any amounts attributable to the $142,000 face value bearer bonds nor the $1,503.45 in coupon interest deposited in Mrs. Ludwig's checking account during 1974. On May 15, 1975, petitioner was interviewed by Special Agent John I. Burns of the United States Bureau of Customs in connection with an investigation into Seatrain's payment of rebates to Tenna. During this interview, petitioner denied under oath having any knowledge of the receipt of kickbacks or rebates from Seatrain by Tenna, Max Kay, or himself. Two weeks later, on May 29, 1975, while petitioner was in Geneva, Switzerland, attending an automobile show, he received a package at his hotel containing nineteen $1,000 face value bearer bonds issued by AT&T and fourteen $1,000 face value bearer bonds issued by the New York Telephone Company (hereinafter the third set of bonds). On the following day, petitioner opened a personal bank account at the Union Bank of Switzerland where he placed the third124 set of bonds. Shortly thereafter, petitioner was contacted by Neal Nunnelly of Seatrain who inquired whether petitioner had received the third set of bonds and who advised that he would be mailing an additional $60,000 in bonds in $5,000 packets to petitioner's home. 11From approximately July 7, 1975 to July 25, 1975, twelve registered packages, each containing five $1,000 face value AT&T bearer bonds (hereinafter the fourth set of bonds) were delivered to petitioner's personal residence from Rotterdam, The Netherlands. As each package arrived, petitioner opened it and placed the bonds in his dresser drawer. When all twelve packages had been received, petitioner gave them to his wife who deposited them in her safe deposit box. As with the first two sets of bonds, petitioner never told her that the bonds belonged to Tenna, that he was holding the bonds for Tenna, or that she should not clip the interest coupons. During the 1975 taxable year, Mrs. Ludwig clipped the matured coupons on the $202,000 face value bonds in125 her safe deposit box and $7,542.50 in coupon interest was deposited in her personal checking account. In computing their 1975 Federal income tax liability, petitioners did not provide their accountant with any information regarding petitioner's receipt of $93,000 face value bearer bonds during 1975. Petitioners' original 1975 Federal income tax return did not include any amounts attributable to the $93,000 face value bearer bonds, nor the $7,542.50 in coupon interest deposited in Mrs. Ludwig's personal checking account during 1975. Petitioner, as Chief Executive Officer, knew that Tenna never reported the bonds or the coupon interest on its corporate income tax returns during either calendar year 1974 or 1975. From his receipt of the first set of bearer bonds in February 1974, until September 1975, petitioner took no steps to inform any officers or employees of Tenna that he had received $235,000 face value bearer bonds from Seatrain. In September 1975, petitioner sought legal advice regarding the bearer bonds from the attorney who was both Tenna's corporate counsel and petitioner's personal attorney, although what advice petitioner sought or obtained from him at that time126 is not disclosed. In late June 1976, petitioner informed Tenna's President and Board of Directors that he had received $235,000 in bearer bonds from Seatrain and he offered them to Tenna. Tenna refused the bonds and petitioner subsequently delivered the first, second, and fourth sets of bonds to the United States Bureau of Customs Special Agent John I. Burns, on July 14, 1976. 12By letter dated September 27, 1976, petitioner was advised by counsel 13 to file amended tax returns for their 1974 and 1975 taxable years. On October 7, 1976, petitioner was advised by the Intelligence Division of the Internal Revenue Service that his returns for taxable years 1972, 1973, 1974, and 1975 were under investigation. On October 8, 1976, petitioner filed amended returns for taxable years 1974 and 1975 including thereon as additional taxable income the coupon interest collected by Mrs. Ludwig from the bonds deposited in her safe deposit box. 14127 On May 1, 1978, in the United States District Court for the Northern District of Ohio, Eastern Division, petitioner plead guilty and was convicted of conspiracy to violate the Shipping Act of 1916. Petitioner was given a suspended two-year sentence and fined $10,000. In the notice of deficiency, respondent determined that petitioners understated their taxable income for their 1974 and 1975 taxable years by failing to include in income the fair market value of the bonds that petitioner had received from Seatrain. Furthermore, respondent determined that a part of the underpayment for each of petitioners' taxable years in issue was due to fraud, and, therefore, he imposed the 50 percent addition to tax for fraud under section 6653(b). The following table shows the taxable income as reported on petitioners' joint original and amended returns, their taxable income as determined by respondent in his amended answer, and the amount of unreported taxable income determined by respondent: Taxable IncomeTaxable Income 15Unreported TaxableReported byas DeterminedIncome as DeterminedYearPetitionersby Respondentby Respondent1974$56,586$148,307.25$91,721.25197576,644140,811.5064,167.50128 ULTIMATE FINDINGS OF FACT Petitioners underreported taxable income for both of the years in issue. Part of petitioners' underpayments of tax for each of the years in issue was due to fraud with intent to evade tax within the meaning of section 6653(b). OPINION 129 We must determine whether petitioners are liable for deficiencies and additions to tax as determined by respondent for the years in issue. Issues 1 and 2: Deficiencies and Date of InclusionRespondent maintains that the fair market value of the $235,000 face value bearer bonds were income to petitioners when received by petitioner, Harvey Ludwig, in four installments during 1974 and 1975. Petitioner, on the other hand, argues that he is not properly taxable on the fair market value of the bearer bonds because he was holding them as an agent for Tenna, and that Tenna is properly taxable on the fair market value of the bonds. It is well settled that a taxpayer who receives amounts under a claim of right or without restrictions as to its disposition must include such amounts in gross income. North American Oil Consolidated v. Burnet,286 U.S. 417">286 U.S. 417 (1932). That the amounts received under a claim of right are in the nature of kickbacks or rebates does not alter the fact that they constitute income to the recipient. Lydon v. Commissioner,351 F. 2d 539 (7th Cir. 1965),130 affg. a Memorandum Opinion of this Court. As the Supreme Court stated in Rutkin v. United States,343 U.S. 130">343 U.S. 130, 137 (1952) "An unlawful gain * * constitutes taxable income when its recipient has such control over it that * * * he derives readily realizable economic value * * ." Where, however, a taxpayer acts as an agent or mere conduit for the funds, the existence of the claim of right is negated and the amounts received are not income. Goodwin v. Commissioner,73 T.C. 215">73 T.C. 215, 230 (1979); Diamond v. Commissioner, 56 T.C. 530">56 T.C. 530, 541 (1971), affd. 492 F. 2d 286 (7th Cir. 1974); Heminway v. Commissioner,44 T.C. 96">44 T.C. 96 (1965). 16On the record in this case, we are convinced that petitioner did not receive the bonds as an agent or conduit, but that he had such control over the bonds that he is properly taxable on the fair market value of the bonds. In support of his argument that he was acting as an agent for Tenna, petitioner testified at trial that throughout the years in issue he continuously sought a method to legally reflect131 the bonds on Tenna's books. This testimony directly contradicts statements that petitioner made under oath to the Securities and Exchange Commission (SEC) on July 28, 1976. Our review of the evidence convinces us that petitioner did not seek any legal advice with respect to reflecting the bonds as an asset of Tenna between June 1973, when he was notified that acceptance of the rebates was illegal, and June 1976, when he first offered the bonds to Tenna.17 We believe that petitioner saw an opportunity to personally collect money due a failing company under circumstances that would give him unfettered control over the funds: on the one hand Seatrain would be paying the rebates to Tenna's Chief Executive Officer and Board Chairman in accordance with their prior agreement and they would not question his right to collect the funds; while on the other hand, Tenna's President had specifically repudiated any effort to collect the rebates and did not anticipate their receipt or notice their absence. 132 The factors which typically indicate the existence of an agency or conduit relationship are wholly lacking in this case.Generally, prompt transmittal of the funds to the purported principal is suggestive of an agency or conduit status. Lashells' Estate v. Commissioner,208 F.2d 430">208 F. 2d 430, 435 (6th Cir. 1953). In the instant case, petitioner received the first set of bonds in February 1974, but he did not offer them to Tenna until June 1976, almost two and a half years after he received them and after he had been interviewed several times by the IRS, the SEC, and U.S. Customs with respect to these bonds. Further evidence that petitioner was not acting as an agent or conduit for Tenna is suggested by Tenna's lack of knowledge before June 1976 that petitioner had received the rebates. Riverfront Groves, Inc. v. Commissioner,60 T.C. 435">60 T.C. 435, 446 (1973). Prior to petitioner's acceptance of the rebates Tenna's President twice told him to stop seeking the rebates because they could not legally be brought into the company. Notwithstanding the President's express statements to stop seeking the rebates, petitioner continued to negotiate for their receipt. Once133 petitioner succeeded in obtaining the rebates, however, he never advised any officers or employees of Tenna that he received the bonds. A purported agency relationship in which a purported principal is unaware of the transaction out of which the agency grows is indeed suspect. Riverfront Groves, Inc. v. Commissioner,supra.In addition, there was no restriction on petitioner's use of the economic benefits of the bonds.Throughout the years in issue, Beverly Ludwig regularly clipped the coupons from the bonds in her safe deposit box and deposited them in her personal checking account. Petitioners' assertion that they realized neither gain nor economic benefit from the bonds is totally fallacious and strains credulity since they deposited and personally consumed in excess of $9,000 in bond coupon interest throughout the years in issue. It was only by having control over the bonds that allowed petitioners the opportunity to obtain and utilize the coupon interest. Since petitioners admit they are taxable on the bond coupon interest, they cannot seriously contend that they are not taxable on the fair market value of the underlying bonds that gave rise to that interest. 134 See Helvering v. Horst,311 U.S. 112">311 U.S. 112, 121 (1940); Lucas v. Earl,281 U.S. 111">281 U.S. 111 (1930). %petitioner's receipt of the economic benefits from the bonds is totally at odds with the claim that he was merely holding them on Tenna's behalf. Finally, petitioner's receipt of the third set of bonds in Switzerland is highly suspect since it strongly suggests that petitioner was trying to conceal the bonds from his purported principal. Petitioner easily could have opened an account in Tenna's name or otherwise have designated the bonds as belonging to Tenna but he simply opened a personal account and deposited the bonds with the Swiss bank. Petitioner's argument that he could not send the bonds to the U.S. because of a U.S. Customs rule requiring that negotiable instruments with a value in excess of $5,000 be declared is meritless. The third set of bonds consisted of thirty-three separate $1,000 face value bonds which could have been mailed to his home or work in packets of $5,000 each, just like the fourth set of bonds that were mailed to his home from Rotterdam, The Netherlands, in twelve packets of $5,000 each. Clearly, therefore, petitioner does not135 come within the agent or conduit exception and he is taxable on the fair market value of the bonds and the associated coupon interest. 18Having determined that petitioner is taxable on the fair market value of the bonds, a subsidiary issue is the date on which the first set of bonds are includable in petitioner's income. We believe that the first set of bonds were taxable income to petitioner on the date that he assumed complete dominion and control over them by taking them from the corporate safe and placing them in his dresser drawer 19 during March 1974. Until petitioner took the bonds home, they were in Tenna's possession and control and conceivably were for Tenna's benefit, notwithstanding that petitioner knew that acceptance of rebates was illegal and that Tenna's President had expressly told petitioner to stop seeking payment136 of the rebates. Because we have determined that petitioners had additional unreported taxable income during the years in issue, a Rule 155 computation will be necessary to redetermine petitioners' 1975 medical expense deduction. Issues 3 and 4: Addition to Tax and the Statute of LimitationsRespondent determined that part of petitioners' underpayment of tax for each of the years at issue was due to fraud and, therefore, claims that the section 6653(b) fraud addition to tax should be imposed. Petitioner denies that any underpayment of tax was due to fraud. For the reasons set forth below, we hold for respondent on this issue. The existence of fraud is a question of fact to be resolved upon consideration of the entire record. 137 Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 199 (1976), affd. without published opinion, 578 F. 2d 1383 (8th Cir. 1978). Respondent has the burden of proving fraud for each year that it is alleged by clear and convincing evidence. Sec. 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Cefalu v. Commissioner,276 F. 2d 122, 128 (5th Cir. 1960); Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970). The taxpayer nust be shown to have acted with the specific intent to evade a tax believed to be owing. Mitchell v. Commissioner,118 F.2d 308">118 F. 2d 308, 310 (5th Cir. 1941); Estate ofTemple v. Commissioner,67 T.C. 143">67 T.C. 143, 159 (1976). Since direct evidence of fraud is seldom available, respondent may meet his burden of proof through circumstantial evidence. Nicholas v. Commissioner,70 T.C. 1057">70 T.C. 1057, 1065 (1978). We have found that petitioner failed to report substantial amounts of income from his receipt of rebates that he ostensibly collected on behalf of Tenna but which he converted to his own use. We based this finding on the substantial evidence contained in the record138 including petitioner's failure to advise anyone on Tenna's Board that he had received the bonds, his placing of the bonds in his wife's safe deposit box and a personal Swiss bank account, Mrs. Ludwig's clipping of the matured coupons in her possession and depositing of the rpoceeds in her personal checking account and the use of these proceeds for personal purposes. These factors lead us to conclude that respondent has shown by clear and convincing evidence that petitioner had substantial unreported income from his use and control of the bonds received from Seatrain. It is well settled that a consistent failure to report substantial amounts of income over a number of years is effective evidence of fraudulent intent. Gromacki v. Commissioner,361 F. 2d 727 (7th Cir. 1966), affg. a Memorandum Opinion of this Court; Kalil v. Commissioner,271 F. 2d 550 (5th Cir. 1959), affg. a Memorandum Opinion of this Court. On petitioner's original return they failed to report either the fair market value of the bonds or the coupon interest obtained from the bonds which139 was deposited in Mrs. Ludwig's personal checking account. During each of the years in issue petitioners reported interest and dividend income in excess of $4,000 and they obviously were aware that interest and dividends constitute taxable income. Moreover, petitioner owned several hundred thousand dollars in stocks and bonds and he was an intelligent businessman who clearly knew that the bonds constituted taxable income. Petitioners' failure to report the bonds or the coupon interest as taxable income suggests that they intended to evade a tax believed to be owing. Mitchell v. Commissioner,supra.Although petitioners subsequently filed amended returns reporting the coupon interest, the amended returns still failed to include in income the fair market value of the bonds. 20Further evidence of petitioner's fraudulent intent is evidenced by the concealment of the third set of140 bonds in his personal Swiss bank account. Friedman v. Commissioner,421 F. 2d 658 (6th Cir. 1970), affg. a Memorandum Opinion of this Court; Beaver v. Commissioner,supra at 93 ("willful attempt to evade tax may be found from any conduct calculated to mislead or conceal.") Finally, petitioner's denial of any knowledge of the rebates to the United States of Customs investigator in May 1975, after petitioner had received $142,000 face value bearer bonds clearly illustrates an intent to mislead and conceal receipt of the bonds which, when coupled with his failure to report the bonds in income, smacks of fraudulent intent sufficient to trigger the section 6653(b) addition to tax. Consequently, notwithstanding petitioners' arguments to the contrary, we hold that respondent has established that petitioners are liable for the fraud addition to tax for each of the years in issue. Having found that petitioners filed false and fraudulent returns with the intent to evade taxes for both years in issue, respondent's notice of deficiency clearly was not barred by the statute of limitations. See section 6501(c)(1) and (2). To reflect the foregoing141 and to allow a recomputation of petitioners' 1975 medical expense deduction, Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩2. See n. 15.↩3. In the event we find that petitioners received unreported taxable income during 1975, a Rule 155 computation will be necessary to redetermine petitioners' 1975 medical expense deduction.↩4. Donald Vanke maintained the requested records from June 1972 through December 1974.↩5. As of at least March 7, 1973, Tenna's corporate counsel, who also served on Tenna's Board of Directors, was aware that the rebates were illegal under the Shipping Act of 1916, 39 Stat. 728, 734 (as amended 10/3/61), Title 46 USC § 815↩, and at some point between March 1973 and June 1973 he so advised petitioner and the other members of Tenna's Board. On March 7, 1973, Tenna's corporate counsel possessed a copy of an article taken from the March 5, 1973, Wall Street Journal entitled "Seatrain Is Charged With Giving Favors to Certain Shippers." The article was subtitled "Justice Unit Asserts Line Used Illegal Discounts and Rebates to Undercut Formal Tariffs." The article referred to a $5,000 criminal penalty for each violation of the 1916 Shipping Act and it stated that William Gohlke was among those charged with giving illegal discounts and rebates. 6. Between 1969 and 1973 Tenna's fortunes declined from a $3 million annual profit to a $1.4 million annual loss, and throughout the years in issue, Tenna's losses continued to mount at an accelerating rate.↩7. In a memo dated January 22, 1974, Ronald White wrote to petitioner: "Please acknowledge by your signature hereon that I have advised against and am not in agreement with the acceptance of rebates from Seatrain." Petitioner signed this memo on January 28, 1974, approximately one month before he received the first of four installments of bearer bonds in payment of the Seatrain rebates.↩8. This safe deposit box was rented by Mrs. Ludwig in November 1957. Petitioner was an authorized deputy of Mrs. Ludwig and had equal access to the safe deposit box. On March 12, 1975, Mrs. Ludwig also made Gertrude Goldfarb a deputy with access to the safe deposit box. ↩9. Beverly Ludwig kept meticulous records of her checking account deposits and expenditures. After each of the bond interest deposits she wrote either "Bonds," or the name of the specific bond from which the coupons had been clipped.↩10. Petitioners' taxable income includes a $3,759 loss from the sale or exchange of capital assets. Schedule D of petitioners' 1974 Federal income tax return (Capital Gains and Losses) reflects a $2,601 long-term capital gain from the sale of land, and a $77,833 long-term capital loss from the sale of land and other stocks and securities.↩11. The parties believed that negotiable instruments mailed to the United States with a value of $5,000 or less did not have to be declared in U.S. Customs.↩12. The remaining $33,000 face value bonds were mailed to United States Attorney James R. Williams on February 7, 1979, by petitioner's counsel, David N. Webster, from petitioner's personal Swiss bank account.↩13. In approximately May 1976, petitioner's counsel suggested to petitioner that he hire David N. Webster to represent him in connection with the various investigations and other proceedings involving Seatrain's rebate payments. Mr. Webster suggested that petitioner file the amended tax returns.↩14. See n. 15.↩15. Respondent determined the amount of petitioners' unreported taxable income by including in income the fair market value of bearer bonds that petitioner received during each of the years in issue. Subsequent to the mailing of the notice of deficiency and the filing of his original answer herein, respondent discovered that petitioners had improperly calculated the bond coupon interest reported on their 1975 income tax return by $905.50. In addition, respondent discovered that the original notice of deficiency improperly determined the fair market value of the bearer bonds as of the end of the month prior to the month that petitioner received the bonds. The parties have stipulated that the proper valuation date is the end of the month in which petitioner received the bonds. Respondent, therefore, decreased petitioners' omitted income adjustment for 1974 by $1,287.50, and increased it for 1975 by $171.25.↩16. Shaara v. Commissioner,T.C. Memo. 1980-247↩.17. When petitioner was interviewed by the SEC on July 28, 1976, in regard to Tenna's acceptance of rebates, petitioner stated under oath that after he was told that acceptance of rebates carried a $5,000 penalty he never sought legal advice with respect to reflecting the rebates in Tenna's books during the years in issue. We note, however, that the parties have stipulated that petitioner told his attorney about his receipt of the rebates in September 1975, although we have no information regarding the nature of the advice that petitioner sought or obtained at that time.↩18. We note that respondent has not attempted to tax petitioners on the matured coupon interest belonging to the third set of bonds even though petitioner may have been in constructive receipt of that interest when the coupons matured. Section 1.451-2(b), Income Tax Regs.↩ This issue has not been raised by the parties.19. At trial petitioner claimed that he took the bonds home for safe keeping because approximately thirty people had access to the corporate safe. We fail to see how petitioner could believe that his dresser drawer was a more secure location than a corporate safe especially when no more than three of Tenna's employees were aware of the bond's existence.↩20. The subsequent filing of amended returns, cannot eliminate imposition of the 50 percent fraud addition to tax on the original return where respondent proves fraud by clear and convincing evidence. Plunkett v. Commissioner,465 F. 2d 299, 303↩ (7th Cir. 1972).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623236/	Marie Anna Eisenmenger v. Commissioner.Eisenmenger v. CommissionerDocket No. 99914.United States Tax Court1943 Tax Ct. Memo LEXIS 142; 2 T.C.M. (CCH) 676; T.C.M. (RIA) 43394; August 25, 1943142 Jack C. Foote, Esq., and Edgar G. Vaughan, Esq., for the petitioner. S. U. Hikon, Esq., for the respondent. MELLOTTSupplemental Memorandum Opinion MELLOTT, Judge: Opinion was promulgated herein May 14, 1941, and published in 44 B.T.A. at page 489. Decision was entered May 16, 1941, holding that there were deficiencies in income tax of $1,847.48 and $1,610.99 for the calendar years 1936 and 1937, respectively. On August 8, 1941, petitioner filed a "REQUEST FOR SPECIAL LEAVE TO FILE MOTION TO VACATE JUDGMENT AND TO OBTAIN REHEARING." Order was entered August 11, 1941, granting petitioner's request and the decision was set aside. The "MOTION TO VACATE JUDGMENT AND TO OBTAIN A REHEARING" was ordered filed and hearing thereon was set for September 24, 1941. On that date the motion was argued, granted, and the proceeding was restored to the calendar for rehearing in due course. On July 6, 1942, the proceeding was duly called for hearing at St. Paul, Minnesota. At that time respondent filed a "MOTION TO VACATE BOARD ORDERS ENTERED AUGUST 11 AND SEPTEMBER 24, 1941, AND TO REINSTATE OPINION PROMULGATED MAY 14, 1941 AND DECISION ENTERED MAY 16, 1941." The motion143 was denied on the same date. Thereupon counsel for the respective parties stipulated that "the original record in this case up to and including the motion filed by respondent this morning will be considered a part of the record for the purpose of the rehearing." Petitioner then offered in evidence, as Exhibit No. 11, certified copies of certain proceedings in the District Court, 2nd Judicial District, County of Ramsey, and State of Minnesota - which will be described or referred to with more particularity later herein - and rested. Respondent then called the Clerk of the District Court and one of petitioner's attorneys as his witnesses and also introduced in evidence additional court records. Thereupon he rested and the parties were given time for the filing of briefs. The issue discussed by the parties following the rehearing is the force and effect of the proceedings had in the District Court of Ramsey County, Minnesota, subsequent to the promulgation of our opinion. Petitioner's Exhibit No. 11 contains six documents, certified by the Clerk of the District Court of Ramsey County to be true and correct copies of "Petition for Confirmation of Appointment", "Order Confirming Appointment", 144 Acceptance of Appointment and Oath", "Petition", "Order for Haring" and "Findings, Conclusions of Law and Judgment." The first five documents were all filed in the office of the Clerk of the District Court on June 9, 1941. On the same date an affidavit of Vernoa Stubbs showing the mailing of a notice was also filed. Each document bears the caption "State of Minnesota, County of Ramsey, District Court, Second Judicial District. In the Matter of the Charles W. Eisenmenger Trust #1." They are all set out at length herein, exclusive of caption, signatures and purely formal parts. PETITION FOR CONFIRMATION OF APPOINTMENT OF TRUSTEES Your petitioners, Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger petition and represent to the Court as follows: I. Your petitioners, Charles W. Eisenmenger, Marie Anna Eisenmenger and Ottilie Eisenmenger are all residents of the City of Saint Paul, Minnesota. II. On December 31, 1931, your petitioner, Charles W. Eisenmenger created a trust, known as the Charles W. Eisenmenger Trust #1, by instrument in writing, a true and correct copy of which has been filed herein and is, by this reference, made a part hereof. Under said trust145 said Charles W. Eisenmenger, Marie Anna Eisenmenger and Ottilie Eisenmenger were appointed trustees. WHEREFORE your petitioners pray for an order of this Court in the above-entitled matter confirming their appointment as trustees under the Charles W. Eisenmenger Trust #1 pursuant to the provisions of Chapter 259, Session Laws of Minnesota for 1933. Dated May 29, 1941. [Signed and sworn to before a notary public May 29, 1941.] ORDER CONFIRMING APPOINTMENT OF TRUSTEES Upon reading the attached petition dated May 29, 1941, of Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger praying for confirmation of their appointment as trustees under the Charles W. Eisenmenger Trust #1, and it appearing to the satisfaction of the Court that all matters set forth in said petition are just and true and that the confirmation prayed for therein should be granted, IT IS HEREBY ORDERED that the appointment of Charles W. Eisenmenger, Marie Anna Eisenmenger and Ottilie Eisenmenger as trustees under the Charles W. Eisenmenger Trust #1 be, and the same hereby is ratified and confirmed pursuant to the provision of Chapter 259 of the Session Laws of Minnesota for 1933. IT IS FURTHER146 ORDERED that said Charles W. Eisenmenger, Marie Anna Eisenmenger and Ottilie Eisenmenger shall qualify as trustees by filing with the Clerk of this Court their acceptance in writing of their appointment and oaths as such trustees as hereby confirmed. Dated June 2, 1941. (Signed) Albin S. Pearson District Judge. ACCEPTANCE OF APPOINTMENT OF TRUSTEES AND OATH OF TRUSTEES Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger, being first duly sworn, do hereby accept the appointment as trustees of the Charles W. Eisenmenger Trust #1 as confirmed by order of the District Court of Ramsey County, Minnesota, dated June 2, 1941, and do hereby take oath that they will faithfully and justly perform the duties of such office and trust. Dated June 9, 1943. [Subscribed and sworn to before a notary public June 9, 1943.] PETITION I. The appointment of the petitioners as trustees of the above-entitled trust has heretofore been confirmed by order of this Court dated June 2, 1941. II. Petitioner Marie Anna Eisenmenger (wife of Charles W. Eisenmenger) is life beneficiary of said trust. Petitioner Ottilie Eisenmenger (unmarried) is one of the contingent life beneficiaries of147 said trust. Petitioner Charles W. Eisenmenger is the grantor of said trust. The other beneficiaries of said Trust are Anna Eisenmenger (unmarried), Louisa Schuldt (wife of Dr. F. Schuldt), and Emily Trudeau (widow), who are life beneficiaries after the death of Marie Anna Eisenmenger, and Frederick C. Schuldt, Jr., Louis John Schuldt, Carolyn Louise Schuldt and Mary Ann Schuldt, children of Louisa Schuldt, ultimate beneficiaries, all of whom are of age except Mary Ann Schuldt, who is nineteen (19) years of age. III. Section I of said trust reads: "The trustees shall pay to Marie Anna Eisenmenger, the wife of the grantor, for and during the term of her natural life, annually or as received, the net cash income received by them from said shares of stock." IV. Petitioners have been advised by counsel that said Section I of said trust authorizes them to distribute to said Marie Anna Eisenmenger only such income of said trust as is received by the trustees in cash, and prohibits the distribution of any income of the trust which is received in the form of property or other assets other than cash. WHEREFORE, petitioners pray: 1. That the Court by order fix a time and place at which148 it will hear proof of the matters set forth in this petition and at which it will determine the proper construction of said trust as to the authority of petitioners, and that such order provide for notice thereof to the beneficiaries of said trust. 2. That upon such hearing the Court examine and construe the trust deed and instruct the petitioners as to the proper construction thereof. 3. That the Court grant such other relief as may be proper. Dated this 2nd day of June, 1941. [Signed Doherty, Rumble, Butler, Sullivan & Mitchell, Attorneys.] [Subscribed and sworn to by the three trustees before a notary public June 2, 1941.] ORDER FOR HEARING Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger, trustees of the above-named trust, having filed a petition praying for a construction of said trust, IT IS ORDERED that said petition be heard at the special term at the Court House in the City of Saint Paul, County of Ramsey, State of Minnesota on Saturday, June 21, 1941, at 10 o'clock A.M. and IT IS FURTHER ORDERED that notice thereof be given by mailing a copy of this petition and this order to beneficiaries of said trust by registered mail, return receipt requested, 149 to their last known address at least ten (10) days prior to the date of said hearing. Dated June 5, 1941. (Signed) Albin S. Pearson District Judge AFFIDAVIT OF MAILING state of minnesota c/ounty of Ramsey] ss. Verona Stubbs of said County and State, being first duly sworn, deposes and says that she is a clerk of the office of Doherty, Rumble, Butler, Sullivan & Mitchell, the attorneys for the petitioners in the above-entitled matter; that on the 6th day of June, 1941, she mailed copies of the attached petition and order for hearing, by registered mail, return receipt requested, to each of the following named persons who are all of the beneficiaries of said trust, at the address stated opposite the name of each, to-wit: NAMEMrs. Marie A. Eisenmenger162 Cambridge Ave.,St. Paul, Minn.Miss Ottilie Eisenmenger863 Osceola Ave.,St. Paul, Minn.Miss Anna Eisenmenger863 Osceola Ave.,St. Paul, Minn.Mrs. Louisa Schuldt55 N. Lexington Pkwy.,St. Paul, Minn.Mrs. Emily Trudeau863 Osceola Ave.,St. Paul, Minn.Mr. Frederick C. Schuldt, Jr.55 N. Lexington Pkwy.,St. Paul, Minn.Mr. Louis John Schuldt55 N. Lexington Pkwy.,St. Paul, Minn.Miss Carolyn Schuldt55 N. Lexington Pkwy.,St. Paul, Minn.Miss Mary Ann Schuldt55 N. Lexington Pkwy.,St. Paul, Minn.(Signed) Verona Stubbs150 Findings of Fact, Conclusions of Law and Judgment The petition of Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger, Trustees under the Charles W. Eisenmenger Trust No. 1, for a construction of Section I of said trust, having come on before the Court in chambers, Saturday, June 21, 1941, at ten o'clock A.M., at which time the matter was heard; service of the petition and order for hearing having been duly made on the beneficiaries named in said Trust; J. C. Foote, of Doherty, Rumble, Butler, Sullivan & Mitchell, having appeared on behalf of the Trustees, there being no other appearances. NOW THEREFORE, upon all the files and records herein, including the official Reporter's transcript of the record in the case of Marie Anna Eisenmenger v. Commissioner of Internal Revenue, Docket No. 99914, heard by the Board of Tax Appeals therein (Eisenmenger v. Commissioner of Internal Revenue, 44 B.T.A. No. 79, May 14, 1941), and after due consideration the Court makes the following: Findings of Fact I. That on December 31, 1931, Charles W. Eisenmenger created the Charles W. Eisenmenger Trust No. 1, consisting of two hundred (200) shares of the capital stock151 of the Chamar Investment Company, a Minnesota corporation, represented by Certificate No. 7, naming Charles W. Eisenmenger, Marie Anna Eisenmenger, and Ottilie Eisenmenger as trustees. II. That the appointment of said Trustees was confirmed by this Court pursuant to law on June 2, 1941, and the acceptance of the Trustees and their oaths were in due course filed with this Court. III. That Section I of said Trust reads as follows: The trustees shall pay to Marie Anna Eisenmenger, wife of the grantor, for and during the term of her natural life, annually or as received, the net cash income received by them from said shares of stock. IV. That during the years 1936, 1937, 1938, 1939, and 1940, the Trustees received as income of the trust, dividends on the shares of stock of Chamar Investment Company constituting the corpus of the Trust in the form of cash, dividends on said stock in the form of subordinated debenture notes, and interest on such debenture notes, in the form of cash. NOW, THEREFORE, the Court makes the following: Conclusions of Law I. The words "net cash income" as used in Section I of the Charles W. Eisenmenger Trust No. 1 were intended by the grantor of the Trust152 to, and do, refer solely to income received by the Trustees in the form of cash, and Maria Anna Eisenmenger, the beneficiary named in said Section I, is entitled to receive only such income as may be received by the Trustees in the form of cash. II. That the interest payments received in cash by the Trustees on the subordinated debenture notes received by the Trustees as dividends on the shares of stock constituting the original corpus of the trust is cash income subject to distribution to Marie Anna Eisenmenger pursuant to the provisions of Section I of said trust. III. The use of the word "net" to modify the term "cash income" as used in Section I of said Trust was intended by the grantor of the trust to, and does, authorize and direct the Trustees to retain out of the cash income received by them during any year such amount as the Trustees may reasonably estimate to be necessary for the payment of income taxes on the non-distributable items of income not in the form of cash received by them during such year, provided that when such income taxes are actually determined, any excess of the amount theretofore retained by the Trustees out of the cash income of the trust for the payment153 of taxes over the amount actually needed is distributable to Marie Anna Eisenmenger under the terms of Section I of said Trust. Further, the term "net cash income" was intended to, and does, authorize the Trustees to pay the current expenses of the Trust out of a cash income received by them, and the amount necessary to pay such expenses is therefore not distributable under Section I of said trust to Marie Anna Eisenmenger. WHEREFORE, the Court having assumed jurisdiction of this trust, it is ORDERED that the Court keep and retain said jurisdiction now and hereafter for all purposes. FURTHER ORDERED that the Trustees be and they hereby are authorized and directed to proceed in accordance with the Conclusions of Law set forth above. (Signed) Albin S. Pearson District Judge. Dated July 3, 1941. The files in the office of the Clerk of the District Court of Ramsey County, Minnesota, indicate that there had been filed therein a transcript of the hearing before this tribunal, a copy of the opinion heretofore promulgated (44 B.T.A. 489">44 B.T.A. 489), and copies of petitioner's and respondent's original and reply briefs filed with the Board following the original hearing. 154 Accompanying these documents was another, reading as follows: CHARLES W. EISENMENGER TRUST #1 ORGANIZATION: Organized December 31, 1931. FIRST BENEFICIARY: Section 1 of said Trust provides - "The trustees shall pay to Marie Anna Eisenmenger, the wife of the grantor, for and during the term of her natural life, annually or as received, the net cash income received by them from the said shares of stock." SHARES OF STOCK REFERRED TO: This relates to 200 shares of Chamar Investment Co. stock, being certificate #7 in name of Charles W. Eisenmenger Trust #1. INCOME RECEIVED BY TRUST #1: December 31, 1936, a dividend on 200 shares of Chamar Investment Co. stock: Cash$1,600.001 Subordinated DebentureNote dated December 31,1936, due December 31,194614,400.00Total$16,000.00December 29, 1937, a dividend on 200 shares of Chamar Investment Co. stock: Cash$2,100.001 Subordinated DebentureNote dated December 31,1937, due December 31,194711,900.00Total$14,000.00December 30, 1939 a dividend on 200 shares of Chamar Investment Co. stock: 1 Subordinated DebentureNote dated December 30,1939, due December 31,1946$9,000.00These Subordinated155 Debenture notes were canceled and reissued as follows: 1936 Note$14,400.001937 Note11,900.001939 Note9,000.00Total$35,300.00 Were included in a new note dated January 1, 1940 bearing interest at 2 1/2% in sum of $35,300.00 maturing December 30, 1965. Interest payable semi-annually in January and July. STATEMENT OF CASH RECEIPTS AND PAYMENTS: Account ofAccount ofTotalReceiptsDividendsInterestReceived1936$1,600.00$1,600.0019372,100.00$ 720.002,820.001938193919402,511.00882.503,393.50$3,700.00$4,113.50$7,813.50SUMMARY OF CASH PAYMENTS: MinnesotaFederalP.P.TaxTaxTaxExpenseTotal19361937$1,290.00$ 45.00$1,335.001938$ 759.651,265.9645.501,077.951939391.20579.25107.501,077.95194086.0086.0019418.2766.05$113.8230.00218.14$1,159.12$3,201.26$113.82$314.00$4,788.20Receipts$7,813.60Payments4,788.20June 18, 1941 balance$3,025.30MRS. EISENMENGER'S INTEREST IN CASH DIVIDENDS: A summary is presented following showing the cash receipts and payments as follows: CashCash receivedDividendsInterestTotal1936$1,600.00$1,600.0019372,100.00$720.002,820.00$3,700.00$720.00$4,420.001938 No cash receipts1939 No cash receipts$4,420.00Cash paymentsTaxesExpensesTotal1937$1,290.00$45.00$1,335.0019382,025.6145.502,071.111939970.45970.45$4,286.06$90.50$4,376.56$4,376.56$ 43.44Received 1940Interest$3,393.50$3,436.94Payments 1940-1941Tax$ 74.32P.P. Tax112.82Expense223.50$ 411.64Balance on hand June 18, 1941$3,025.30156 It is true, as petitioner argues, that state law controls when the Federal taxing act, by express language or necessary implication, makes its own application dependent upon state law, Burnet v. Harmel, 287 U.S. 103">287 U.S. 103; Lyeth v. Hoey, 305 U.S. 188">305 U.S. 188; and an order of a state court having jurisdiction of a trust is generally determinative as to what is distributable income for the purpose of division of the tax between the trustee and the beneficiary. Freuler v. Helvering, 291 U.S. 35">291 U.S. 35. "The power to transfer or distribute assets of a trust is essentially a matter of local law., Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, 9." Helvering v. Stuart et al., 317 U.S. 154">317 U.S. 154. The rule referred to above has been applied by this tribunal in many cases. See e.g. Lawrence Fox et al., 31 B.T.A. 1181">31 B.T.A. 1181; Susan B. Armstrong, 38 B.T.A. 658">38 B.T.A. 658; George N. Spiva, 43 B.T.A. 1174">43 B.T.A. 1174; Estate of Sallie Houston Henry, 47 B.T.A. 843">47 B.T.A. 843; Josephine Towne Clegg, 47 B.T.A. 934">47 B.T.A. 934;157 and John Frederick Lewis, Jr., 1 T.C. 449">1 T.C. 449 (on appeal C.C.A. 3 * ). See also Erie Railroad Co. v. Tompkins, 304 U.S. 64">304 U.S. 64; Hubbell v. Helvering, 70 Fed. (2d) 668; Commissioner v. Dean, 102 Fed. (2d) 699; Plunkett v. Commissioner, 118 Fed. (2d) 644. It is also probably true that it may be applied even though the suit in the state court was instituted while the proceeding was pending before the Board or the Tax Court, which, it has been suggested, may sometimes require that "the role of ventriloquist's dummy to the courts of some particular state" be played. Richardson v. Commissioner, 126 Fed. (2d) 562. Respondent's suggestion that this, in effect, provides a taxpayer with an additional remedy, notwithstanding the provisions of Sec. 1141, I.R.C. giving exclusive jurisdiction to the Circuit Courts of Appeal to review the decisions of this tribunal is not without substance; but that seems to be wholly immaterial. Whether158 the instant proceeding should have been reopened is beside the point. Vandenbark v. Owens-Illinois Glass Co., 311 U.S. 538">311 U.S. 538, indicates that an Appellate Court may reverse a judgment, correct when entered, if intervening decisions justify or require it. Decision in the instant proceeding had not become final (section 1140, I.R.C.); so we deemed it proper to grant the requested rehearing to the end that appropriate inquiry could be made as to the effect, if any, of the decision by the state court upon our decision. While a practice of litigating a question before us and then, following an adverse decision, going into a state court for the purpose of attempting to secure a contrary holding is not to be encouraged by us, we do not agree with the respondent, that such "conduct is reprehensible." The question now before us is: Is the judgment of the state court such a decision as to preclude us from passing upon the merits of the controversy as originally submitted? In other words, is a decision by us in accordance with that of the State District Court now required? In a recent case ( Francis Doll, 2 T.C. 276">2 T.C. 276) we expressed the159 opinion that a state decision, in order to have the effect now urged upon us by petitioner, "must have been entered in a proceeding whether there was a real controversy to be determined and after such trial as would properly and fully present the facts and issues." After reviewing the facts then before us it was pointed out that the actual controversy sought to be litigated in the state court had really been the identical controversy which the petitioner proposed to litigate when he filed petition before us. We said: While a hearing of some sort was had in the proceeding in the state court, the facts show that the petitioner, in his answer, admitted all of material allegations contained in the petition filed by * * * [his wife in the state court] and it is the decree entered in that proceeding that the petitioner contends is conclusive here. With that contention we do not agree. The proceeding was not a proceeding such as the Supreme Court had in mind in Freuler v. Helvering, supra. See and compare Botz v. Helvering, 134 Fed. (2d) 538; First-Mechanics National Bank of Trenton v. Commissioner, 117 Fed. (2d) 127;160 Masterson v. Commissioner, 127 Fed. (2d) 252; and Anna Eliza Masterson, 1 T.C. 315">1 T.C. 315. Since the opinion in the Doll case, supra, became extant, the parties herein have discussed it in supplemental (letter) briefs. Respondent contends it is squarely in point and furnishes ample authority for deciding the case in his favor. Petitioner denies that this is so, arguing that in the instant case a serious question of law was involved and the trustees felt impelled to have an adjudication which would be binding upon them and all the beneficiaries. The facts indicate that the proceeding relied upon by petitioner was non-adversary in fact. The trust instrument, the terms of which are set out in our earlier opinion, makes provision for the distribution of the income of a personal holding company within the intimate family group of the settlor. It is not our present purpose to repeat the discussion contained in our published opinion. It suffices to point out at this juncture that the only one having an interest adverse to petitioner was her co-trustee and husband, the grantor, who might be interested in having the court161 declare a resulting trust in his favor as to the "non-cash" income. There was then, as there is now, small likelihood that any such contention would be made by him. Since the remaindermen were not financially interested in the "non-cash" income, the service of notice upon them (if made in accordance with the laws of the state, which will be referred to more fully later) did not result in bringing before the court anyone having an adverse interest in the issue then before it. This is borne out to some extent by the failure of any of the parties, including the settlor and the remaindermen, to make an appearance. As a matter of fact no one except the lawyers for petitioner appeared before the court. Moreover the pleadings presented no real issue. Petitioner was making, and it was intended that she should make, no contention at variance with the contention made by her as a trustee. In other words she and her associate trustees as well as the lawyers instituting the proceeding for her, were all interested in but one thing - in securing a judgment which might be used as a foil against an extant decision of this tribunal. But even if we are in error in holding that the proceeding was non-adversary162 there are other reasons for refusing to allow it to overturn our decision. As the Circuit Court of Appeals for the Eighth Circuit recently pointed out in Otto C. Botz et al., Transferees v. Helvering, 134 Fed. (2d) 538, the "Full Faith and Credit" provision of the Constitution is applicable in Federal courts; but it "does not require recognition of a judgment if the party against whom the judgment is thus urged was not a party, or privy or appeared in the judgment suit." Respondent was not a party to the state proceeding or in privity with anyone who was a party. He had no knowledge of its filing or pendency until after it was rendered and had become final. Yet the very purpose of securing it was, if possible, to overthrow a decision which had previously been rendered in his favor. Passing respondent's argument to the effect that the real question before the court was the determination of the grantor's intent and therefore his testimony was proper and required, and passing also the fact that no showing has been made that the inventory and annual accounts required by the Minnesota Statutes have not been filed, we mention a few circumstances in connection163 with the suit which seems to us to be more important. The Clerk of the District Court, in response to subpoena, produced the court records. Asked to "enumerate those records by description in the chronological order of the date in which they appear" he stated: "Petition for confirmation of appointment of trustees filed June 9th, 1941." According to his testimony the "Order confirming appointment of trustees dated June 2nd, 1941 [was] filed the same date, June 9th, 1941." Later he stated - "This is the petition for the appointment of the Petitioner as trustee in the above entitled trust, heretofore being confirmed by order of this Court dated June 2nd, 1941, filed June 9th, 1941. Next is an order for hearing dated - order for hearing on Saturday June 21, 1941 at 10:00 o'clock A.M. dated June 5th 1941, Albin S. Pearson, District Judge. Next is an affidavit of mailing signed by Verona Stubbs, sworn to on the 6th day of June, 1941, before Louisa N. Adams, notary public, Ramsey County, Minnesota, filed June 9th, 1941." He made no mention of any notice by publication ever having been made and the records do not indicate that any ever was made. The exhibits and documents referred to by164 the witness bear dates coinciding with those mentioned by him; but the filing stamp of the clerk's office does not appear upon the copies before us. Petitioner's motion for rehearing and her reply brief, however, confirm that "the petition for construction of the trust agreement was dated, not filed, on June 2nd. The petition and order setting the date for hearing were presented to the court on the 5th day of June, and the order setting the date for hearing was made on that day. The petition for the construction of the trust, the order setting the day for hearing, and the affidavit of one of our employees showing the mailing of a copy of the order to all beneficiaries, pursuant to the order, were then all filed as of June 9, 1941." 1 Collectively the facts suggest several queries: Does the state statute under which petitioner was proceeding authorize the District Court to "consider the application to confirm the appointment of the trustee and specify the manner in which he shall qualify" before the petition is actually filed? Cf. Sec. 9244 Mason's Minnesota Statutes. In other words, did the courts have jurisdiction to sign the order confirming the appointment of the trustees 7 days165 prior to the filing of the petition therefor or to order the proceeding set for hearing 4 days prior to the filing of the petition? The statute providing that "Upon the filing of such petition [i.e. petition for instructions or for a construction of the trust instrument] the court shall make an order fixing a time and place for hearing * * " can the order of the court, signed 4 days prior to the filing of the petition, be construed to be such an order as is contemplated by the statute? Since the statute provides that "Notice of such hearing shall be given by publishing a copy of such order one time in a legal newspaper of such county at least 20 days before the date of such hearing, and by mailing a copy thereof to each party in interest then in being, at least 10 days before the date of such hearing or in such other manner as the court shall order * ," may the publication of such notice and the mailing of the copies thereof be dispensed with? In other words does the clause "in such manner as the court shall order" refer to the service to be made upon the parties in interest or does it authorize the court to dispense with the publishing of the notice in a legal newspaper? Finally, 166 was the respondent a "part in interest then in being" within the purview of the statute? Whether the decision is "binding in rem upon the trust estate and upon the interests of all beneficiaries" is outside of our jurisdiction and is not decided. We rest our decision primarily upon the fact that the proceeding was non-adversary in character and secondarily upon a substantial doubt as to the regularity of the judgment which, we think, justifies us in failing to give it "full faith and credit," especially since respondent had not notice of any of the proceedings upon which it is based. Some of the circumstances indicating that we are justified in finding that the proceeding was non-adversary have already been set out. It may be added that the same counsel represented the taxpayer in both cases. One of them, testifying as a witness, stated: "Well, I can't say that any contention was presented to the District Court. As attorney for the trustees presenting the matter it was submitted merely on the briefs and records in the tax case, with a request that the Court construe the trust and state whether or not the income167 in question was distributable, so that the trustees could be directed." The views expressed in our published opinion represent our best judgment upon the issue litigated before us. No useful purpose would be served by repeating them here or by re-publishing the opinion. It, by reference, is incorporated herein. In addition we hold that the state proceeding is not binding upon us. The decision heretofore entered and set aside will be re-entered in due course. Footnotes. TC decision affirmed by CCA-3, 141 Fed. (2d) 221↩.1. The quotations are from "Answering Brief of Petitioner."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623247/	ESTATE OF F. J. NESSELRODT, DECEASED, WILLIAM WHITLOCK, SAM L. HUNTER, JR., AND ROBERT LYNN NESSELRODT, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Nesselrodt v. CommissionerDocket No. 38921-84.United States Tax CourtT.C. Memo 1988-489; 1988 Tax Ct. Memo LEXIS 521; 56 T.C.M. (CCH) 452; T.C.M. (RIA) 88489; October 11, 1988. Harold D. Jones, for the petitioner. Nancy W. Hale, for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined523 a deficiency in petitioner's Federal estate tax of $ 755,271.21. After concessions, the issues for decision are (1) whether petitioner made a valid election to claim "special use values" pursuant to section 2032A1 with respect to several parcels of real estate and (2) whether petitioner must include in the decedent's gross estate certain stock of the Federal Land Bank Association. The facts have been fully stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner is the Estate of F. J. Nesselrodt. F. J. Nesselrodt is hereinafter referred to as "decedent." Decedent died testate on January 6, 1981. At the time of his death, decedent resided in Lilbourn, Missouri. 2On October 6, 1981, petitioner524 filed a Form 706 (Estate Tax Return) 3 with the Internal Revenue Service Center, Kansas City, Missouri. On that return, petitioner valued three parcels of farmland owned by decedent at his death at their special use value under section 2032A. The parties agree that, subject to the percentage limitations of section 2032A(b)(1) and the validity of petitioner's election, those parcels qualify for special use valuation. The instructions on the Form 706 relating to the special use valuation election required that petitioner attach a statement (the notice of election) giving 11 items of information including copies of written appraisals and the name, address, taxpayer identification number and relationship to the decedent of each person taking an interest in the property and the value of that interest. In addition, the instructions required that petitioner attach "an agreement to express consent to personal liability under section 2032A(c) in the event of certain early dispositions of the property or early cessation of the qualified use." They further provided : "The agreement must be executed by all parties receiving525 any interest in the property being valued based on its qualified use." We will refer to this agreement as the recapture agreement. Petitioner did not submit any written appraisals of the property. Furthermore, petitioner stated that only Eva Nesselrodt, decedent's wife, had an interest in the property, and only Mrs. Nesselrodt signed the recapture agreement that was incorporated in the notice of election attached to the return. Under decedent's will, decedent's daughter and decedent's grandchildren, all of whom were either beneficiaries or potentially beneficiaries of a trust created by the will, received an interest in the property. On October 11, 1983, petitioner filed a document entitled "First Amended Agreement to Special Valuation Under Section 2032A." This document was signed by all of the beneficiaries of the trust created by decedent's will, but it did not include their addresses, social security numbers or the values of their respective interests. In it, they consented "to personal liability under Subsection (c) of (Code Section) 2032A for the additional tax imposed by that subsection with respect to their respective interests in the * * property in the event of526 certain early dispositions of the property or early cessation of the qualified use of the property." In this document, petitioner attempted to extend its election to two other parcels of real property in addition to that which it had specified in the estate tax return. Decedent owed $ 261,918.55 to the Federal Land Bank Association of Sikeston (FLBA). Petitioner deducted the full amount of the loan from decedent's gross estate on the estate tax return. In addition, decedent owned stock in the bank with a face value of $ 13,500. The stock had been issued to decedent in lieu of cash in an amount equal to the face amount of the stock at the time that he loan was made. That stock would be applied at face value to offset his indebtedness at the time that the loan was repaid. The stock could not be sold, and it could only be transferred if the loan was transferred. Decedent earned no income from the stock. In general, under section 2032A, estates may elect to value certain qualifying farms and other real property used in a trade or business according to the property's actual use at the time527 of the decedent's death, rather than at the property's fair market value based upon its highest and best use. See sec. 2032A. In general, strict compliance with the requirements of section 2032A and the regulations thereunder is required for the election to be valid. Estate of Gunland v. Commissioner,88 T.C. 1453">88 T.C. 1453, 1459 n.4 (1987). Section 2032A(d)(1) provides: "The election under this section shall be made on the return of the tax imposed by section 2001. Such election shall be made in such manner as the Secretary shall be regulation prescribe." Those regulations require a notice of election that, in substance, provides the same information required by the instructions to the Form 706 used by petitioner. See sec. 20.203A-8(a)(3), Estate Tax Regs. The regulations also require as part of the notice of election that affidavits be filed "describing the activities constituting material participation and the identity of the material participant or participants" in the farm or business. Sec. 20.2032A-8(a)(3)(xiii), Estate Tax Regs. Finally, as part of the election, the recapture agreement must be attached to the estate tax return. See sec. 20.2032A-8(3), Estate528 Tax Regs. The agreement must be signed by all the parties having any interest in the property being valued. Sec. 20.2032A-8(c)(1), Estate Tax Regs. Respondent contends that petitioner's attempted election to value the property under section 2032A was invalid because the election was not in substantial compliance with the regulations. Petitioner argues that it manifested sufficient intent on the original return that it wished to use special use valuation, and taking into account certain local practices, it either claimed, or, or under certain provisions allowing taxpayers to cure special use valuation elections, it should be allowed to claim, special use values. We agree with respondent. It is clear that petitioner's initial election does not qualify under section 2032A because it did not include the recapture agreement signed by all the parties having an interest in the property at the time of the decedent's death. McDonald v. Commissioner,853 F.2d 1494">853 F.2d 1494 (8th Cir. 1988), affg. on this issue 89 T.C. at 305; see also Estate of Gunland v. Commissioner,88 T.C. at 1458-1459. 4529 McDonald involved a situation where, because of the retroactive effect given to the surviving spouse's disclaimer, no person having an interest in the property signed the original recapture agreement. In the instant case, which is appealable to the Eighth Circuit, Eva Nesselrodt did sign the agreement so that technically McDonald is not controlling. Golsen v. Commissioner,54 T.C. 742">54 T.C. 742, 756-758 (1970), affd. on the substantive issue 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Consequently, although we are satisfied that our conclusion herein should be the same as that reached in McDonald, we turn to a consideration of petitioner's main contentions. Petitioner relies on a 1984 amendment to section 2032A. The Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 1025(a), 98 Stat. 1030, added section 2032A(d)(3), 5 which provides: The Secretary shall prescribe procedures which provide that in any case in which -- (A) the executor makes an election under paragraph (1) within the time prescribed for filing such election, and (B) substantially complies530 with the regulations prescribed by the Secretary with respect to such election, but -- (i) the notice of election, as filed, does not contain all required information, or (ii) signatures of 1 or more persons required to enter into the agreement described in paragraph (2) are not included on the agreement as filed, or the agreement does not contain all required information, the executor will have a reasonable period of time (not exceeding 90 days) after notification of such failures to provide such information or agreements. The Conference report provides that a recapture agreement may be cured if, for example, not all required signatures are affixed (provided that those that are not are those of holders of interests of relatively minor value) or if a parent, rather than a guardian ad litem, signs for a minor child. H. Rept. 98-861 (Conf.) 1240-1241 (1984), 1984-3 C.B. (Vol. 2) 494-495. Petitioner does not531 come within the terms of this relief provision because it has not shown that the defects in the recapture agreement fall within the scope of curable defects. In particular, it has not shown that the only signatures omitted were those of persons whose interests were of relatively minor value. See McDonald v. Commissioner, supra. Thus, petitioner is not entitled to relief under section 2032A(d)(3). See Estate of Killion v. Commissioner,T.C. Memo. 1988-244 (in which we also discuss Prussner v. United States, an unpublished order ( C.D. Ill. 1987, 87-2 U.S.T.C. par. 13,739) relied upon by petitioner).6Petitioner also relies on section 1421 of the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1421, 100 Stat. 2716 (1986 Act), which contains further provisions for the curing532 of certain defective special use valuation elections. The essential difference between this provision and section 2032A(d)(3) is that substantial compliance is with reference to the instructions on the return rather than respondent's regulations. Petitioner has not argued that the requirements of the instructions varied from those regulations, and we conclude that the 1986 Act provision provides petitioner no more relief than section 2032A(d)(3). McDonald v. Commissioner,853 F.2d at 1498. 7We turn to the question of the includability of decedent's FLBA stock in his gross estate. Section 2001 imposes a tax on the transfer of the taxable estate of all citizen and resident decedents. Section 2051 defines taxable estate as the gross estate less deductions. "The value of the gross estate shall include the value of all property533 to the extent of the interest therein of the decedent at the time of his death." Sec. 2033. Petitioner, while conceding that it has an interest in the FLBA stock, argues that such stock had no value because it could not be sold and earned no income or that, in the alternative, its value should be discounted from the face amount of the stock because the stock earned no income. We disagree. While it may be the case, as petitioner argues, that purchase of the FLBA stock merely increased the effective interest rate on the loan, petitioner deducted the face amount of that debt in determining its taxable estate. Petitioner did not deduct the face amount of the stock from the face amount of the debt, nor did petitioner discount the face amount of the debt to reflect the higher interest rate it alleges it was paying.8 Furthermore, because the face amount of the stock would be either deducted from the debt or refunded at the time the debt was paid, we think that, relative to that debt, the value of the stock was its face value, even though it earned no income. With respect to the discounting argument, petitioner, who had the burden of proof, Rule 142(a), 9 has presented no evidence*534 that would allow us to determine some other value as the fair market value. Estate of Killion v. Commissioner,T.C. Memo 1988-244">T.C. Memo. 1988-244. To reflect the foregoing and concessions, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect as decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure. ↩2. At the time they filed the petition, William Whitlock, Sam L. Hunter, Jr. and Robert Lynn Nesselrodt, the executors of the estate, all resided in states within United States Court of Appeals for the Eighth Circuit. ↩3. Petitioner filed the January 1979 version of Form 706. ↩4. It is equally clear that the amended agreement will in no event serve to extend the election to the two parcels of real property included only on that document, because the election to use special use valuation must be made on a timely filed estate tax return. Sec. 20.2032A-8(a)(3)↩, Estate Tax Regs. 5. The amendment applies to estates of decedents dying after Dec. 31, 1976. Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 1025(b), 98 Stat. 1031.↩6. In view of this result, we need not deal with the arguments of the parties regarding the extent to which petitioner substantially complied with other requirements applicable to the special use valuation election under section 2032A. See McDonald v. Commissioner,853 F.2d 1494">853 F.2d 1494, 1498 n.7 (8th Cir. 1988), affg. 89 T.C. 293">89 T.C. 293↩ (1987). 7. We note that the Form 706 filed by petitioner is not the Form 706 targeted by this provision. McDonald v. Commissioner,89 T.C. 293">89 T.C. 293, 307 (1987), affd. on this issue on another ground 853 F.2d 1494">853 F.2d 1494↩ (8th Cir. 1988). 8. We note in this regard that the full value of securities pledged to secure a debt is includable in a decedent's gross estate. Sec. 20.2031-2(g), Estate Tax Regs. ↩9. That a case is fully stipulated does not change the burden of proof. Service Bolt & Nut Co. 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); Rule 122(b).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623253/	Louisa J. Calder, Petitioner v. Commissioner of Internal Revenue, RespondentCalder v. CommissionerDocket No. 28344-82United States Tax Court85 T.C. 713; 1985 U.S. Tax Ct. LEXIS 21; 85 T.C. No. 42; November 6, 1985, Filed 21 Decision will be entered under Rule 155. Upon the facts, held:1. P's transfer to four trusts, involving six beneficiaries, constituted six separate gifts.2. A blockage discount should be applied to each gift separately in valuing P's gifts, based on the actual annual sales figure for each of the gifts.3. P's gifts did not create present interests which qualified for exclusion from the gift tax under sec. 2503(b), I.R.C. 1954. Edward L. Sadowsky and S. Sidney Mandel, for the petitioner.Michael Menillo, for the respondent. Korner, Judge. KORNER713 Respondent determined a Federal gift tax deficiency against22 Louisa J. Calder (hereinafter petitioner) for the taxable quarter ending December 31, 1976, in the amount of $ 459,418.60.The issues for decision are: (1) Whether petitioner's transfers on December 21, 1976, to four trusts, involving six beneficiaries, constituted four or six separate gifts; (2) whether 714 a blockage discount should be applied in valuing petitioner's gifts and, if so, should it be applied to each gift, separately, or applied on an aggregate basis, and in what amounts; and (3) whether petitioner is entitled to a $ 3,000 exclusion under section 2503, 1 for each of these gifts.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.At the time of filing her petition herein, 23 petitioner was a resident of Roxbury, Connecticut. Petitioner filed a Federal gift tax return for the calendar quarter ending December 31, 1976, with the Internal Revenue Service at Philadelphia, Pennsylvania.Petitioner is the widow of Alexander Calder, a well-known artist, who died on November 11, 1976. The Estate of Alexander Calder distributed approximately 1,226 gouaches 2 to petitioner. The 1,226 gouaches were included as part of 1,292 gouaches listed by the executors of the Estate of Alexander Calder on its Federal estate tax return filed February 13, 1978. The 1,292 gouaches were reported on the estate tax return as having a fair market value of $ 949,750, or an average value per gouache of $ 735. Respondent's appraiser, Karen Carolan, in her valuation report, estimated that the average value per gouache ranged from $ 2,250 to $ 2,500, resulting in a total value ranging from $ 2,907,000 to $ 3,230,000 for the 1,292 gouaches in the estate. She further determined that because of the large number of gouaches, a "blockage" discount of about 60 percent was in order. This resulted in a net fair value ranging from $ 1,164,600 to $ 1,293,800. Respondent concluded that the24 $ 949,750 claimed on the estate tax return was within an acceptable range and no change was recommended.On December 21, 1976, petitioner created four irrevocable trusts, one each for the benefit of her daughters, Sandra Calder Davidson (the Davidson Trust) and Mary Calder Rower 715 (the Rower Trust), one for the benefit of her grandchildren, Shawn and Andrea Davidson (the Davidson Children Trust), and one for the benefit of her other grandchildren, Alexander and Holton Rower (the Rower Children Trust). The two trust indentures creating the Davidson and the Rower Trusts were identical except for the designation of the person who was to constitute the beneficiary of each trust. The relevant provisions of one of the trust indentures are as follows:This Indenture or Deed of Trust, made this 21st day of December, 1976, By and Between LOUISA25 J. CALDER, residing at Sache 27190, Republic of France, party of the first part (hereinafter referred to as the Grantor) and ROBERT S. FRIEDMAN, of 261 Madison Avenue, New York, New York and STANLEY COHEN, of 44 Avenue des Champs-Elysees 75008 Paris, France, parties of the second part (hereinafter referred to as the Trustees), Witnesseth:* * * First: A. The Trustees shall hold, invest and reinvest the Trust Estate for and during the lifetime of the Grantor's daughter, SANDRA CALDER DAVIDSON, and shall collect and receive the interest, dividends, issues and income of the Trust Estate and after paying therefrom all necessary and property [sic] charges and expenses, the Trustees shall pay over the net income to the Grantor's daughter, SANDRA CALDER DAVIDSON, in periodic installments for and during the term of her natural life.The two trust indentures creating the Davidson Children and the Rower Children Trusts were identical except for the designation of the persons who were to constitute the beneficiaries of each trust. The relevant provisions of one of the trust indentures are as follows:This Indenture or Deed of Trust, made this 21st day of December, 1976 By and Between LOUISA26 J. CALDER, residing in Sache 37190, Republic of France, party of the first part (hereinafter referred to as the Grantor) and ROBERT S. FRIEDMAN, of 261 Madison Avenue, New York, New York and STANLEY COHEN, 44 Avenue des Champs-Elysees 75008 Paris, France, parties of the second part (hereinafter referred to as the Trustees), Witnesseth:* * * First: A. The Trustees shall divide the Trust Estate into two equal parts, and shall hold, invest and reinvest such parts as separate trust funds, subject to the terms hereof, for the respective lifetimes of SHAWN DAVIDSON and ANDREA DAVIDSON (the "beneficiaries") and shall collect and receive the 716 interest, dividends, issues and income of the Trust Estate and after paying therefrom all necessary and proper charges and expenses, the Trustees shall pay over the net income in equal shares to the beneficiaries or to their issue, as hereinafter provided, in periodic installments for and during the term of their respective lives.The relevant provisions common to all four trusts are as follows:Anything hereinabove contained to the contrary notwithstanding the trustees, in the exercise of their absolute and uncontrolled discretion, may at27 one time or from time to time pay over to either of the beneficiaries from the principal of the Trust Estate such a sum or sums, even to the extent of the whole thereof, as the Trustees may deem advisable for the welfare of the beneficiaries, and upon making any such payment or payments the Trustees shall be discharged from all further liability, responsibility or accountability with respect thereto. * * Fifth: The Trustees shall have the following express powers exercisable in their sole and absolute discretion with respect to all property whether principal or income at any time coming into their hands, whether by purchase or in any other manner, and every power of the trustees shall continue with respect to any such property until the execution of every trust and every power in trust with respect thereto shall have been completed by the actual and final distribution thereof under the terms of this agreement.A. To hold and continue to hold as an investment the property received hereunder, and any additional property which may be received by them, so long as they deem proper, whether or not income producing, deemed by them to be for the best interests of the trust and the beneficiaries28 hereunder, without being limited to trust or chancery investments provided by law, and notwithstanding that the same may constitute leaseholds, royalty interest [sic], patents, interests in mines, oil and gas wells, or timber lands, or other wasting assets, and without any responsibility for any depreciation or loss by or on account of such investments.* * * C. To sell and convey any of the property of the trust or any interest therein, or to exchange the same for other property, whether or not such other property is income producing, for such price or prices and upon such terms as in their discretion and judgment may be deemed for the best interest of the trust and the beneficiaries hereunder, and to execute and deliver any deed or deeds (with or without warranty), receipts, releases, contracts or other instruments necessary in connection therewith. * * *717 Ninth: The Grantor hereby declares that this agreement and all trusts and beneficial interests, whether vested or contingent, hereby created, shall be irrevocable and that the Grantor shall hereafter stand without power at any time to revoke, change or annul any of the provisions herein contained or any of the contingent29 or beneficial interests effected thereby, whether pursuant to a statute of the State of New York or decisions of its courts or otherwise.Tenth: This agreement shall be governed by the laws of the State of New York and shall become effective upon its being executed by the Grantor and one Trustee. * * On the same day the trusts were created, December 21, 1976, petitioner executed the following transfers:TABLE 1Reportedfair market valueNumberon Schedule Aof gouachesof petitioner'sTrust titleBeneficiariestransferredgift tax returnDavidson TrustPetitioner's daughterSandra Calder Davidson 306 $ 237,437.50Davidson ChildrenPetitioner's grandchildrenTrust Shawn and Adrea Davidson307 237,437.50Rower TrustPetitioner's daughterMary Calder Rower 306 237,437.50Rower ChildrenPetitioner's grandchildrenTrust Alexander and Holton Rower 307 237,437.50Total 1,226949,750.00The parties have stipulated that the average retail value per gouache was $ 2,375 and that the value of the individual gouaches did not vary between the date of Alexander Calder's death, November 11, 1976, and the date of petitioner's30 gift, December 21, 1976. As table 1 indicates, petitioner reported the total value of the gifts on her gift tax return to be $ 949,750. 3 Petitioner estimated that because the fair market value of the gouaches did not vary between the date of the death and the date of the gift, the same blockage discount of 60 percent that was used for the estate tax return should be used for the gift tax return. Accordingly, the gouaches were claimed to have the same value for both gift and estate tax return purposes.718 Respondent, however, calculated that for gift tax purposes the blockage discount should be based on six separate transfers, 432 with the impact on the market of each transfer being 31 considered independently. The blockage discount was calculated by respondent for each transfer as follows:TABLE 2EstimatedEstimatedNumber ofaverage numberapproximate numberTransfergouaches in/of gouaches=of years requirednumbereach transfer5 sold per year to sell off block1 (Davidson)306 6152 (Rower)306 6153 (Davidson child)154 5134 (Davidson child)153 5135 (Rower child)153 5136 (Rower child)154 513Total 1,226PresentEstimatedvalue factoraverage numberAgreedTransfer6 at 10 percent Xof gouaches soldXaverage price=Determinednumberfor annuitiesper yearper gouachevalue1 3.7907861$ 2,375$ 550,0002 3.79078612,375 550,000 3 2.4868 512,375 300,000 4 2.4868 512,375 300,000 5 2.4868 512,375 300,000 6 2.4868 512,375 300,000 Rounded total value of the transfers2,300,000The net result or effect of respondent's approach was to grant petitioner a blockage discount of 25 percent with respect to transfers 1 and 2, and a discount of 18 percent with respect to transfers 3 through 6. 733 719 Respondent accordingly determined a deficiency of gift tax based, inter alia, upon the difference between the $ 949,750 value reported by petitioner and the $ 2,300,000 value determined by him.Respondent calculated the figure for the estimated average number of gouaches sold per year for the estate tax return using an estimated liquidation period of 25 years for the total number of gouaches in the estate (1,296), resulting in approximately 50 sales per year for the entire estate (1,296 / 25 = 51.84). In calculating the appropriate valuation for purposes of the instant gift tax case, respondent built upon his prior valuation of the gouaches for estate tax purposes, viz, that the marketplace would absorb about 50 of these art works each year. In the case of the transfers in trust of 153/154 gouaches to the Davidson children and the Rower children (transfers 3 through 6), respondent used approximately the same liquidation rate (51 per year) for each gift that he had assumed for estate tax purposes for the entire estate. For the transfers to the Davidson Trust and the Rower Trust (transfers 1 and 2), however, respondent assumed a liquidation of 61 gouaches per34 year for each of the gifts.Apparently from the date of the gift until March 31, 1978, the exclusive representative for the sale of the gouaches was the Perls Gallery of New York City. Beginning April 1, 1978, and continuing until April 1, 1984, the exclusive representative was M. Knoedler & Co., Inc., of New York City. Thereafter, and continuing for a period of 5 years, the exclusive representative was the Pace Gallery of New York City.The number of gouaches which were actually sold during the years 1977 through 1984 is as follows:TABLE 3Number of Gouaches SoldDavidsonRowerYearDavidsonChildrenRowerChildrenendedTrustTrustTrustTrustTotal10/7716 14166 52 10/7820 12182070 10/7934 31312512110/8014 6 101545 10/819 14121752 10/827 6 3 4 20 10/833 4 1 8 10/841 1 Total 103889187369Average numbersold per yearduring the years1977-198413 11111146 Average numbersold per yearduring the years1977-198217 14151460 720 On her gift tax return, petitioner claimed the annual donee exclusion pursuant to section35 2503 of $ 3,000 for each income beneficiary of each of the four trusts, viz, six persons, for an aggregate of $ 18,000 of total annual donee exclusions. Respondent determined that such exclusions were not allowable.OPINIONThe first issue for decision is whether petitioner's transfers on December 21, 1976, to the four trusts, involving six beneficiaries, constituted four or six separate gifts.In the present case, there were four transfers made to four trusts. Two of these trusts, the Davidson Trust and the Rower Trust, each had one beneficiary, while the remaining two trusts, the Davidson Children Trust and the Rower Children Trust, each had two beneficiaries.Petitioner apparently contends that because four transfers were made to four trusts, only four gifts were made, despite the fact that there were six beneficiaries. 8Respondent's position that six gifts36 are presented for valuation purposes is well fortified both in the law and in the provisions of the trust instruments, themselves. It is well 721 settled that gifts in trust are to be regarded for gift tax purposes as gifts to the beneficiaries rather than to the trustees. Helvering v. Hutchings, 312 U.S. 393">312 U.S. 393, 396 (1941); United States v. Pelzer, 312 U.S. 399">312 U.S. 399, 401-402 (1941); Jones v. Commissioner, 29 T.C. 200">29 T.C. 200, 210 (1957); Avery v. Commissioner, 3 T.C. 963">3 T.C. 963, 970 (1944). The Davidson Children Trust and the Rower Children Trust both provide "The Trustees shall divide the Trust Estate into two equal parts, and shall hold, invest and reinvest such parts as separate trust funds" and "the Trustees shall pay over the net income in equal shares to the beneficiaries."It follows that for purposes of the gift tax and for purposes of valuation, there were six separate gifts. The two gifts to the Davidson Trust and to the Rower Trust each consisted of 306 gouaches. For calculation purposes, the four gifts to the Davidson Children Trust and to the Rower Children 37 Trust should be divided into four approximately equal portions, two gifts consisting of 154 gouaches and two gifts consisting of 153 gouaches. Respondent properly did this.The second issue for decision is whether a blockage discount 9 should be applied in valuing petitioner's gifts, and if so, should it be applied to each gift separately or applied on an aggregate basis, and in what amounts.It is noteworthy that the parties agree that the average retail 10 value per gouache was $ 2,375. Thus, this is not a strict valuation case per se, but rather the controversy centers on the appropriate blockage discount, if any, to be applied. 38 Respondent initially contends that it is inappropriate to apply the blockage discount in the gift tax area. The discount is appropriate in the estate tax area since the estate may have difficulty disposing of a large block of inventory; on the other hand, in the gift tax area, contends respondent, the discount is inappropriate because gifts, unlike deaths, are contemplated events and one can manipulate the circumstances surrounding the transfers. However the regulations and the case law are squarely to the contrary. Sec. 25.2512-2(e), Gift Tax Regs.; 722 Rushton v. Commissioner, 498 F.2d 88">498 F.2d 88, rehearing denied 502 F.2d 1167">502 F.2d 1167 (5th Cir. 1974), affg. 60 T.C. 272">60 T.C. 272 (1973); Whittemore v. Fitzpatrick, 127 F. Supp. 710">127 F. Supp. 710 (D. Conn. 1954). As such, we feel that 39 the blockage discount may be applied to gifts.Petitioner argues that a discount should be applied to the 1,226 gouaches on an aggregate basis in order to take into account the time necessary for an orderly liquidation. Respondent, on the other hand, contends that the blockage discount must be applied to each gift separately. In support of this proposition respondent cites section 25.2512-2(e), Gift Tax Regs.; Rushton v. Commissioner, supra; and Whittemore v. Fitzpatrick, supra.Section 25.2512-2(e), Gift Tax Regs., states in pertinent part that:If the donor can show that the block of stock to be valued, with reference to each separate gift, is so large in relation to the actual sales on the existing market that it could not be liquidated in a reasonable time without depressing the market, the price at which the block could be sold as such outside the usual market, as through an underwriter, may be a more accurate indication of value than market quotations. * * * [Emphasis added.]Petitioner contends that the principles set forth in this regulation apply only when valuing stocks and bonds and are not applicable40 when valuing works of art. Under petitioner's approach we would value the gouaches under the more general guidelines appearing in section 25.2512-1, Gift Tax Regs., which provides in part that:The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. * The relevant facts petitioner would have us examine are the ability of an art dealer to control the market in terms of determining how many gouaches would be available for sale at any one time, and the length of time necessary to liquidate the art work. These same factors are relevant in determining the amount of the blockage discount. In fact, in determining the appropriate blockage discount for both estate and gift tax purposes, the length of time necessary to liquidate the gouache 723 holdings was a primary factor used by both parties in coming up with their results.Thus, in effect, petitioner urges us to apply the same factors used in estimating the blockage discount without being bound by the regulation which authorizes its use. With41 this we cannot agree. If petitioner desires the benefits of the blockage discount, she must also be willing to accept its limitations. Accordingly, the blockage discount must be applied with reference to each separate gift.We are not without authority in this area. In Rushton v. Commissioner, supra, the Fifth Circuit was requested to value 16 gifts of unlisted common stock. The court held that section 25.2512-2(e), Gift Tax Regs., required it to apply the blockage discount to each gift separately without considering companion donations. It reasoned:An aggregation principle, however, directly contradicts the regulatory intent of appraisal in a realistic market; for under such a system the question becomes not what would each block have returned if sold in the market existing at the time of valuation, but rather what would the same block have brought in a fictitious market, one flooded by the other gifts. 11 [498 F.2d at 93.]42 The blockage discount has also been applied to separate rather than to consolidated gifts in the area of closely held stock. Whittemore v. Fitzpatrick, supra. Thus, it hardly seems a quantum leap to extend these principles to the valuation of art work, particularly because, as petitioner admits on brief, liquidating a block of closely held securities is analogous to liquidating a block of 1,226 gouaches. In both cases, there is no established market in which to make a disposition, and both involve sales which are privately negotiated between the buyer and the seller. We therefore conclude that a blockage discount must be determined separately for each of the six gifts.Having decided that separate discount rates are required, we must now determine the appropriate discount rates for each gift. It is here that we part company with respondent.724 Respondent calculated the blockage discount by estimating the number of gouaches to be sold per year for each of the six gifts. (See table 2, p. 718.) Then, using this figure, respondent computed the number of years it would take to liquidate each block. This next figure was then used as a basis for43 determining the appropriate annuity factor to be applied in calculating the discount. Thus, respondent treated the gouaches here as a large number of illiquid assets, whose worth could be realized only through liquidation over a period of time at a uniform rate, yielding an assumed amount of dollars each year over such period. Under this approach, realization of the value of the art works can be compared to the right to receive an annuity of the stated amount over the given period, and the present worth of such annuity can be determined from the appropriate valuation tables. Sec. 25.2512-5, Gift Tax Regs. The appropriate valuation factor reflects a discount for the amount of time the various installments of the annuity are deferred. As applied in the instant case, the effect is to grant a blockage discount in a somewhat more sophisticated manner than the usual method of applying a single percentage discount to the retail value of the items at the date of the gift. We are not prepared to say that respondent's theory is unreasonable, but its accuracy obviously depends upon the validity of respondent's assumptions regarding the number of gouaches that can be liquidated each year44 and, thus, the length of time such liquidation will require.As table 2 indicates, respondent calculated the selloff period for the blocks of 306 gouaches using estimated sales of 61 gouaches per year. The blocks of 154 and 153 gouaches were computed to be sold at a rate of 51 per year. The problem with respondent's method is that it yields a total annual sales figure for all six blocks of approximately 330. This simply does not comport with reality, as revealed by this record. The record shows that the average sales figure for all four trusts (i.e., all six blocks) during the years 1977 through 1982 was 60 per year. 12 (See table 3, pp. 719-720.) We agree that the discount 725 should be calculated for each gift separately, but it is not realistic to apply the total sales figures for all gouaches sold during the year to each gift, separately, in determining the liquidation period. Rather, it seems more logical to us to use the actual average annual sales for each of the six gifts to determine the relative liquidation periods. There is no evidence that any of the trusts withheld gouaches from the market during the period 1977-82. To the contrary, they were45 placed with an art gallery in New York City and were all for sale.46 While respondent contends that Rushton v. Commissioner, supra, requires us to look to what the market would absorb (here 60 gouaches per year) and apply this figure to each gift, separately, to determine the liquidation period, we believe that because blockage is a question of fact rather than a rule of law ( Estate of Sawade v. Commissioner, T.C. Memo. 1984-626; Estate of Christie v. Commissioner, T.C. Memo. 1974-95; see Safe Deposit & Trust Co. of Baltimore v. Commissioner, 35 B.T.A. 259 (1937), affd. 95 F.2d 806">95 F.2d 806 (4th Cir. 1938)), the actual sales experience in the period is the best evidence we have of the true absorption rate of the gouaches in the marketplace, and should be preferred to determine the estimated liquidation period for the purposes of determining the appropriate amount of blockage through an annuity approach. Moreover, in Rushton, the court was concerned that an aggregation principle would require it to create a fictitious market, one flooded by the other gifts to determine the appropriate discount. Here, however, 47 as we have stated, it is unnecessary to create any market fictions because we have access to the actual sales figures.It is for these reasons that we feel that the following table, which uses the actual average annual sales figure for each of the six gifts, provides a better estimate of the blockage discount rates to be applied in determining the value of the gifts: 726 TABLE 4NumberAverage numberAppropriate numberGiftof gouaches/of gouaches=of years requirednumberin each gift13 sold per year to sell off block130617182306152031547 2241537 2251537 2261547 22Presentvalue factorAverage numberGiftat 10 percentof gouachesAverage pricenumberfor annuitiesXsold per yearXper gouache=Value18.201417$ 2,375$ 330,00028.5136152,375 300,000 38.77157 2,375 145,000 48.77157 2,375 145,000 58.77157 2,375 145,000 68.77157 2,375 145,000 Total value of the gifts1,210,00048 Accordingly, we conclude that the appropriate value of the property for gift tax purposes is $ 1,210,000, which includes an appropriate discount for blockage.The third issue for decision is whether petitioner is entitled to six $ 3,000 annual exclusions under section 2503, in computing taxable gifts for transfers of the gouaches to the four trusts.Section 2503(b), as in effect at the time of transfer, 1450 provided for the exclusion of the first $ 3,000 of gifts to any 727 person 15 during a calendar year. The exclusion, however, is only available to gifts "other than gifts of future interests in property," or in other words to present interests. Accordingly, the determination of this issue requires the inquiry whether, at the date of each gift, the interest received by a beneficiary was a present or future interest. Blasdel v. Commissioner, 58 T.C. 1014">58 T.C. 1014, 1017 (1972), affd. per curiam 478 F.2d 266">478 F.2d 266 (5th Cir. 1973). For gift tax purposes the term "present interest in property" is defined as "An unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life 49 estate or term certain)." Sec. 25.2503-3(b), Gift Tax Regs. The term "future interest in property" refers to "any interest or estate, whether vested or contingent, limited to commence in possession or enjoyment at a future date." H. Rept. 708, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 478; S. Rept. 665, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 526. See also Commissioner v. Disston, 325 U.S. 442">325 U.S. 442, 446 (1945), revg. 144 F.2d 115">144 F.2d 115 (3d Cir. 1944), revg. a Memorandum Opinion of this Court; sec. 25.2503-3(a), Gift Tax Regs. The Supreme Court in Fondren v. Commissioner, 324 U.S. 18">324 U.S. 18, 20 (1945), refined these definitions by indicating that the donor is entitled to the exclusion only if he has conferred on the donee "the right to substantial present economic benefit."These principles are exemplified in Commissioner v. Disston, supra, where the Supreme Court concluded that a future interest was created when the trust had income but limitations were placed on its disbursement. In that context the Court explained:In the absence of some indication from the face of the trust or surrounding circumstances that a steady flow of some ascertainable portion of income to the [beneficiary] would be required, there is no basis for a conclusion that there is a gift of anything other than for the future. The taxpayer claiming the exclusion must assume the burden of showing that the value of what he claims is other than a future interest. * * * [325 U.S. at 449.]Disston thus requires the taxpayer to prove three things: (1) That the trust will receive income, (2) that some portion of that income will flow51 steadily to the beneficiary, and (3) that 728 the portion of income flowing out to the beneficiary can be ascertained. See also Maryland National Bank v. United States, 609 F.2d 1078">609 F.2d 1078, 1080 (4th Cir. 1979).Application of these principles to the facts of this case does not present a problem. Petitioner has failed to meet even the first prong of the Disston test. At the date of transfer, although the beneficiaries had the right to periodic distributions of income, the corpora of the trusts in question merely consisted of the gouaches. There has been no showing that the trust assets will generate income for distribution to the beneficiaries. Petitioner has not, for example, shown that the gouaches will generate rental income or, for that matter, any other type of income. In Maryland National Bank v. United States, supra, the Fourth Circuit was faced with determining whether the gift of an unqualified right to receive profits from the operation of a partnership's business was a present interest. In holding that a future interest was created, the court stated "The executor has failed to prove that the partnership52 has produced any income for distribution to the beneficiaries, that steps have been taken to eliminate the losses it has sustained annually, or that there will be any income in the foreseeable future." 609 F.2d at 1080. 16 Similarly, here the record does not establish that the beneficiaries will actually receive a steady flow of income or any income whatsoever. 53 1754 Petitioner, on the other hand, contends that a present interest exists because the trustees have the discretionary 729 power under the terms of the trusts to convert non-income-producing assets (i.e., the gouaches) into income-producing property. Moreover, petitioner argues that pursuant to the State law governing the terms of the trusts, a fiduciary duty is imposed on the trustees to liquidate the gouaches and convert them into income-producing property. In support of this proposition petitioner cites Rosen v. Commissioner, 397 F.2d 245">397 F.2d 245 (4th Cir. 1968), revg. 48 T.C. 384">48 T.C. 384 (1967). In Rosen, the Fourth Circuit held that the donee exclusion was allowable, relying partially on the fact that the trustees had the power to sell non-income-producing assets (i.e., stock which had no dividend history) and to reinvest the proceeds in income-producing property.Rosen is inapposite to the facts herein for several reasons. First, Rosen was actually addressing the third prong of the Disston test, that is, whether the income interest was subject to valuation. There the Government had conceded that "a valuable right55 to receive income has been donated" (379 F.2d at 248), and that "a present income interest * * was in fact donated." 397 F.2d at 245 (emphasis in original). Here no such concessions have been made. Second, in Berzon v. Commissioner, 63 T.C. 601">63 T.C. 601 (1975), affd. 534 F.2d 528">534 F.2d 528 (2d Cir. 1976), we refused to follow Rosen. There we disagreed with the Fourth Circuit's reliance in Rosen on the power of the trustees to sell gifted shares and reinvest the proceeds in income-producing property where there was no direction in the trust indenture or inclination shown by the trustees to do so. We stated, "In such cases the possibility itself that the trustees would sell the gifted stock and reinvest in income-producing property is so uncertain as to be incapable of being valued." 63 T.C. at 618-619. Thus, even assuming, arguendo, that a present interest was created, it is not capable of valuation because it is impossible to predict with certainty whether and to what extent the trustees would sell the gouaches and invest in income-producing property. 56 This proposition is further supported by the Second Circuit 1857 which, in affirming Berzon, 730 stated "the [actuarial] tables are not appropriate in the case of a non-income yielding investment, for in such a case one can predict with assurance that the income generated will be zero and, therefore, that the actuarial tables would produce an obviously erroneous result." 534 F.2d at 532 (emphasis in original). 19 Accord Stark v. United States, 477 F.2d 131">477 F.2d 131 (8th Cir. 1973); Fischer v. Commissioner, 288 F.2d 574">288 F.2d 574 (3d Cir. 1961), affg. a Memorandum Opinion of this Court.Finally, although the trust indentures in the present case authorize the trustees to sell the gouaches and reinvest the proceeds in income-producing property (as well as non-income-producing property), there is no indication in the record that they intended to reinvest in such a manner. In fact, the record merely indicates that when a gouache was sold a check was issued to the trustee. No mention is made as to whether the proceeds were actually invested in any type of property.In sum, neither the circumstances of the case nor the provisions of the trust indentures realistically establish that the beneficiaries will receive a steady flow of income. We therefore conclude58 that petitioner's gifts did not create a present interest that qualified for exclusion from the gift tax.To reflect the foregoing,Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect in the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise noted.↩2. As used in this opinion the term "gouache" refers to a form of original painting executed with opaque water colors. See The Random House College Dictionary (rev. ed. 1982).↩3. Petitioner, in Schedule A of the gift tax return erroneously listed the 1,226 gouaches transferred to the four trusts as having an aggregate fair market value of $ 949,750, the same aggregate fair market value as reported for the 1,292 gouaches on the estate tax return, when in fact only the 1,226 gouaches were transferred.↩4. Respondent treated the transfers made to each beneficiary as separate gifts.↩5. This annual liquidation rate is not revealed in respondent's evidence, but is derived mathematically from his other computations.↩6. Sec. 25.2512-9, Gift Tax Regs., indicates that for transfers made after Dec. 31, 1970, and before Dec. 31, 1983 (as is the case here), the present value factor is based on a 6-percent factor. If applied here this would result in a higher capitalization factor and consequently a higher value for gift tax purposes. Respondent has inexplicably applied a 10-percent discount rate (the effective rate for transfers made after Nov. 30, 1983. Sec. 25.2512-5). Neither party contests this treatment.↩7. Thus: As to transfers 1 and 2:306 gouaches X $ 2,375 (agreed retail value) = $ 726,750 (total retail value)$ 550,000 (determined value) / $ 726,750 = 0.75As to transfers 3 through 6:153/154 gouaches X $ 2,375 = $ 365,750$ 300,000 (determined value) / 365,750 = 0.82↩8. Petitioner inconsistently claims, however, that for purposes of the annual exclusion under sec. 2503, six gifts were made. See discussion infra↩.9. The blockage rule provides that when a commodity is being valued, the size of the block being valued, and not simply the value determined for each item, is a relevant consideration. See Rushton v. Commissioner, 498 F.2d 88">498 F.2d 88, 90, rehearing denied 502 F.2d 1167">502 F.2d 1167 (5th Cir. 1974), affg. 60 T.C. 272">60 T.C. 272↩ (1973).10. Sec. 25.2512-2, Gift Tax Regs., indicates that the value to be used for gift tax purposes is the price at which the item would be sold at retail.↩11. Petitioner apparently contends that Rushton is distinguishable because there, four blocks of stock were gifted over the course of 15 months, unlike here, where all of the gifts were made simultaneously. This is not a relevant distinction because in Rushton, the court concluded that even gifts made on the same day could not be aggregated for purposes of determining the blockage discount. 498 F.2d at 91-95↩.12. Sales of art work before and after the date of the gift may be used to corroborate the ultimate determination of value provided they are not too far removed from such date. Estate of Smith v. Commissioner, 57 T.C. 650">57 T.C. 650, 659 n. 8 (1972), affd. on other grounds 510 F.2d 479">510 F.2d 479 (2d Cir. 1975), cert. denied 423 U.S. 827">423 U.S. 827 (1975). We realize that Estate of Smith is an estate tax case, however, the provisions relating to value in the gift and estate tax areas have been held to be in pari materia. Merrill v. Fahs, 324 U.S. 308">324 U.S. 308, 311-313↩ (1945). The average annual sales figure was calculated by respondent without including the sales of 1983 and 1984. Respondent contends that these years were not representative because during this time the trustees entered a contract with a different gallery which did not make the same effort to market the gouaches as the previous gallery had. Petitioner has offered no evidence on this point. Without deciding the validity of respondent's contention we feel the sales for 1983 and 1984, which were substantially lower than those during the prior 6-year period, are not representative because they are too far removed from the date of the gift, Dec. 21, 1977.13. These figures are taken from table 3, with slight variations to account for the fact that six rather than four gifts were made.↩14. As it read in 1976, sec. 2503(b) provided:SEC. 2503(b)↩. Exclusions From Gifts. -- In computing taxable gifts for the calendar quarter, in the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year 1971 and subsequent calendar years, $ 3,000 of such gifts to such person less the aggregate of the amounts of such gifts to such person during all preceding calendar quarters of the calendar year shall not, for purposes of subsection (a), be included in the total amount of gifts made during such quarter. Where there has been a transfer to any person of a present interest in property, the possibility that such interest may be diminished by the exercise of a power shall be disregarded in applying this subsection, if no part of such interest will at any time pass to any other person.15. In the case of gifts made in trust, the beneficiary, not the trust or trustee, is the "person" to whom the statute refers. Helvering v. Hutchings, 312 U.S. 393">312 U.S. 393, 396↩ (1941).16. Petitioner contends that Maryland National Bank v. United States, 609 F.2d 1078">609 F.2d 1078, 1080 (4th Cir. 1979), is distinguishable from the present case because there, unlike here, the trustees were prohibited from converting the non-income-producing assets into income-producing assets. The court in Maryland National Bank relied on two points in reaching its conclusion: that neither the circumstances of the case nor the provisions of the trust established that the beneficiaries received a steady flow of income. Here we are only concerned with whether the circumstances of the case provide a basis for determining that the beneficiaries would receive a steady flow of income. The provisions of the trust will be examined infra↩.17. Nor can it be said that at the date of gift a right to a "substantial present economic interest" was conferred on the donees. Although petitioner could contend that the beneficiaries have received a substantial present economic interest in that they have apparently received the proceeds from the sales of the gouaches (though this is far from made clear in the record), the distribution of the proceeds (i.e., trust corpus) is at the discretion of the trustees, and thus, not a right of the beneficiaries. It is well settled that where, as in the instant case, there is a gift of income coupled with a power in the trustee to encroach upon principal at such times and in such amounts as it deems proper, the interest of the beneficiaries in such possible advancement is a future interest. Jones v. Commissioner, 29 T.C. 200">29 T.C. 200, 210 (1957); Fondren v. Commissioner, 324 U.S. 18">324 U.S. 18, affg. 141 F.2d 419">141 F.2d 419 (5th Cir. 1944), affg. 1 T.C. 1036">1 T.C. 1036 (1943); Commissioner v. Disston, 325 U.S. 442">325 U.S. 442, 446, 447 (1945), revg. 144 F.2d 115">144 F.2d 115 (3d Cir. 1944), revg. a Memorandum Opinion of this Court; Kniep v. Commissioner, 172 F.2d 755">172 F.2d 755, 756 (8th Cir. 1949), affg. 9 T.C. 943">9 T.C. 943↩ (1947).18. In the instant case, any appeal lies to the Court of Appeals for the Second Circuit and thus we must consider that court's interpretation of the law in this area. Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971). As indicated in the text, Berzon v. Commissioner, 63 T.C. 601">63 T.C. 601 (1975), affd. 534 F.2d 528">534 F.2d 528 (2d Cir. 1976), was affirmed by the Second Circuit and thus we feel compelled to apply the Berzon reasoning, rather than using that of the court in Rosen v. Commissioner, 397 F.2d 245">397 F.2d 245 (4th Cir. 1968), revg. 48 T.C. 384">48 T.C. 384 (1967). Moreover, the Fourth Circuit seems to have backed down from the stance originally taken in Rosen. See Maryland National Bank v. United States, supra↩ at 1081-1083.19. Petitioner contends that Berzon is distinguishable from Rosen because in Berzon, unlike Rosen, there was a shareholders' agreement restricting the transfer of the stock and because the trustee manifested no intention to generate income from its investments. Without deciding the validity of these distinctions, we feel that Rosen↩ is not applicable to the facts here because of the reasons enumerated in the text.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623257/	GERALDINE H. KIRKPATRICK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKirkpatrick v. CommissionerDocket No. 23488-90United States Tax CourtT.C. Memo 1992-421; 1992 Tax Ct. Memo LEXIS 446; 64 T.C.M. (CCH) 277; July 27, 1992, Filed 446 As appropriate order and decision will be entered. For Petitioner: Walter Weiss. For Respondent: Jennifer H. Decker. DINANDINANMEMORANDUM OPINION DINAN, Special Trial Judge: This matter is before the Court on petitioner's motion for allowance of reasonable litigation costs filed pursuant to section 7430 and Rule 231. 1This case was settled without trial. A stipulation of settlement was filed with the Court on October 28, 1991. Respondent filed a response to petitioner's motion and petitioner then filed a reply to respondent's response to petitioner's motion. Pursuant to section 7430(a), the "prevailing party" in any administrative or court proceeding brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under the Internal Revenue Code may be awarded reasonable447 costs incurred in connection with such proceeding. Petitioner bears the burden of proof that she is entitled to such an award. Rule 232(e); . To be eligible for an award of litigation costs, petitioner must establish that: (1) All administrative remedies available to her have been exhausted; and (2) she satisfies the statutory definition of a prevailing party. Sec. 7430(b)(1) and (c)(4). To fall within the statutory definition of prevailing party, petitioner must establish that: (1) The position of the United States in the proceeding was not substantially justified; (2) she has substantially prevailed with respect to the amount in controversy or with respect to the most significant issue or set of issues presented; and (3) she meets specified net worth requirements. Sec. 7430(c)(4)(A)(i)-(iii). Respondent agrees that petitioner has substantially prevailed in this case and that the position of respondent was not substantially justified. Respondent also agrees that petitioner has not unreasonably protracted the proceedings in this case. Section 7430(b)(4). Respondent does not agree that petitioner448 has exhausted all available administrative remedies or that petitioner meets the net worth requirement, nor does she agree that the amount of costs claimed is reasonable. In the response to petitioner's motion for costs, respondent specifically stated that she does not agree that petitioner meets the net worth requirements of section 7430(c)(4)(A)(iii) because petitioner had not submitted any proof of her net worth. In petitioner's reply to respondent's previously filed response to petitioner's motion, no mention was made of the net worth requirement. In , we denied the taxpayer's motion for an award of litigation costs on the ground that the taxpayer offered no proof as to net worth. As we stated in : In this case, it is obvious that petitioners are aware of the net worth requirements. Petitioners were put on notice that respondent was specifically objecting to an award of litigation costs because of petitioners' failure to offer any proof of their net worth. Petitioners, nevertheless, failed to provide any supporting information to establish449 the net worth or to even address the issue in the supplemental motion and reply brief. Petitioners have not asked for a hearing to specifically address this issue in accordance with Rule 231(b)(6). Having failed to offer any proof that they meet the net worth requirements necessary to be a "prevailing party" under section 7430(c)(2)(A)(iii), petitioners are not entitled to an award of litigation costs. Since petitioner has offered no proof as to net worth, her motion for award of litigation costs will be denied. An appropriate order and decision will be entered. Footnotes1. All section references are to the Internal Revenue Code as in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623258/	ESTATE OF BESSIE I. MUELLER, DECEASED, JOHN S. MUELLER, PERSONAL REPRESENTATIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Mueller v. CommissionerDocket No. 2733-90.United States Tax Court107 T.C. 189; 1996 U.S. Tax Ct. LEXIS 44; 107 T.C. No. 13; November 5, 1996, Filed R determined a deficiency in P's estate tax liability. P claims that it is entitled to equitable recoupment of previously paid income tax, the refund of which is barred by the statute of limitations. In Estate of Mueller v. Commissioner, 101 T.C. 551 (1993), we held that we have jurisdiction to consider claims of equitable recoupment. As a result of our valuation of stock includable in the estate, see Estate of Mueller v. Commissioner, T.C. Memo. 1992-284, it is now apparent that there is no deficiency in estate tax; rather, P is entitled to recover an overpayment of estate tax, regardless of equitable recoupment. Under these circumstances, any application of equitable recoupment would increase the amount that P is entitled to recover as an overpayment. Held: Equitable recoupment is restricted to use as a defense against an otherwise valid claim. For purposes of equitable recoupment, the notice of deficiency is considered to be R's claim for additional estate tax. See Bull v. United States, 295 U.S. 247 (1935). Once it is determined that R has no valid claim for additional tax, the defense of equitable recoupment has no application. Equitable recoupment 45 cannot be used to increase the amount of an overpayment that P is entitled to recover. Stevan Uzelac, Michael A. Indenbaum, and Paul L. Winter, for petitioner. Thomas M. Rath, and Trevor T. Wetherington, for respondent. RUWE, JUDGE. COHEN, CHABOT, SWIFT, JACOBS, GERBER, WRIGHT, PARR, WHALEN, CHIECHI, FOLEY, and VASQUEZ, JJ., agree with this majority opinion. CHABOT, J., concurring. COHEN, PARR, and RUWE, JJ., agree with this concurring opinion. WELLS, J., dissenting. COLVIN, BEGHE, and GALE, JJ., agree with this dissent. HALPERN, J., dissenting. BEGHE, J., dissenting. RUWE190 OPINION RUWE, Judge: * Respondent determined a deficiency of $ 1,985,624 in petitioner's Federal estate tax. Respondent's deficiency determination was primarily based on her assertion that the date-of-death value of shares of stock in the Mueller Co. was $ 2,150 per share, as opposed to $ 1,505 per share as reported on the estate tax return. The amount of the deficiency determined by respondent was the result of this increase in value and other adjustments not in issue, including respondent's allowance of a credit for tax on prior transfers in the amount of $ 1,152,649, that had not been claimed by petitioner 46 on its estate tax return. Petitioner petitioned this Court for a redetermination. 1 Petitioner subsequently filed an amended petition alleging that "The Commissioner erred in determining said Deficiency by disallowing recoupment against such [estate] tax amount for the income tax paid by the 47 Bessie I. Mueller Trust * * * on capital gains realized from the post-death sale of * * * 191 Mueller Company common stock includable in the Decedent's gross estate." The Bessie I. Mueller Administration Trust (the Trust) is the residuary legatee of decedent's estate. After decedent's death, the Trust sold shares of Mueller Co. stock that were included in decedent's gross estate. On its income tax return, the Trust reported gain on the sale using a basis of $ 1,500 per share. 2 The Trust's basis in the stock is controlled by the value of the stock at decedent's date of death. See sec. 1014 (a) (1). 3In Estate of Mueller v. Commissioner, T.C. Memo. 1992-284 (Mueller I), we found that the date-of-death value of the Mueller Co. stock was $ 1,700 per share, as opposed to $ 1,505 per share as reported on petitioner's 48 estate tax return or $ 2,150 as determined by respondent in the notice of deficiency. As a result, it is now clear that the Trust understated its basis and overstated its gain on the sale of Mueller Co. stock and, therefore, overpaid its income tax. However, the statute of limitations bars refund of the Trust's overpayment of income tax. Respondent moved to dismiss petitioner's claim for recoupment on the ground that we lacked jurisdiction to consider equitable recoupment. In Estate of Mueller v. Commissioner, 101 T.C. 551">101 T.C. 551 (1993) (Mueller II), we held that this Court is authorized to entertain the affirmative defense of equitable recoupment in an action for redetermination of a deficiency and denied respondent's jurisdictional motion. Id. at 561. However, we made no findings with respect to whether petitioner satisfied the requirements for applying equitable recoupment in this case. It subsequently became clear that our opinion in Mueller I, which increased decedent's taxable estate by less than the amount determined in the notice of deficiency, combined with respondent's allowance in the notice of deficiency of the credit for tax on prior transfers, will result in a decision that 49 there is no deficiency in petitioner's estate tax. 4 Indeed, petitioner 192 is entitled to recover an overpayment of its estate tax, regardless of whether or not equitable recoupment applies in this case. 5 The threshold issue we must address is whether petitioner may use equitable recoupment against respondent, where respondent has no valid claim for additional estate tax against which petitioner needs to defend. Pursuant to the doctrine of equitable recoupment, "a party litigating a tax claim in a timely proceeding may, in that proceeding, seek recoupment of a related, and inconsistent, but now time-barred tax claim relating to the same transaction." United States v. Dalm, 494 U.S. 596">494 U.S. 596, 608 (1990). 50 Equitable recoupment can be used as a defense by both taxpayers and the Government. Stone v. White, 301 U.S. 532">301 U.S. 532 (1937). While recoupment claims are generally not barred by the statute of limitations if the main action is timely, use of recoupment based on an otherwise time-barred claim is limited to defending against the claim in the main action. 6Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 264 (1993); United States v. Dalm, supra at 605; Stone v. White, supra at 538-539; Bull v. United States, 295 U.S. 247">295 U.S. 247, 262-263 (1935); United States v. Forma, 42 F.3d 759">42 F.3d 759, 765 (2d Cir. 1994); 751 In re Greenstreet, Inc., 209 F.2d 660">209 F.2d 660, 663 (7th Cir. 1954). 8193 Petitioner acknowledges that equitable recoupment is limited to defensive use. However, petitioner argues that it should be allowed to use equitable recoupment to defend against 52 the additional tax that would have been due as a result of our valuation of decedent's stock, assuming that respondent had not allowed the credit for prior transfers in the notice of deficiency. Petitioner would have us apply recoupment against a hypothetical tax liability on a transaction-by-transaction basis, regardless of whether there was a valid claim for additional tax liability against which to defend. On brief, petitioner describes this as an issue of first impression. Respondent takes the position that equitable recoupment can be used by a taxpayer only as a defensive measure to reduce or eliminate a taxpayer's actual liability for additional tax. Respondent argues that once it is clear that the taxpayer has no additional tax liability, there is no valid claim against which to defend. Respondent contends that to allow equitable recoupment of time-barred taxes to increase the overpayment that is already due petitioner is the same as permitting petitioner affirmatively to collect the time-barred overpayment of tax. Respondent's position finds support in Mueller II where we stated: the party asserting equitable recoupment may not affirmatively collect the time-barred underpayment 53 or overpayment of tax. Equitable recoupment "operates only to reduce a taxpayer's timely claim for a refund or to reduce the government's timely claim of deficiency". O'Brien v. United States, 766 F.2d 1038">766 F.2d 1038, 1049 (7th Cir. 1985). [Estate of Mueller v. Commissioner, 101 T.C. at 552.]The opinion in O'Brien v. United States, 766 F.2d 1038">766 F.2d 1038, 1049 (7th Cir. 1985), also supports respondent's position that equitable recoupment may be used only as a defense against the additional tax that would otherwise be due: Recoupment * * will permit a taxpayer to recoup an erroneously paid tax, the refund of which is time-barred, against a timely and correctly asserted deficiency by the government. The doctrine thus operates only to reduce * * * the government's timely claim of deficiency; it does not allow the collection of the barred tax itself. In summary, the doctrine requires 194 some validly asserted deficiency or refund against which the asserting party desires to recoup a time-barred refund or deficiency. * * * Attempts by taxpayers to utilize the doctrine to revive an untimely affirmative refund claim, as opposed to offset a timely government claim of deficiency with a barred claim of the taxpayer, 54 have been uniformly rejected. * * [Id. at 1049; citation omitted.]Likewise, in Brigham v. United States, 200 Ct. Cl. 68">200 Ct. Cl. 68, 80-81, 470 F.2d 571">470 F.2d 571, 577 (1972), the court explained the function of equitable recoupment as follows: When its benefits are sought by the taxpayer, the function of the doctrine is to allow the taxpayer to reduce the amount of a deficiency recoverable by the Government by the amount of an otherwise barred overpayment of the taxpayer. * * Petitioner correctly points out that none of these cases, nor any others relied upon by respondent, specifically address the situation that confronts us; i.e., whether equitable recoupment applies where, in the main action, the Court finds that there is an increase in a taxable item, but because of another adjustment in the main action, which is in the taxpayer's favor (the allowance of the credit for prior transfers), there is no additional tax owed to the Government. Further examination of the origin and nature of equitable recoupment is, therefore, appropriate. The doctrine of equitable recoupment in tax cases was first articulated in Bull v. United States, supra. The Commissioner had determined a deficiency in estate tax, which 55 the estate paid. Thereafter, the Commissioner inconsistently determined that there was a deficiency in the income tax liability of the estate based on the same item. The taxpayer paid the income tax deficiency and brought suit for refund. It was ultimately determined that the additional income tax liability, as determined by the Commissioner, was correct, but that the additional estate tax liability determined by the Commissioner based on the same item, was incorrect. The problem was that the additional estate tax had already been paid, and the statute of limitations barred any refund of the estate tax. While no refund action could be brought for recovery of the estate tax, the Supreme Court recognized that if the taxpayer 195 had been defending against a lawsuit by the Government for the additional income tax, the taxpayer would have been permitted, by the doctrine of recoupment, 9 to raise time-barred claims arising out of the same transaction as a defense to the Government's suit. But the taxpayer had filed the refund suit and was the plaintiff. The Government had already collected the disputed income tax and was seeking no further relief against which the taxpayer had to defend. 56 The Supreme Court, nevertheless, recognized that it was the Government that had initiated the controversy by making its income tax deficiency determination and that the taxpayer, although technically the plaintiff, was, in reality, defending against the Government's determination.10 The Supreme Court therefore fashioned the doctrine of equitable recoupment to allow the taxpayer to defend against the Government's claim for additional taxes. The Supreme Court explained this as follows: If the claim for income tax deficiency had been the subject of a suit [by the Government], any counter demand for recoupment of the overpayment of estate tax could have been asserted by way of defense and credit obtained notwithstanding the statute of limitations had barred an independent suit against the Government therefor. This is because recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff's action is grounded. Such a defense is never barred by the statute of limitations so long as the main action itself is timely. The circumstance that both claims, the one for estate tax and the other for income tax, were prosecuted to judgment and execution 57 in summary form does not obscure the fact that in substance the proceedings were actions to collect debts alleged to be due the United States. It is immaterial that in the second case, owing to the summary nature of the remedy, the taxpayer was required to pay the tax and afterwards seek refundment. This procedural requirement does not obliterate his substantial right to rely on his cross-demand for credit of the amount which if the United States had sued him for income tax he could have recouped against his liability on that score. [Bull v. United States, 295 U.S. at 262-263; fn. ref. omitted.]In Bull v. United States, supra, and United States v. Dalm, 494 U.S. at 602-605, the Supreme 58 Court made it clear that 196 the purpose of "equitable recoupment" was to replicate the role that "recoupment" would have played had the Government actually brought suit to collect the additional tax. It is instructive then to look at how recoupment would have applied if the Government had brought suit to collect the additional estate tax liability that it claimed as a deficiency in the instant case. The Government would have brought suit in the District Court against the taxpayer for the amount of additional estate tax that it claimed -- $ 1,985,624. Assuming that the District Court found a $ 1,700 per share value for the stock, as opposed to the $ 2,150 alleged by the Government, there would be a judgment that the taxpayer owed no tax debt to the Government. 11 As a result, the Government would totally lose its claim as plaintiff. Once the Government's claim for additional tax was shown to be meritless, the purely defensive use of recoupment would not be available to allow the taxpayer to recover any portion of the time-barred overpayment of income tax. To allow recoupment in this situation would go beyond its exclusively defensive nature and beyond the District Court's jurisdiction. 59 12In the instant case, as in Bull v. United States, supra, the Government's claim for additional tax is embodied in its deficiency determination. However, as previously explained, when the stock is valued at $ 1,700 per share, there is no additional tax due. As a result, the Government does not have a valid claim for a tax debt, and there is no liability against which equitable recoupment can be used to defend. 1360 In Stone v. White, 301 U.S. 532">301 U.S. 532 (1937), the Supreme Court allowed the Government to use equitable recoupment to 197 defend against an income tax refund suit brought by a trustee. The Court ultimately held that the trustee had overpaid income tax and that the income in issue should have been taxed to the trust's beneficiary. However, the statute of limitations barred assessment against the beneficiary. The tax on the beneficiary 61 would have exceeded the amount of tax paid by the trust. The Government raised the equitable recoupment defense. The trust argued that the statute of limitations barred assessment against the beneficiary and that the beneficiary's tax should not be considered. The Supreme Court allowed the equitable recoupment defense, stating: The statutory bar to the right of action for the collection of the tax does not prevent reliance upon a defense which is not a set-off or a counterclaim, but is an equitable reason, growing out of the circumstances of the erroneous payment, why petitioners ought not to recover. Here the defense is not a counter demand on petitioners, but a denial of their equitable right to undo a payment which, though effected by an erroneous procedure, has resulted in no unjust enrichment to the government, and in no injury to petitioners or their beneficiary. The government, by retaining the tax paid by the trustees, is not reviving a stale claim. Its defense, which inheres in the cause of action, is comparable to an equitable recoupment or diminution of petitioners' right to recover. "Such a defense is never barred by the statute of limitations so long as the main action 62 itself is timely." Bull v. United States, 295 U.S. 247">295 U.S. 247, 262 * * * [Id. at 538-539.]Even though the uncollected tax from the time-barred year exceeded the tax in the main action before the Court, the Government did not affirmatively recover the excess. To have done so would have allowed equitable recoupment to be used for more than defensive purposes. In Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 301-303 (1946), the Supreme Court indicated that it was unwilling to expand the doctrine of equitable recoupment beyond its established parameters, because to have done so would have infringed upon the statute of limitations.1464 198 Petitioner's position would also infringe upon the statute of limitations by allowing petitioner affirmatively to recover time-barred overpayments. Nevertheless, petitioner asks us to expand the application of equitable recoupment beyond what any court has ever done. In the final analysis, we agree with the following observation of the Court of Claims: If the doctrine of recoupment were a flexible one, susceptible of expansion, it might well be applied in the instant case. But the teaching of Rothensies is that it is not a flexible doctrine, but a doctrine 63 strictly limited, and limited for good reason. [Ford v. United States, 149 Ct. Cl. 558">149 Ct. Cl. 558, 569, 276 F.2d 17">276 F.2d 17, 23 (1960).]Use of equitable recoupment is limited to defending against a valid claim. It allows an otherwise time-barred tax claim arising out of the same transaction to be used as a defense or credit against any additional tax ultimately found to exist in the main action. 15 If all or part of the Government's claim for additional tax is sustained, equitable recoupment can be used to reduce or eliminate it. However, once equitable recoupment of the time-barred tax overpayment completely eliminates the additional tax liability in the main action, equitable recoupment has served its restricted defensive purpose.1665 Equitable recoupment cannot be used affirmatively to recover a tax overpayment, the refund of which is barred by the statute of limitations.Where the Government claims that the taxpayer owes additional tax and the court finds that there is no additional tax due to the Government, there is nothing left to defend against. 1766 The additional estate tax liability that would have 199 resulted from our valuation of the stock in decedent's estate was less than the credit that respondent correctly allowed in the notice of deficiency. As a result, respondent has no valid claim for additional tax. Respondent's claim for additional tax has been totally defeated, and petitioner is entitled to a decision that there is no deficiency and that it overpaid its estate tax. Any use of equitable recoupment at this point would not be defensive. We hold that petitioner is not entitled to use equitable recoupment affirmatively to increase the amount of an overpayment it is entitled to recover. It follows that equitable recoupment has no application in this case. As a result of our disposition, we express no opinion regarding whether any of the other requirements for equitable recoupment have been satisfied. An appropriate order will be issued. Reviewed by the Court. COHEN, CHABOT, SWIFT, JACOBS, GERBER, WRIGHT, PARR, WHALEN, CHIECHI, FOLEY, and VASQUEZ, JJ., agree with this majority opinion. CHABOT, J. CHABOT, J., concurring: I join in the majority opinion and the interpretation that the "claim" in the instant case, against which equitable recoupment is sought to lie, is respondent's claim that there is a deficiency in estate tax. The dissenters maintain that the claim against which equitable recoupment is sought to lie is only respondent's claim that, because of the revaluation of the Mueller Co. stock, the estate tax liability is greater than it otherwise would be. Judge Beghe's dissenting opinion, infra pp. 75-79, 67 relies on Hemmings v. Commissioner, 104 T.C. 221">104 T.C. 221 (1995), for the proposition "that the credit for previously paid taxes is not part of the same claim or cause of action as that attributable to the date of death value of the shares." Dissenting op. p. 79 (Beghe, J.). However, as explained in Hemmings v. Commissioner, 104 T.C. at 233-235, it appears that the only situation where the issues of the unclaimed credit and the stock value could be litigated in separate actions would be where the taxpayer first proceeds in a refund forum on one 200 of the issues and the Commissioner then raises the other issue in a later notice of deficiency. Also, with exceptions not relevant in the instant case, in deficiency proceedings in the Tax Court, the different issues are merged into a single cause of action and neither side is permitted to bring a separate suit "in any court" once a decision on liability for "estate tax in respect of the taxable estate of the same decedent" has become final. Sec. 6512(a); Hemmings v. Commissioner, 104 T.C. at 226, 232-233. Indeed, even in the other forums, the taxpayer apparently is barred from bringing a second suit for the same tax even if that second suit is based 68 on a different issue. Hemmings v. Commissioner, 104 T.C. at 233-234. Thus, Hemmings does not support the dissent's contentions as to what is respondent's claim in the instant case, against which equitable recoupment is sought to lie. Because the majority opinion's analysis, in combination with Mueller I, appears to dispose of the instant case, failure to respond to the other considerations dealt with in Judge Beghe's dissent, is not to be taken as acceptance of, or disagreement with, the views Judge Beghe expresses as to the many hurdles petitioner must overcome in order to succeed in the highly technical realm of equitable recoupment. COHEN, PARR, and RUWE, JJ., agree with this concurring opinion. WELLS, J.; HALPERN, J. WELLS, J., dissenting: I respectfully disagree with the majority's overly restrictive view of the applicability of the doctrine of equitable recoupment. I agree with Judge Beghe that all of the conditions for application of the doctrine have been met. I, however, want to focus my disagreement on what I believe is the majority's mistaken notion that the application of the doctrine of equitable recoupment in the instant case is offensive rather than defensive simply 69 because the amount of an unrelated overpayment of tax resulting from the estate's failure to claim a credit for tax on prior transfers exceeds the amount of additional estate tax due by reason of the increased valuation of the shares in issue. I believe that, once an equitable recoupment claim is properly raised by a taxpayer in defense of an asserted deficiency, 201 the mere fact that the Commissioner's partial victory fails to produce a deficiency should not prevent the Court from allowing the equitable recoupment claim. If respondent had been totally sustained on the deficiency, or even if the increase in the valuation of the shares of stock in issue had been great enough to create an overall deficiency in estate tax, I think the majority would concede (assuming that they would agree that the other requirements are met) that the recoupment claimed would be allowed. The application of the doctrine should be governed solely by matters relating to the shares, and not upon the fortuity of unrelated circumstances, i.e. the convergence of (1) respondent's concession in the notice of deficiency of the credit for tax on prior transfers that petitioner had failed to claim on the estate tax 70 return with (2) the valuation of the shares at an amount that resulted in an overpayment rather than a deficiency. The relevant circumstances may be briefly summarized. For estate tax purposes, the estate valued the shares in issue at $ 1,505 each. Shortly after decedent's death, the Administration Trust sold those shares for $ 2,150 each, computing the gain realized on the sale using a basis of $ 1,500 per share, which was approximately the value claimed for estate tax purposes. Respondent determined that each share was worth $ 2,150. In Estate of Mueller v. Commissioner, T.C. Memo 1992-284">T.C. Memo. 1992-284, we found the value of each share to be $ 1,700 for estate tax purposes. Accordingly, the estate underpaid its estate tax by $ 957,099 as a result of the undervaluation. However, because the Trust used $ 1,500 as the basis of the shares to compute the gain on the sale, the Trust paid $ 265,999 more in income tax on the sale of the shares than it would have if the proper basis of $ 1,700 per share had been used. The period of limitations for claiming a refund of that overpayment of income tax had expired. In the notice, respondent allowed the estate a $ 1,152,649 credit for tax on prior transfers 71 to which it was entitled but had not claimed on its estate tax return. The credit was completely unrelated to the issue of the valuation of the shares. If we had sustained respondent's valuation of the shares, a deficiency would have been due from the estate even considering the overpayment attributable to the allowance of the credit. As it turned out, the additional estate tax attributable to the revaluation of the shares was less than the overpayment 202 resulting from the estate's failure to claim the credit on its return, and the estate is therefore due a refund. Petitioner argues that it should be allowed to recoup against the additional estate tax attributable to the revaluation of the shares ($ 957,099) the amount of income tax overpaid on their sale ($ 265,999). The majority would allow equitable recoupment only if there were an overall deficiency in tax after taking into account all issues in the case (other than the equitable recoupment claim). I agree with Judge Beghe that the recoupment claim should be allowed so long as it did not exceed the additional tax due as a result of the increased valuation of the shares; i.e. recoupment should be applied to correct the error on a 72 transactional basis, not just on the basis of whether some amount is finally determined to be owed to the party who received the windfall. Recoupment has been characterized as a counterclaim or defense against asserted liability relating to the same transaction, item, or event upon which the main action is grounded. Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 264 (1993); United States v. Dalm, 494 U.S. 596">494 U.S. 596, 605 n.5, 608 (1990); Bull v. United States, 295 U.S. 247">295 U.S. 247, 262 (1935). The doctrine is designed to prevent unjust enrichment of either the taxpayer or the Government. Stone v. White, 301 U.S. 532">301 U.S. 532, 537-539 (1937); Bull v. United States, supra at 260-261. While admittedly no case has squarely considered the issue presented by the instant case, recoupment has always been applied on an item-by-item or transaction-by-transaction basis, and the circumstances surrounding unrelated items or transactions have not been deemed relevant to the application of the doctrine. Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 299 (1946) (recoupment "has never been thought to allow one transaction to be offset against another, but only to permit a transaction which is made the subject of suit by a 73 plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole" (emphasis supplied)). Consequently, I believe the majority's limitation on the application of the doctrine is inconsistent with its nature and the policy underlying it. As there is no issue as to the entitlement to the credit, the "main action" in the instant case is not the entire liability of the estate for tax, but rather the additional estate tax claimed with respect to the shares. 203 I believe that the majority overstates its case regarding the defensive use of equitable recoupment, in that the cases relied on by the majority do not go as far as the majority would have them go. The rejection of equitable recoupment as an offensive weapon by the Supreme Court in United States v. Dalm, supra, does not require the result reached by the majority. If petitioner had paid the full deficiency determined by respondent and sued for a refund, the reach of Dalm would not have precluded the right of petitioner to obtain a refund of the income tax attributable to the sale of the shares even if the refund forum court had reduced the estate tax valuation of the shares 74 as we have done in the instant case. The only limitation imposed by Dalm would have been to preclude petitioner from increasing the amount of its claimed refund by any amount attributable to the claimed overpayment of income tax. Similarly, Bull v. United States, supra, does not require the result the majority reaches because that case did not involve an unrelated claim for refund, and therefore the majority's hypothetical construction of the Government's claim were it to sue for the deficiency determined mistakenly emphasizes the taxpayer's overall liability as the determinative factor in deciding whether to apply the doctrine. Accordingly, I would hold that, to the extent that petitioner's recoupment claim does not exceed the amount of the additional tax sought by respondent with respect to the shares of stock, the use of the doctrine is purely defensive and does not enable petitioner to affirmatively recover on a time-barred claim. I therefore respectfully dissent. COLVIN, BEGHE, and GALE, JJ., agree with this dissent. HALPERN, J. dissenting: I join in section 7, Overpayment Status, of Judge Beghe's separate opinion and dissent for the reasons stated therein. BEGHE, J., dissenting: 75 I respectfully dissent. I believe this case satisfies all requirements for equitable recoupment. In particular, petitioner's overpayment posture, which results 204 from a completely unrelated, fortuitous issue, should not prevent recoupment. The majority has created a new rule about offensive use of equitable recoupment that unnecessarily perpetuates unjust enrichment of the Government, thwarts the fundamental purposes of equitable recoupment, and seems likely to prevent equitable recoupment in other cases where justice may even more clearly require it. I have no disagreement with the facts recited by the majority opinion; the facts on the recoupment issue were almost completely stipulated by the parties. However, I provide a supplemental statement of the procedural and factual background, both to aid understanding of the overpayment issue and to lay the foundations for my conclusions on the other issues. Bearing in mind equitable recoupment's objective of promoting one-stop shopping, 1 I think petitioner is now entitled to see a reasoned opinion charting the path to the destination I would reach. After summarizing 76 the background, I address all the other issues before dealing, infra pp. 67-93, with the overpayment issue; my rejoinder to the majority opinion begins infra p. 70. ContentsBackground Discussion 1. Refund Time-Barred 2. Single Transaction 3. Inconsistent Treatment 4. Identity of Interest 5. Statutory Mitigation 6. Other Equitable Considerations 7. Overpayment Status i. Code sections are no obstacle to recoupment ii. Recoupment's defensive nature and the unrelated overpayment don't bar recoupment iii. Barring recoupment would be inconsistent with tax precedent iv. Barring recoupment would be inconsistent with other precedentConclusion 205 BackgroundIn Estate of Mueller v. Commissioner, T.C. Memo. 1992-284 (Mueller I), we redetermined the increased value of shares of the Mueller Co. included in the gross estate of Bessie I. Mueller (decedent). In Estate of Mueller v. Commissioner, 101 T.C. 551">101 T.C. 551 (1993) (Mueller II), we held that this Court is authorized to apply equitable recoupment and therefore denied respondent's motion to dismiss for lack of jurisdiction those paragraphs of petitioner's amended petition asserting its right to equitable recoupment. Petitioner's claim for equitable recoupment 77 would reduce the additional estate tax arising from an increase in the estate tax value of the shares by the amount of a time-barred overpayment of income tax made by the Bessie I. Mueller Administration Trust (the Administration Trust). This income tax overpayment was attributable to the overstated gain the Administration Trust reported on the sale of the shares because it failed to take into account the step-up in basis resulting from respondent's estate tax determination, as modified by our holding in Mueller I, and then failed to file a timely refund claim. It thus remained for us to decide whether to apply equitable recoupment in this case. When decedent, Bessie I. Mueller, died on March 24, 1986, her gross estate included 8,924 shares of common stock of Mueller Co. (the shares). 278 Petitioner's Federal estate tax return, timely filed on December 23, 1986, reported the date-of-death fair market value of the shares as $ 13,430,620, or $ 1,505 per share. The total value of decedent's gross estate reported on the estate tax return was $ 14,623,510. By statutory notice of deficiency issued on November 24, 1989, respondent determined that the date-of-death fair market value of the shares was $ 19,186,600, or $ 2,150 per share. As a result of this increase in value and other adjustments not in issue, including respondent's allowance of a credit for tax on prior transfers, in the amount of $ 1,152,649, that had not been claimed on the Federal estate tax return, respondent determined a deficiency of $ 1,985,624 in petitioner's Federal estate tax. Petitioner petitioned this Court for a redetermination. 206 In Mueller I, we found that the date-of-death value of the shares was $ 15,170,800, or $ 1,700 per share. Our revaluation, standing alone, would result in an increase in Federal estate tax of $ 957,099, computed at the top marginal estate tax rate of 55 percent in effect during 1986, prior to allowance of additional credits for State death taxes and for tax on prior transfers and a small reduction in the unified credit. The Administration Trust is a revocable inter vivos trust established by decedent 381 and is the residuary legatee of her probate estate. 4 Under Article IV of the trust instrument, the Administration 79 Trust is obliged to pay all death taxes, but Article III of the second codicil to decedent's will directs that all death taxes be first paid out of decedent's probate estate as an expense of administration and that none of such taxes be apportioned between or among the recipients of her property. Since the probate assets were only sufficient to pay approximately 5 percent of the death taxes, the trustees of the Administration Trust advanced the funds for full payment of death taxes, including the tax liability shown on petitioner's estate tax return. The parties in interest thereafter petitioned the probate court for an apportionment order; the ground of the petition was the apparent conflict in the death tax payment provisions of decedent's will and the Administration Trust, and the requirements of the Michigan Uniform Estate Tax Apportionment Act, Mich. Comp. Laws secs. 720.11-720.21 (1979). The probate court's order held the Administration Trust responsible for 71.9 percent of the Federal estate tax liability already paid. 5 The probate court's 207 order concludes that the apportionment will be subject to adjustment, following review by the tax authorities, in accordance with the same 80 methodology used to effectuate the apportionment of the original payment. The Administration Trust will be reimbursed for payment of some additional estate tax arising from our determination of the increased date-of-death fair market value of the shares. However, any such reimbursement will not disturb or reduce the estate tax paid by the Trust with respect to the shares owned by it that were included in the gross estate, and with respect to which it overpaid income tax when it sold the shares. Under the apportionment order of the probate court, any recoupment allowed would relate solely to estate tax that the Administration Trust has paid on the inclusion in the gross estate of shares owned by and appointed to it. Any adjustment through recoupment would benefit solely the Administration Trust (and, through it, its three beneficiary subtrusts and their beneficiaries).On decedent's date of death, the Administration Trust owned 5,150 of the 8,924 shares included in her gross estate. The Administration Trust received an additional 1,500 shares from the Ebert B. Mueller Marital Trust, pursuant to decedent's exercise of a testamentary general power of appointment. 6 Consequently, as of the date of death, the Administration Trust owned 6,650 shares of Mueller Co., all of which were 82 included in decedent's gross estate. 7 On May 30, 1986, 67 days after decedent died, the Administration Trust (along with all other owners of shares in Mueller Co.) sold all its shares for $ 2,150 per share. 883 On April 15, 1987, the Administration Trust filed its fiduciary income tax return (Form 1041) for the taxable year 1986 reporting $ 4,572,500 of capital gain on the sale of all 208 6,650 shares owned by it, and paid $ 912,378 in Federal income tax on the gain. The Administration Trust computed its capital gain using a date-of-death fair market value basis of $ 1,462 per share under section 1014(a) (1). On November 16, 1987, 11 months after petitioner had filed its Federal estate tax return reporting the fair market value of the shares at $ 1,505 per share, the Administration Trust filed an amended fiduciary income tax return recomputing the gain, using a basis of $ 1,500 per share, rather than $ 1,462. The "amended return", as it was labeled, stated: "Taxpayer erroneously used the wrong basis for the shares of Mueller Company which were sold during the year. The amended return reflects the correct tax basis of $ 1,500 per share. There were no other changes." Other than the return itself and the statement attached thereto, no written or oral communication to the Internal Revenue Service preceded 84 or accompanied the filing of the amended return. On February 15, 1988, respondent responded to the amended return by refunding $ 50,001, plus interest, to the Administration Trust. Respondent has never issued a statutory notice of deficiency to the Administration Trust or otherwise determined a deficiency in its Federal income tax for the taxable year 1986. The Administration Trust is not a party to this proceeding. On or about September 10, 1990, the Administration Trust filed a second amended fiduciary income tax return claiming an $ 862,377 refund of the income tax it had paid on the capital gain from the sale of the 6,650 shares. This amended return was filed 3 years and 5 months after the Administration Trust had originally filed its Federal income tax return and paid the income tax for the taxable year 1986. This was less than 3 years after the Administration Trust had filed its first amended 1986 income tax return, almost 1 year after respondent had issued the statutory notice to petitioner, and 7 months after petitioner had filed its petition. The Administration Trust's second amended return bore the designation "Amended Return - Correction" and claimed that, in computing the 85 gain on the sale of the shares, it had used a fair market value basis that was $ 650 lower than the fair market value respondent used in determining the amount includable in decedent's gross estate and that the claim was being filed to protect the Administration Trust's rights pending the outcome of this Tax Court proceeding to redetermine the date-of-death 209 fair market value of the shares. On April 22, 1991, respondent disallowed the Administration Trust's claim for refund of 1986 income tax on the ground that the claim had not been timely filed within the 3-year statutory limitation period. Not considering any other issues, the income tax that would have been reported by the Administration Trust from the gain on the sale of the 6,650 shares, using a sales price of $ 2,150 and a cost or other basis of $ 1,700 per share, would have been approximately $ 596,378. Not considering any other issues, the difference between the amount of income tax actually paid by the Administration Trust on the gain from the sale of 6,650 shares (approximately $ 862,377) and the amount of such tax that would have been reported due using a basis of $ 1,700 per share (approximately $ 596,378) would have 86 been approximately $ 265,999. Based on our decision that the fair market value of the shares was $ 1,700 per share at the time of decedent's death, her gross estate is increased by $ 1,740,180 (8,924 shares X $ 195 per share) over the amount shown on the Federal estate tax return, and this increase results in the increase of $ 957,099 in Federal estate tax liability previously described. Not considering any other adjustments, once one takes into account both our Mueller I opinion on the date-of-death fair market value of the shares and respondent's allowance of the credit for tax on prior transfers not claimed on the Federal estate tax return, 9 the parties agree that there is no deficiency in petitioner's estate tax; petitioner is in an estate tax overpayment posture, whether or not equitable recoupment applies in this case. This is because the credit for previously taxed property that petitioner failed to claim on its estate tax return and that respondent has allowed (and all agree, properly so) exceeds the amount of the tentative deficiency resulting from our valuation of the shares. And this will be true irrespective of whether the credit for State death taxes ultimately allowable 87 is the amount claimed on the estate tax return as filed or the larger credit that the parties agree 210 would be allowed as a result of the increase in the tentative deficiency resulting from our valuation of the shares: 10Credit for previously taxed property$ 1,152,649Less: Agreed reduction in unifiedcredit6,000Deficiency attributable toredetermination of value of sharesat $ 1,700 per share957,099963,099Minimum overpayment prior to recoupment189,550Plus: Maximum increase in credit for Statedeath taxes278,428Maximum overpayment prior to recoupment467,978Plus: Claimed recoupment265,999Maximum overpayment with recoupment733,977Petitioner's amended petition, filed April 22, 1991, asserted two affirmative partial defenses against respondent's estate 88 tax deficiency determination: First, that although the Administration Trust's September 10, 1990, claim for refund was barred by the statute of limitations, respondent erred by not applying equitable recoupment to reduce petitioner's estate tax deficiency by the Administration Trust's 1986 income tax overpayment caused by its use of a basis for the shares that was too low; and, second, that respondent erred in not applying the statutory mitigation provisions to allow the Administration Trust to file a timely claim for refund to recover the amount of the related overpayment. Issue was joined on both the equitable recoupment and statutory mitigation defenses when respondent denied these allegations in her amended answer. After we issued our opinion on the valuation issue, Mueller I, respondent moved, on the ground that the Tax Court lacked jurisdiction to grant equitable recoupment relief, to dismiss those paragraphs of the amended petition asserting the partial defense of equitable recoupment. In response, we issued Mueller II, holding that this Court has authority to apply equitable recoupment, and denied respondent's motion. 211 We reserved the issue of petitioner's entitlement to equitable 89 recoupment relief for further proceedings, and this case has been tried, submitted, and briefed for the Court's opinion on the issue of equitable recoupment. Subsequent to the filing of the amended petition, the parties presented no arguments on the issue of statutory mitigation. It only arose, in a preliminary skirmish that led nowhere, in Respondent's Request for Admissions and Petitioner's Answer to Respondent's Request for Admissions. DiscussionThe doctrine of sovereign immunity persists as a jurisdictional limitation on suits against the United States, FDIC v. Meyer, 510 U.S. 471">510 U.S. 471, , 114 S. Ct. 996">114 S. Ct. 996, 1000 (1994); United States v. Dalm, 494 U.S. 596">494 U.S. 596, 608 (1990); United States v. Forma, 42 F.3d 759">42 F.3d 759, 763 (2d Cir. 1994), and jurisdictional limitations based on sovereign immunity apply equally to counterclaims against the Government, United States v. Forma, supra at 764. Case law, however, has developed a significant limitation to the general bar of sovereign immunity against counterclaims: Despite sovereign immunity, a defendant may, without statutory authority, recoup on a counterclaim that would otherwise be barred by the statute of limitations an amount not in excess of the 90 principal claim. Id. (citing United States v. United States Fidelity & Guaranty Co., 309 U.S. 506">309 U.S. 506, 511 (1940)). In the tax area, where the taxpayer in a refund suit or a proceeding in this Court is put in the position of the "plaintiff", the Supreme Court has applied the general doctrine of recoupment, in the specific form of equitable recoupment, in Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935). See also United States v. Dalm, supra at 605-606 n.5; Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946); Stone v. White, 301 U.S. 532 (1937). Under the equitable recoupment doctrine, taxpayers in Federal tax proceedings may raise recoupment as an affirmative defense, rather than as a counterclaim. United States v. Dalm, supra at 607; Commissioner v. Gooch Milling & Elevator Co., 320 U.S. 418">320 U.S. 418, 420-421 (1943); Mueller II, 101 T.C. at 560. The Government is also entitled to raise this defense, Stone v. White, supra, so that either side may assert it, in certain limited circumstances, to 212 remove the bar of the expired statutory limitation period in order to prevent inequitable windfalls to either taxpayers or the Government. Those limited circumstances are that otherwise such a windfall 91 would result from inconsistent tax treatment of a single transaction, item, or event affecting the same taxpayer or a sufficiently related taxpayer. United States v. Dalm, supra at 605-606 n.5. Equitable recoupment thus requires, and I address in turn: (1) That the refund or deficiency for which recoupment is sought by way of offset be barred by time; (2) that the time-barred offset arise out of the same transaction, item, or taxable event as the overpayment or deficiency before the Court; (3) that such transaction, item, or taxable event have been inconsistently subjected to two taxes; and (4) that there be sufficient identity of interest between the person or persons subject to the two taxes. 1192 Although recoupment may further require (5) that the situation not be one to which the mitigation provisions, sections 1311 through 1314, apply, respondent has waived that argument in this case. I then consider (6) any additional equitable factors and, finally, (7) the effect of the presence of the estate tax overpayment, the issue on which the majority have chosen to dispose of this case. 1. Refund Time-BarredNot until September 10, 1990, did the Administration Trust file the claim for refund of its April 15, 1987, payment of income tax that is now at issue. That claim would appear to be barred by section 6511(a), which requires that such a claim be made within 3 years from the time the return was filed, and the return was filed on the same date that the payment was made, April 15, 1987. 12Petitioner has suggested, although not on brief, that the Administration Trust's refund claim was a timely amendment of the timely filed amended return of November 16, 1987. Petitioner refused respondent's request to admit 93 that the second 213 amended return was not a timely claim for refund. Respondent has argued that petitioner's refusal to stipulate that the second refund claim is barred constitutes a failure to establish an essential element of its claim for equitable recoupment and is sufficient ground for denying petitioner the relief it seeks. To the contrary, I would regard it as sufficient that we can satisfy ourselves that the claim is barred. I don't believe that petitioner needs to concede the point for the purposes of this proceeding. The essential question on this point is whether the original amended return of November 16, 1987, gave respondent sufficient notice of the tax overpayment now sought through equitable recoupment and sufficient information to enable respondent to investigate the claim. United States v. Andrews, 302 U.S. 517">302 U.S. 517, 524 (1938) ("a claim which demands relief upon one asserted fact situation, and asks an investigation of the elements appropriate to the requested relief, cannot be amended to discard that basis and invoke action requiring examination of other matters not germane to the first claim"); United States v. Memphis Cotton Oil Co., 288 U.S. 62">288 U.S. 62, 72 (1933); United States v. Felt & Tarrant Manufacturing Co., 283 U.S. 269">283 U.S. 269, 272-273 (1931); 94 In re Ryan, 64 F.3d 1516">64 F.3d 1516, 1520-1521 (11th Cir. 1995); United States v. Forma, 42 F.3d at 767 n.13; American Radiator & Standard Sanitary Corp. v. United States, 162 Ct. Cl. 106">162 Ct. Cl. 106, 318 F.2d 915">318 F.2d 915, 920-922 (1963); secs. 301.6402-2, 301.6402-3, Proced. & Admin. Regs. Under the variance doctrine, taxpayers are obliged in their refund claims to identify the assets at issue and to state why they were treated improperly. It is not enough to state a related claim. The policy ground for not allowing time-barred claims that impermissibly vary from timely claims is that the Commissioner lacks the time and resources to perform extensive investigations into the precise reasons and facts supporting every taxpayer's claim for refund. Charter Co. v. United States, 971 F.2d 1576">971 F.2d 1576, 1579-1580 (11th Cir. 1992); cf. Angelus Milling Co. v. Commissioner, 325 U.S. 293">325 U.S. 293, 297-298 (1945). Whether the grounds for the Administration Trust's second refund claim of September 10, 1990, vary impermissibly from the grounds for the amended return filed on November 16, 1987, need not detain us -- although I incline to believe they do so vary. Respondent's acceptance and allowance of the214 Administration Trust's 1987 claim 95 provides sufficient basis for the conclusion that its 1990 refund claim is time-barred. See, e.g., Union Pacific R.R. Co. v. United States, 182 Ct. Cl. 103">182 Ct. Cl. 103, 389 F.2d 437">389 F.2d 437, 447 (1968) (fully paid refund claim can't be revived by belated amendment after expiration of the period of limitations on the original claim). The variance doctrine is based on a requirement that respondent have sufficient notice of taxpayers' claims, and, in the facts and circumstances of this case, I would conclude that respondent did not have such sufficient notice of the 1990 claim within the statutory time limits. Cf. United States v. Memphis Cotton Oil Co., 288 U.S. 62">288 U.S. 62, 72 (1933) (suggestion that if amendments to informal claim had been made after it had been rejected on merits, they would have been too late); Lefrak v. United States, 1996 WL 420308">1996 WL 420308 (S.D.N.Y., July 26, 1996) (imperfect claim that has been rejected cannot be perfected by a later, time-barred claim lacking the defect). 2. Single TransactionFor the doctrine of equitable recoupment to apply, a single transaction, item, or event must have been taxed twice inconsistently. United States v. Dalm, 494 U.S. at 608 (construing Bull v. United States, supra, 96 and Stone v. White, supra). Although the "single transaction" requirement was mentioned in passing in Bull v. United States, 295 U.S. at 261, it was the stated ground for decision in Rothensies v. Electric Storage Battery Co., 329 U.S. at 300. In that case, the taxpayer in 1935 obtained a refund of excise taxes paid for the years 1922 through 1926 that turned out not to have been due. Refunds of the type of excise taxes paid could not be obtained for the earlier years 1919 through 1921 because those years were already time-barred. The Commissioner then determined that the excise tax refund for the years 1922 through 1926 should be included in the taxpayer's gross income in 1935, the year of receipt. The taxpayer paid under protest and brought a refund suit, arguing that the refund was not taxable income and, in the alternative, that the income tax should be reduced by equitable recoupment on account of the time-barred overpaid excise taxes for the earlier years 1919 through 1921 for which it had been denied a 215 refund. In District Court, the taxpayer lost on the income inclusion issue, but won on the recoupment issue. Electric Storage Battery Co. v. Rothensies, 57 F. Supp. 731">57 F. Supp. 731 (E.D. Pa. 1944). 97 The Court of Appeals for the Third Circuit affirmed, holding that the interpretation of "transaction" should be informed by the "concepts of fairness" basic to the doctrine of recoupment, so that all the doctrine required was a "logical connection" between the main claim and the recoupment claim. Electric Storage Battery Co. v. Rothensies, 152 F.2d 521">152 F.2d 521, 524 (3d Cir. 1945). In reversing on the equitable recoupment issue, the Supreme Court rejected the Third Circuit's reasoning. The Supreme Court insisted that the equitable recoupment doctrine required that a single transaction constitute both the taxable event claimed upon and the one considered in recoupment and held that the single transaction requirement had not been satisfied. Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 299 (1946). What must be emphasized is that actually there was no logical connection -- much less a causal relationship -- between the time-barred excise tax refunds for 1919-21 and the inclusion in taxable income for 1935 of the excise taxes paid for 1922-26. Considering each year as a separate cause of action, cf. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 598 (1948), there was no transactional nexus 98 whatsoever between the time-barred excise taxes paid in 1919-21 and the excise taxes paid in 1922-26 that the taxpayer recovered and was required to include in income in 1935. All the time-barred and the recovered excise taxes had in common was the coincidence of the same general subject matter. Since Rothensies v. Electric Storage Battery Co., supra, the Supreme Court has not revisited the single-transaction requirement of equitable recoupment except in dicta in United States v. Dalm, supra at 605 n.5, where it did say that in Rothensies v. Electric Storage Battery Co. it had emphasized that the condition that must be satisfied is that "the Government has taxed a single transaction, item, or taxable event". The inclusion of "item" in this phrase is significant for our case. Although the income and estate taxes in this case were arguably imposed on different taxable events (the estate tax was imposed on the transfer of the shares on decedent's death, whereas the income tax was imposed upon the gain from the sale of the shares 67 days 216 thereafter), they were imposed on the same item (the same shares of stock), in the sense that the date-of-death value of the shares was a necessary 99 element in determining the amount of the liability for both taxes. Whether they were imposed on the same "transaction" can be debated, and is addressed below. In the absence of any decision by the Supreme Court on the subject since Rothensies v. Electric Storage Battery Co., supra, the interpretation and application of the single-transaction requirement has largely been left to the lower courts, resulting in two lines of conflicting authority. The two cases on which petitioner largely relies are United States v. Bowcut, 287 F.2d 654">287 F.2d 654 (9th Cir. 1961) and United States v. Herring, 240 F.2d 225">240 F.2d 225 (4th Cir. 1957). Both these cases, like the case at hand, concerned the estate tax and the income tax, and the two taxes had not been imposed on the same taxable event. Nevertheless, in both cases the single-transaction requirement of equitable recoupment was held to be satisfied, and equitable recoupment was applied in the taxpayers' favor. In each case, after a death, estate tax was paid and thereafter the Government sought additional income tax from the estate for income not reported during the decedent's lifetime. After paying the income tax, the estate sued for refund of income tax on the ground 100 that it was entitled to equitable recoupment of the overpayment of then time-barred estate tax resulting from the estate's failure to claim the increased income tax liability as a debt in determining the taxable estate. In Herring, the Court of Appeals found that, although the case might differ from Bull, in practical effect both of the Government's claims grew out of the same transaction and were asserted against the same assets in the hands of the executor. United States v. Herring, 225">240 F.2d at 228. The court in Herring distinguished Rothensies v. Electric Storage Battery Co., supra, on the ground that the two sets of transactions there had been so very remote from each other that the claims for which recoupment was sought were long dead. Id. at 227. In Bowcut, the District Court reached the same result on the basis of Herring. Bowcut v. United States, 175 F. Supp. 218">175 F. Supp. 218, 221-222 (D. Mont. 1959), affd. 207 F.2d 654">207 F.2d 654 (9th Cir. 1961). The Court of Appeals did not consider the single-transaction issue, as the Government appealed primarily 217 on other grounds, lack of clean hands and laches, which the Court of Appeals rejected as grounds for denying equitable recoupment, United States v. Bowcut, 287 F.2d at 656-657101 & n.1. The Commissioner acceded to these decisions in Rev. Rul. 71-56, 1 C.B. 404">1971-1 C.B. 404, 13 which like them concerns the application of a barred overpayment of Federal estate tax against outstanding assessments of income tax owed by a decedent for years preceding death and provides for administrative allowance of equitable recoupment in that situation.Despite the statement of administrative position in Rev. Rul. 71-56, supra, respondent has chosen, in the case at hand, to hang her hat on contrary decisions of the old Court of Claims. In Wilmington Trust Co. v. United States, 221 Ct. Cl. 686">221 Ct. Cl. 686, 610 F.2d 703">610 F.2d 703 (1979), in two consolidated cases, the Commissioner assessed income tax deficiencies against the taxpayers after their deaths, and the executors deducted the income taxes paid as claims against the decedents' gross estates. In the subsequent refund suits to recover the income tax payments, the Commissioner sought, through equitable recoupment of the time-barred estate tax deficiencies, to reduce the refunds. In both cases, the trial judges, citing Herring v. United States, supra, Bowcut v. United States, supra, and Rev. Rul. 71-56, found 102 that the single-transaction requirement had been satisfied, and recommended decision for the Government. Wilmington Trust Co. v. United States, 43 AFTR 2d 79-801, 79-1 USTC par. 9223 (Ct. Cl. Trial Div. 1979); McMullan v. United States, 42 AFTR 2d 78-5723, 78-2 USTC par. 9656 (Ct. Cl. Trial Div. 1978). The Court of Claims reversed and remanded both cases, stating that it was obliged by Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946), to give the single-transaction requirement a narrow, inflexible interpretation. Wilmington Trust Co. v. United States, 610 F.2d at 713. In these consolidated cases, unlike Herring and Bowcut--and unlike the case at hand--it was the Government that was seeking equitable recoupment. In applying the single-transaction test so restrictively, the Court of Claims relied on its earlier opinion in Ford v. United States, 149 Ct. Cl. 558">149 Ct. Cl. 558, 276 F.2d 17">276 F.2d 17 (1960), whose facts were 218 closer to our case. Taxpayers had received shares of stock in 1939 from their father's estate, which had reported the shares at an estate tax value of approximately $ 11,900. On audit of the estate tax return, there had been an upward adjustment to $ 23,715, which the estate 103 accepted. In 1947, taxpayers sold the shares, reported a date-of-death income tax basis of $ 165,800, and claimed refund of an overpayment on this ground. The Court of Claims determined the date-of-death value to be $ 165,000. Neither taxpayers nor the Government adverted to whether the Government might be entitled to recoupment of the time-barred underpaid estate tax against the income tax refund. The Court of Claims on its own initiative considered the issue, and, by a 3-2 vote, held that the Government was not entitled to recoupment because the facts were not identical to those in Bull v. United States, supra, and Stone v. White, supra.The Court of Claims said that Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296 (1946), held that the doctrine of equitable recoupment was not flexible, but strictly limited, and limited for the good reason that if the doctrine were broadened there would never come a day of final settlement in the income tax system. Ford v. United States, 276 F.2d at 23. The Court of Claims did not cite United States v. Herring and United Statesv. Bowcut, and Rev. Rul. 71-56 had not yet been issued. In Ford, as in Wilmington Trust, but not as in Herring, 104 Bowcut, or the case at hand, it was the Government's claim to equitable recoupment that was denied. When the Court of Claims later decided Wilmington Trust, it was already committed to its prematurely expressed and ill-considered view in the Ford case. I agree with petitioner that Herring and Bowcut reflect the preferable view. To deny that there is a single transaction for equitable recoupment purposes in the Herring-Bowcut situation wouldn't serve the purposes of statutes of limitation. Requiring only that the connection between the two taxable events be causally automatic (as in Herring-Bowcut and in our case) serves to avoid the kind of staleness that the Supreme Court feared in Rothensies v. Electric Storage Battery Co., supra. This requirement of at least automatic causality also helps to ensure that the Commissioner and the taxpayer aren't obliged to perform extensive additional investigation and 219 recordkeeping; the concept of final repose isn't overwhelmingly important where the claim of one party may only be inchoate or not even exist until there has been a determination on the open claim, at which time the former claim may already be barred. To rely on the need for final 105 repose as barring equitable recoupment in this situation would make a mockery of the concept of repose. 14The Courts of Appeals have lined up on both sides. In Boyle v. United States, 355 F.2d 233">355 F.2d 233 (3d Cir. 1965), revg. and remanding 232 F. Supp. 543">232 F. Supp. 543 (D.N.J. 1964), after the decedent died leaving shares of preferred stock, dividend arrearages were added to their value, and estate tax was paid accordingly. The distributees, on receiving those dividends, listed them as nontaxable for income tax purposes, and the Commissioner determined income tax deficiencies. The distributees paid the income tax deficiencies and brought a refund suit. The District Court denied them equitable recoupment against the then time-barred estate tax, holding that the single-transaction 106 test of Rothensies v. Electric Storage Battery Co. was not satisfied. Boyle v. United States, 232 F. Supp. at 549-550. The Court of Appeals reversed, Boyle v. United States, 355 F.2d at 236, holding that there had been double taxation of a single item, the same fund, which sufficed to satisfy the requirements of Bull v. United States, and that treatment of the same fund as both corpus and income provided the necessary inconsistency of treatment. Id. at 235. The Court of Appeals distinguished Rothensies v. Electric Storage Battery Co. on the ground that the lapse of so much time there made it more distant from the case before the Court than Bull. Id. at 236-237. Respondent attempts to distinguish Boyle from our case on the ground that what was at issue in Boyle was whether the second tax should have been paid at all on the transaction, not whether it was overpaid. However, the Court of Appeals doesn't seem to have relied on that fact, and I don't see the distinction as dispositive. Thus, Boyle supports 220 Herring-Bowcut, and petitioner's view of the single-transaction issue in this case. In O'Brien v. United States, 766 F.2d 1038">766 F.2d 1038 (7th Cir. 1985), revg. 582 F. Supp. 203">582 F. Supp. 203 (C.D. Ill. 1984), 107 the District Court held squarely that the single-transaction requirement is satisfied where the issue is inconsistency in establishing fair market value of the same property for the purpose of determining the gross estate and the basis of the property (the situation in the case at hand), and the Court of Appeals for the Seventh Circuit appears to have agreed. Respondent correctly points out that any statement of the Court of Appeals to that effect was dictum, as that Court reversed the District Court's decision to apply equitable recoupment, on a ground not relevant to our case (later confirmed by Dalm), that equitable recoupment requires an independent basis for jurisdiction. O'Brien v. United States, 766 F.2d at 1049. But the Court of Appeals did say, even if in dictum, that the single-transaction test of Rothensies v. Electric Storage Battery Co., supra, "appears to be satisfied on these facts if we adopt the reasoning of the Third Circuit in Boyle." Id. at 1050 n.16. After the O'Brien decedent had died, his estate paid estate tax on stock in his estate at one value. Then, after the estate sold the stock, it paid income tax using that same value as its basis. The Commissioner 108 then determined a higher value for estate tax purposes, and a stipulated decision was entered in this Court resolving the estate tax dispute using a higher value. One of decedent's heirs and children then sued for a refund of overpaid income tax, on which the period of limitations had expired, arguing that the basis used for the stock should have been higher and using equitable recoupment as the ground for the suit. The District Court agreed, finding that the single-transaction requirement of Rothensies v. Electric Storage Battery Co. had been satisfied.15O'Brien v. United States, 582 F. Supp. at 205-206. Like the Court of Appeals in Boyle, the District Court in O'Brien relied on Bull, finding it closer to its case than Rothensies v. Electric Storage Battery Co. The District Court distinguished Rothensies v. Electric Storage Battery Co. on the ground that in that case the Government had not taken inconsistent positions, the dispute having been precipitated by the plaintiff's successful, but belated, challenge of the legality of the excise tax. O'Brien v. United States, 582 F. Supp. at 206. The District Court distinguished Ford v. United States, supra, finding it not in point for 109 reasons that it does not make very clear and finding the case before it indistinguishable from Bull. Id. Although the Court of Appeals was somewhat guarded in its language, it does not seem to have disagreed. It reversed solely because of the lack of an independent basis for jurisdiction, the period of limitations having expired on the income tax refund claim that was the subject of the taxpayer's lawsuit. O'Brien v. United States, 766 F.2d at 1048-1051. Even if the reversal of the District Court on this ground caused what the Court of Appeals said about the single-transaction issue to be dictum, all this supports petitioner's view of the issue in our case, which is similar to the facts in O'Brien. Respondent asserts that Minskoff v. United States, 349 F. Supp. 1146 (S.D.N.Y. 1972), affd. per curiam 490 F.2d 1283">490 F.2d 1283 (2d Cir. 1974), supports her view of 110 the single-transaction requirement. In that case, an estate brought a refund action against the Government for recovery of estate tax on the decedent's interest in a corporation; the Government had collected income tax in 1961 on the proceeds from the decedent's sale of his interest in the corporation in 1949, prior to his death in 1950 (at trial, the Government was successful in proving that the decedent had sold his interest prior to his death). As in Herring and Bowcut, the refund suit was ostensibly for overpaid income tax (which was not yet time-barred) but in fact was grounded on equitable recoupment of the earlier, time-barred overpaid estate tax. Equitable recoupment was denied. Respondent interprets this case to mean that, to satisfy the single-transaction requirement, not only must two taxes have been imposed, but they must have been imposed on a single transaction on inconsistent legal theories. However, although both the District Court and the Court of Appeals cited Rothensies v. Electric Storage Battery Co., supra, failure to satisfy the single-transaction test was not clearly the basis of their refusal to allow equitable recoupment. Actually, it was quite proper for 222 111 the Government to impose both taxes on the amount in question, and there was therefore no proper basis for recoupment.16 Indeed, the District Court did say that Bull only allows recoupment where the imposition of two taxes rests on inconsistent theories, as opposed to inconsistent factual determinations, Minskoff v. United States, 349 F. Supp. at 1149, and the Court of Appeals affirmed on that ground, 490 F.2d at 1285. If the opinions in Minskoff were right on this point, petitioner in the case at hand would lose, as the inconsistency in tax treatment rests on a factual issue, the value of the stock. However, the Minskoff courts are unpersuasive in distinguishing Bull on this fact-law distinction: The issue of whether the amounts in Bull were income or part of the gross estate was a mixed question of fact and law. Similarly, the issue in Dalm was the factual one of whether the payments had been gifts or income for services, 17 and everything indicates that, had it not been for the lack of an independent basis for jurisdiction, Mrs. Dalm would have won her suit. 18113 No other decision decides whether or not to apply equitable recoupment on the basis of this distinction. I conclude that 112 the Minskoff case does not clearly use failure to satisfy the single-transaction requirement to justify its refusal to apply equitable recoupment, is wrong in its fact-law distinction, and is in any event clearly distinguishable from our case. 19114 223 The Court of Claims view was applied under somewhat different circumstances in Estate of Mann v. United States, 552 F. Supp. 1132">552 F. Supp. 1132 (N.D. Tex. 1982), affd. 731 F.2d 267">731 F.2d 267 (5th Cir. 1984), a case cited by neither party. There, after a holding that a decedent's estate was entitled to an income tax refund on the ground that a bad debt had 115 been a business debt, the Government's equitable recoupment claim, based on the ground that the estate should have paid estate tax on the refund claim, was denied. As the District Court observed, because refund suits based on the deduction of worthless business debts are allowed for 7 years, under section 6511(d) (1), and because the issues posed by the two claims would require substantially different proof, to allow recoupment in this situation would seriously undermine the statute of limitations. Estate of Mann v. United States, 552 F. Supp. at 1141. However, the District Court also clearly expressed its preference for the reasoning of the Court of Claims over Herring and Bowcut, Estate of Mann v. United States, 552 F. Supp. at 1137-1140, and the Court of Appeals for the Fifth Circuit affirmed, on the basis of Rothensies v. Electric Storage Battery Co., Estate of Mann v. United States, 731 F.2d at 279. Estate of Mann clearly lines up with the Court of Claims on the single-transaction issue, but it can be distinguished from our case. On balance, I regard the later cases as neither strengthening nor weakening my conclusion that Herring and Bowcut represent the preferable view of the 116 law. 20224 Respondent tries to distinguish the case at hand from Herring, Bowcut, and Rev. Rul. 71-56, on the ground that in Herring-Bowcut, both the main action and the recoupment claim are occasioned solely by deficiencies, whereas here that characterization was available only for the proceeding before us prior to issuance of our opinion in Mueller I. However, here both the proceeding before us and the recoupment claim are occasioned solely by inconsistent valuations of the same shares of 117 stock. There may not be a single taxable event here, but that is really true in Herring-Bowcut as well. One can also speak of our situation as a single transaction, decedent's death, which occasions the need to value the shares, both to determine the gross estate for estate tax purposes and the step-up in basis for income tax purposes. There is, moreover, the same fund, which can be considered the same item. Cf. Estate of Vitt v. United States, 706 F.2d 871">706 F.2d 871, 875 (8th Cir. 1983) (taxation of same tract of property and inclusion of identical part of value of that property in two instances of imposition of estate tax sufficient to satisfy single-transaction requirement); United States v. Gulf Oil Corp., 485 F.2d 331">485 F.2d 331, 333 (3d Cir. 1973) (taxation of same fund all that is required); Boyle v. United States, 355 F.2d at 236 (taxation of identical "definite fund" all that is required). This differences between the situation in Rothensies v. Electric Storage Battery Co., on the one hand, and the Herring-Bowcut-Wilmington Trust Co.-Bartels and the Ford-O'Brien-Mueller situations, on the other, and the similarities of the latter two sets of situations, are striking. In Rothensies v. Electric 118 Storage Battery Co. there is no causal connection between the main claim and the barred claim sought to be recouped (actually set-off). In the latter two sets of situations, there is a causal connection. In Herring-Bowcut-Bartels, the determination and payment of an income tax deficiency gave rise to a time-barred estate tax overpayment, which was allowed to be recouped against that deficiency; in Wilmington Trust, the Court of Claims, improperly, I believe, refused to allow the Government to recoup time-barred estate tax deficiencies against the taxpayer estates' recoveries of income tax refunds that generated those deficiencies. Similarly, in our case, as in Ford and O'Brien, the increase in the value of the shares for estate tax purposes generated an estate tax deficiency and a correlative 225 time-barred income tax overpayment with respect to the same shares. In our case the causal connection is clear; in Rothensies v. Electric Storage Battery Co. there is no such connection. 21119 Moreover, in another significant respect, the situation in the case at hand is further removed from the Rothensies v. Electric Storage Battery Co. situation than Herring and Bowcut: Here, all the events happened within the same calendar year, within 67 days of each other. 22 In addition, the dicta of the Court of Appeals in O'Brien (and the decision of the District Court in that case) find the single-transaction requirement satisfied in a situation that is still closer to the case at hand than the Herring-Bowcut situation. Finally, in Mueller II, we decided, having been prompted to do so by United States v. Dalm, supra, that we are authorized to apply equitable recoupment. Dalm wrought a change in the legal landscape that not only led us to change our own view of our authority, but 120 did so in a way that undercuts the broad rationale of the narrow interpretation of the single-transaction requirement urged in Rothensies v. Electric Storage Battery Co., supra. In deciding that case, the Supreme Court stated emphatically that an important reason for keeping equitable recoupment narrowly confined was its fear that otherwise too many tax cases would be diverted from the Tax Court to the District Courts. In Rothensies v. Electric Storage Battery Co., supra, the Supreme Court also expressed concern that allowing, through broadly interpreted equitable recoupment, wholesale reexamination of other years would undermine the whole single-year income tax system. In view of the limitations imposed by my view of the requirements for equitable recoupment, including the single-transaction requirement, the Supreme Court's expression of concern is not reasonably implicated. My approach is merely lenient enough to admit the Herring-Bowcut situation and this case. In Rothensies v. Electric Storage Battery Co., supra, the taxpayer was trying to resurrect claims that were 20 years old, 226 whereas in our case only 67 days within the same calendar year separate the two taxable events. Cf. 121 O'Brien v. United States, 766 F.2d at 1051 n.17 (much to be said for liberally construing single-transaction and identity-of-interest requirements for equitable recoupment, but not for relaxing rule against reopening closed tax years); Aetna Cas. & Sur. Co. v. Tax Appeals, 633 N.Y.S.2d 226">633 N.Y.S.2d 226, 228 (N.Y. App. Div. 1995) (equitable recoupment allowed so long as taxpayer's counterclaim covers same tax period as Government's claim, so that overpayment can be considered part of same "transaction", (citing National Cash Register Co. v. Joseph, 86 N.E.2d 561">86 N.E.2d 561, 562 (N.Y. 1949))). According to Brown v. Secretary of Army, 78 F.3d 645">78 F.3d 645, 650 (D.C. Cir. 1996), the rationale for narrow interpretation of waivers of sovereign immunity is the risk of imposing unanticipated and potentially excessive liabilities on the fisc. The liability imposed on the fisc by interpreting the single-transaction requirement in the way I would do here is strictly limited and can't be regarded as excessive. I would therefore hold, in the circumstances of this case, where not only has the same fund been subjected to inconsistent double taxation by reason of the decedent's death, but the taxable events occurred within the 122 same calendar year, and within 67 days of each other, that the single-transaction, item, or event requirement of equitable recoupment has been satisfied. 3. Inconsistent TreatmentRespondent, in denying the Administration Trust's second refund claim made in 1990, treated the same shares inconsistently with respondent's statutory notice to petitioner determining an estate tax deficiency based on a different valuation of those shares at the same time, the time of decedent's death. It follows from my conclusion in the preceding section that this case satisfies the single-transaction requirement that respondent has subjected the same item to inconsistent tax treatment. Thus, the inconsistent-treatment requirement is met. 23123 227 4. Identity of InterestIn Stone v. White, 301 U.S. 532">301 U.S. 532 (1937), the Supreme Court permitted the Government to recoup its time-barred deficiency claim against the sole beneficiary of a trust to reduce a timely refund claim brought by the trustees of the same trust. Thus, the Government's claim against one taxpayer could be raised as a defense to a claim brought by another taxpayer, so long as the two taxpayers had an "identity in interest". Id. at 537. Later cases have followed Stone v. White, supra, in finding identity of interest between legally 124 different parties because their interests did in fact coincide. Estate of Vitt v. United States, 706 F.2d 871">706 F.2d 871 (8th Cir. 1983) (husband's estate and wife's estate); Boyle v. United States, 355 F.2d 233">355 F.2d 233 (3d Cir. 1965) (estate and all the beneficiaries of the estate); United States v. Bowcut, 287 F.2d 654">287 F.2d 654 (9th Cir. 1961) (decedent and his estate); United States v. Herring, 240 F.2d 225">240 F.2d 225 (4th Cir. 1957) (same); Hufbauer v. United States, 297 F. Supp. 247 (S.D. Cal. 1968) (taxpayer and wholly owned corporation); see also O'Brien v. United States, 766 F.2d 1038">766 F.2d 1038, 1050-1051 (7th Cir. 1985) (dicta; one of three principal heirs). But see Kramer v. United States, 186 Ct. Cl. 684">186 Ct. Cl. 684, 406 F.2d 1363">406 F.2d 1363 (1969) (life tenant annuitant and decedent's estate); Lockheed Sanders, Inc. v. United States, 862 F. Supp. 677">862 F. Supp. 677, 681-682 (D.N.H. 1994) (parent corporation and subsidiary not qualified as member of affiliated group). Respondent argues that petitioner and the Administration Trust don't satisfy the identity-of-interest requirement because: (1) The Administration Trust, far from being the only beneficiary of decedent's estate, is not even a beneficiary; (2) petitioner's recoupment claim will inure to the benefit 125 of all beneficiaries of the Administration Trust, and petitioner hasn't met the burden of showing an identity of interest between the Administration Trust and the estate; (3) the Administration Trust has been and will be reimbursed for 228 part of its payment of decedent's estate taxes by the other parties in interest to whom some portion of the Federal estate tax liability will be apportioned; (4) some of the Administration Trust's beneficiaries aren't beneficiaries of the estate; and (5) the case law supports denying rather than affirming that the requirement is satisfied. These arguments don't seem to me to have force. Although the Michigan Uniform Estate Tax Apportionment Act provides that, unless the will otherwise provides, death taxes shall be apportioned in proportion to the value of the interest that each person has in the estate, Mich. Comp. Laws sec. 720.12 (1979), it also contains several provisions for equitable apportionment, Mich. Comp. Laws secs. 720.13(b), 720.15(d), 720.16 (1979). The aim of this statute is to ensure an equitable allocation of the burden of the tax among those actually affected by that burden. In re Estate of Roe, 426 N.W.2d 797">426 N.W.2d 797, 799-800 (Mich. Ct. App. 1988). 126 I would find that any adjustment through recoupment will solely benefit the Administration Trust (and, through it, its beneficiary subtrusts and their beneficiaries). Even though, because of the reimbursements under probate court order, the Administration Trust has been responsible for only 71.9 percent of the estate tax that has been paid so far, I believe the probate court would apportion any reduction in estate tax arising from allowance of recoupment so that it would inure solely to the benefit of the Administration Trust. The Administration Trust paid all its income tax on the sale of its shares, including the overpaid portion. There is thus an absolute identity of interest. The situation seems to me to be quite analogous to that of Stone v. White, so that any distinction based on the existence of different legal entities would be purely artificial. I would conclude that the identity-of-interest requirement is satisfied. 5. Statutory MitigationCongress in 1938 enacted the mitigation provisions now contained in sections 1311 through 1314 as a supplement to equitable recoupment and other court-created correctives to the injustices resulting from inconsistent treatment of related 127 items for Federal tax purposes. S. Rept. 1567, 75th 229 Cong., 3d Sess. 48 (1938), 1939-1 C.B. (Part 2) 779, 815. 24128 If the complicated requirements of these provisions are satisfied, then either a taxpayer or the Government (depending on which has suffered from the inconsistency) can obtain redress, regardless of the bar of a statute of limitations. If the result of the required adjustment is a tax deficiency, then it will be assessed and collected in the same way as any other deficiency. If the result is a tax overpayment, then the taxpayer must file a claim for refund, unless the Government refunds it without the filing of a formal claim. If the claim is denied or is not acted on in 6 months, the taxpayer may then sue for a refund. Secs. 6532(a)(1), 7422(a). The Administration Trust here applied for an income tax refund, which was denied. Thereafter, petitioner in this case raised mitigation as one of the affirmative defenses in its amended petition, treating respondent's denial of its refund claim as the final determination that would bring the mitigation provisions into play. Respondent did not move to strike this defense. Nevertheless, because petitioner failed to argue mitigation further at trial or on brief, I would deem petitioner to have waived this defense, insofar as its ability to assert it in this proceeding is concerned. That might not be the end of the matter. The mitigation provisions may have a preemptive effect on petitioner's right to equitable recoupment. Compare, e.g., Brigham v. United States, 200 Ct. Cl. 68">200 Ct. Cl. 68, 470 F.2d 571">470 F.2d 571, 577 (1972) with First Natl. Bank of Omaha v. United States, 565 F.2d 507">565 F.2d 507, 512, 518 (8th Cir. 1977). However, respondent has not argued that equitable recoupment 129 is unavailable to petitioner because mitigation preempts it, nor did petitioner argue that there is no preemption. Under the circumstances, I would hold that respondent has waived the preemption argument. 25130 230 Consequently, the mitigation provisions do not prevent the application of equitable recoupment in this case. 6. Other Equitable ConsiderationsRespondent raised arguments that application of equitable recoupment to petitioner was blocked by other considerations: (1) Lack of clean hands, largely because of considerations having to do with trial tactics that are essentially irrelevant; and (2) lack of diligence or laches, because the Administration Trust had more than 4 months following issuance of the estate tax statutory notice in which it could have filed a timely protective claim for an income tax refund. On brief, however, respondent has essentially conceded these issues and admitted that, where the proper circumstances for the application of equitable recoupment are present, such equitable considerations won't prevent its application. All that remains in respondent's briefs of the 131 original arguments about other equitable factors are trace references to their factual bases and what appears to be an argument in the alternative: "if the Court believes that other factors should be taken into account," then respondent suggests we take into account the Administration Trust's lack of diligence and failure to provide some necessary information during discovery and at and after trial. Petitioner argues in detail against respondent's specific charges, but only after initially arguing that respondent's concession that such equitable considerations shouldn't be taken into account in determining the availability of recoupment moots the specifics of respondent's charges. Because I would agree with petitioner that respondent's concession settles the issue, it's unnecessary to address respondent's charges. 26132 I would therefore decide that neither 231 of these considerations prevents the application of equitable recoupment in petitioner's favor. 7. Overpayment StatusPetitioner's overpayment status is attributable to two functionally unrelated factors: respondent's uncontested allowance of credit for tax on prior transfers under section 2013, and our redetermination of the value of the shares in an amount which, although greater than the value reported on the estate tax return, is substantially less than the value determined in respondent's statutory notice. If petitioner had filed the estate tax return claiming the previously taxed property credit to which it 133 is clearly entitled, we wouldn't even be discussing this issue. Petitioner would have paid estate tax in an amount that was $ 1,152,649 less than the amount that accompanied the return as prepared and filed, and respondent would have determined an estate tax deficiency in excess of $ 3 million rather than the one slightly less than $ 2 million in the statutory notice that was actually sent. 27 As a result of our valuation redetermination of the value of the shares at $ 1,700 per share in Mueller I, there would be an estate tax deficiency of $ 957,099, against which there would be recoupment of $ 265,999, resulting in a reduced deficiency on the order of $ 691,100. Petitioner hasn't attempted to explain why it failed to claim the previously taxed property credit on the estate tax return, but whether petitioner has a valid excuse should have no bearing on the outcome. As indicated supra pp. 66-67, laches and lack of diligence don't adversely affect a taxpayer's right to recoupment. For purposes of recoupment, petitioner shouldn't be disadvantaged by its initial 134 oversight in failing to claim a credit that respondent acknowledges petitioner's clearly entitled to. To allow respondent to take advantage of petitioner's oversight would perpetuate in 232 another guise the unjust enrichment that equitable recoupment is designed to prevent. i. Code sections are no obstacle to recoupmentSection 6214(a) grants this Court "jurisdiction to redetermine the correct amount of a deficiency". Deficiency, as defined in section 6211, depends generally on the relationship between the amount of the tax imposed on the taxpayer and the amount the taxpayer showed as the tax on the tax return. In Mueller II, when the parties argued the case on the assumption that petitioner would have a deficiency, respondent argued that these sections did not authorize us to use equitable recoupment to adjust petitioner's deficiency. We decided in Mueller II that, even if petitioner should have a deficiency, we have authority to apply equitable recoupment. We recently reaffirmed that conclusion in Estate of Bartels v. Commissioner, 106 T.C. 430">106 T.C. 430 (1996). There is less restriction on our overpayment jurisdiction under section 6512(b). Although section 6512(b) (1) does require that the 135 overpayment have been made by "the taxpayer", and the Administration Trust is not the same as petitioner, the identity of interest that I would find, and the fact that the Administration Trust has paid and is responsible for the estate tax on transfers of the shares held by and appointed to it, satisfy this requirement, given the nature and purposes of equitable recoupment. Moreover, the requirements of section 6512(b)(3), which sets time limits on any credit or refund, and whose restrictions section 6512(b)(1) incorporates, have been satisfied so as to allow the refund of the overpayment in this case. Because the statutory notice in this case was mailed within 3 years of the Administration Trust's overpayments of both income tax and estate tax, section 6512(b)(3)(B) has been satisfied. ii. Recoupment's defensive nature and the unrelated overpayment don't bar recoupmentRespondent argues and the majority conclude that petitioner's overpayment status prevents us from applying equitable recoupment. They've been beguiled by the notion that allowing equitable recoupment when there's already a net overpayment 233 would increase the overpayment, and that this would be the same as allowing 136 an affirmative recovery of time-barred taxes that recoupment can't provide. As we've said, Mueller II, 101 T.C. at 552, and as United States v. Dalm, 494 U.S. 596 (1990), clearly establishes, a taxpayer asserting equitable recoupment may not affirmatively collect the time-barred overpayment of tax, but may only use equitable recoupment to reduce the Government's timely determination of a deficiency. Respondent and the majority (majority op. p. 8) cite for their conclusion Brigham v. United States, 200 Ct. Cl. 68">200 Ct. Cl. 68, 470 F.2d 571">470 F.2d 571 (1972). There, the taxpayers were seeking refunds of ordinary income tax paid in barred years that, it turned out under a later Supreme Court case, had been erroneously paid, because the underlying transaction should have been treated as an installment sale resulting in capital gains. The Commissioner acquiesced and allowed the taxpayers a refund for 1962 but not for earlier, barred years. The taxpayers then sued for refunds of their overpayments for those earlier years, under the alternative theories of mitigation and equitable recoupment. The Court of Claims denied mitigation on the ground that the Commissioner had not actively maintained inconsistent positions. 137 The Court of Claims then denied equitable recoupment, primarily because it believed that mitigation, within its area of applicability, preempts equitable recoupment, but also on the alternative ground that equitable recoupment can only be used to reduce the amount of deficiencies recoverable by the Government in later years, and there were no such deficiencies, just time- barred earlier years. Brigham v. United States, 470 F.2d at 577. 28Brigham's language might, in isolation, like some language in Mueller II, 101 T.C. at 552, be extended to support respondent's view, but petitioner persuasively argues that such an extension would make no sense. Under respondent's 138 view, this Court's jurisdiction to apply equitable recoupment would evaporate if and when it turned out that the petitioner 234 was in an overpayment status, which might well not be known until we were about to enter a decision after a Rule 155 computation in a multi-issue case. To tie the requirement that the assertion of equitable recoupment be defensive to a taxpayer's total position, rather than to the single transaction to which equitable recoupment would attach, would be a radical departure from the history of recoupment. Recoupment arose as an equitable rule of joinder that permitted adjudication in one suit of two claims, both arising out of the same transaction, that otherwise had to be brought separately under the common law forms of action. In re Davidovich, 901 F.2d 1533">901 F.2d 1533, 1537 (10th Cir. 1990). Hence, when recoupment was imported into the tax law by the Supreme Court in Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935), the Court did require that both claims arise out of the same transaction and that the recoupment claim be defensive, but it did not require that the taxpayer have a deficiency. Bull v. United States, 295 U.S. at 262. Indeed, the Court could not have done so; in 139 Bull v. United States, supra, as in all later refund cases where taxpayers obtained equitable recoupment, the taxpayers had overpaid. The fact that the amount that they claimed in recoupment did not exceed the amount claimed by the Government from the same transaction sufficed to render their claim defensive. The language in Brigham v. United States, supra, on which respondent relies means no more than that equitable recoupment is only available against a deficiency determined by respondent, whether or not it turns out to exceed any recoupment sought.29140 The foundations, such as they are, of the majority opinion lie in its footnotes 13 and 14. Footnote 13 provides the majority's rationale for refusing to decide whether petitioner is in a deficiency posture and thus to refuse to apply recoupment 235 before taking into account the credit for tax on prior transfers. Footnote 14 asserts a policy reason for this refusal. The cases cited in footnote 13 30 can be made to stand for the proposition that, for purposes of res judicata with respect to whether a taxpayer in a new action can raise new tax issues with respect to a tax year or estate concerning which there has already been a final court decision, all issues having to do with the same tax, the same taxpayer, and the same tax year 141 (or same estate) are part of one undivided claim. However, the fact that two issues are part of the same claim or cause of action for one purpose doesn't mean they must be deemed to be such for any and all other purposes. Olympia Hotels Corp. v. Johnson Wax Dev. Corp., 908 F.2d 1363">908 F.2d 1363 (7th Cir. 1990). The language in Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 598 (1948), 31 appears to imply more than the other cases cited in footnote 13. However, this language is pure dictum: the Supreme Court in Sunnen was denying that res judicata blocked Government litigation of the same tax issue that had been previously decided for earlier tax years, not asserting a res judicata effect with respect to the same year. The holding of Sunnen was significantly limited in Montana v. United States, 440 U.S. 147">440 U.S. 147, 161 (1979). 32143 Sunnen now only stands for the proposition that res judicata doesn't prevent the Government from litigating the same tax issue for different years if the 142 law has changed since the prior lawsuit. Cf. Greene v. United States, 79 F.3d 1348">79 F.3d 1348, 1352 (2d Cir. 1996); Kamilche Co. v. United States, 53 F.3d 1059">53 F.3d 1059, 1061 n.2 (9th 236 Cir. 1995); ITT Corp. v. United States, 963 F.2d 561">963 F.2d 561, 564 (2d Cir. 1992); Blair v. Taxation Div. Director, 9 N.J. Tax 345">9 N.J. Tax 345, 352-353 & n.7 (N.J. Tax Ct. 1987), affd. 543 A.2d 99">543 A.2d 99 (N.J. Super. Ct. 1988). Since the Supreme Court spoke its dictum about the annual nature of the income tax in aid of its conclusion that res judicata didn't prevent new litigation of the same issue for later years, query how much of that dictum the Supreme Court would repeat today, in view of its change of view on that conclusion (different year no longer implies different claim or cause of action). This Court decided, in Hemmings v. Commissioner, 104 T.C. 221 (1995), that a final judgment in District Court in a refund suit didn't prevent respondent from issuing a statutory notice for the same year on a different issue and this Court from refusing to grant partial summary judgment to the taxpayers on the basis of res judicata. Although 144 it's settled law that the requirements for claim preclusion are: (1) identical parties (met); (2) court of competent jurisdiction (presumably met); (3) final judgment on merits (met); and (4) identical cause of action, United States v. Shanbaum, 10 F.3d 305">10 F.3d 305 (5th Cir. 1994), we decided in Hemmings that the Government was only prevented from litigating in a new suit after a concluded refund suit all its compulsory counterclaims and such permissive counterclaims as are actually litigated. Hemmings v. Commissioner, 104 T.C. at 234. What this means is that this Court has held that it's not always and for all purposes that all tax issues having to do with the same taxpayer and the same tax year are parts of one indivisible claim or cause of action. In Hemmings v. Commissioner, 104 T.C. at 234-235, we cited a number of cases holding or stating that unrelated tax claims by the Government having to do with the same tax year or same estate are not compulsory counterclaims in a refund suit by the taxpayer in District Court. See, e.g., Gustin v. IRS, 876 F.2d 485">876 F.2d 485, 490 n.1 (5th Cir. 1989) (wrong to dismiss for lack of jurisdiction Government's counterclaim in refund suit, because that counterclaim 145 is not compulsory); Caleshu v. United States, 570 F.2d 711">570 F.2d 711, 713-714 (8th Cir. 1978) (pending refund suit in District Court does not prevent collection action to reduce unpaid assessments to judgment in different District Court); Pfeiffer Co. v. United States, 518 F.2d 124">518 F.2d 124, 128-130 (8th Cir. 1975) (pending refund suit in 237 District Court does not render statutory notice and resulting deficiency assessment invalid); Bar L Ranch v. Phinney, 400 F.2d 90">400 F.2d 90, 92 (5th Cir. 1968) (pending refund suit in District Court does not render statutory notice and resulting deficiency assessment invalid); Florida v. United States, 285 F.2d 596">285 F.2d 596, 602-604 (8th Cir. 1960) (pending refund suits in District Court do not prevent Government action in different District Court to enforce payment of taxes). Most of these cases cite dictum to the same effect in Flora v. United States, 362 U.S. 145">362 U.S. 145, 166 (1960). 33146 If these counterclaims are not compulsory and thus can be the basis of a separate action, tax cases can be split, at least for some purposes.Our issue here, whether the credit for prior taxes is part of the same claim for the issue of blocking equitable recoupment, is clearly less closely related to the issue 147 of Finley v. United States, 612 F.2d 166">612 F.2d 166 (5th Cir. 1980), and Estate of Hunt v. United States, 309 F.2d 146">309 F.2d 146 (5th Cir. 1962) (whether the new issue is part of the same claim for the purpose of preventing the plaintiff taxpayer from separately litigating the new issue) than the issue of Hemmings v. Commissioner, supra (whether the new issue is part of the same claim for the purpose of preventing the defendant Government from separately raising the new issue through a statutory notice and then continuing to litigate it in the Tax Court). Hemmings v. Commissioner, supra, being closer to our case, furnishes ground for confining recoupment to the same transaction and not impeding it with the overpayment arising from allowance of the credit for taxes on prior transfers, a completely unrelated issue. The language of Bull v. United States, supra, quoted by the majority suggests that for our equitable recoupment issue we should look to Hemmings v. Commissioner, 238 supra, not to Finley and Hunt: Defenses that the taxpayer could have asserted if the Government had brought suit for the tax are to be allowed taxpayers in suits that they bring. Bull v. United States, 295 U.S. at 263. If the United 148 States had sued petitioner in this case for the estate tax deficiency, the estate wouldn't have had to raise the credit for prior taxes as a defense or counterclaim. Since it doesn't spring from the same transaction as the estate tax claim, it wouldn't have had to be raised as a compulsory counterclaim. Fed. R. Civ. P. 13. Thus, petitioner could have raised recoupment as a defense in such a suit and, in the absence of any claims about the credit, would have been entitled to recoupment. Thereafter, the estate could have brought a separate suit for the credit for prior taxes. It's highly significant that this is the test that was applied in Hemmings: The Government's claim was allowed in the second action because in the first action the claim would have been a permissive, not a compulsory, counterclaim. Hemmings v. Commissioner, 104 T.C. at 232, 234-235. 34149 I conclude, for the purposes of applying equitable recoupment, that the cases cited in the majority's footnote 13 are inapposite and that the credit for previously paid taxes is not part of the same claim or cause of action as that attributable to the date of death value of the shares. The majority's footnote 14 quotes at length a passage in Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 301 (1946), that emphasizes the importance and desirability of maintaining a statute of limitations in the income tax area. As I've already observed, supra pp. 48, 58-59, the purposes underlying statutes of limitations--preventing stale litigation and protecting repose--don't apply when the timely claim that initiates a lawsuit is subjected to an otherwise time-barred defensive claim that arose out of the same transaction, item, or event. Indeed, those purposes are repugnant to disallowance of such a defense, since such a limitation 150 would encourage delay in the bringing of some claims until 239 a defense is time-barred. United States v. Western Pac. R.R., 352 U.S. 59">352 U.S. 59, 72 (1956). In any event, Rothensies v. Electric Storage Battery Co. (like Ford v. United States, 149 Ct. Cl. 558">149 Ct. Cl. 558, 276 F.2d 17">276 F.2d 17 (1960), which the majority also cites and quotes in this connection, majority op. p. 15), stands not just for limiting equitable recoupment, but for limiting it through a narrow interpretation of the single-transaction requirement. 35 To limit equitable recoupment in the way that those two cases do is more defensible than to limit it in the way that the majority does here. There's a connection between the defensive purpose of equitable recoupment and the single-transaction requirement.Recoupment is allowed to circumvent such bars as statutes of limitations, sovereign immunity, and bankruptcy because it would be unjust to allow one party to benefit from some aspects of a transaction when another party can't derive the benefits of other aspects of that same transaction merely because of the presence of some procedural 151 bar. Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 265 n.2 (1993); Rothensies v. Electric Storage Battery Co., 329 U.S. at 299; In re Peterson Distrib., Inc., 82 F.3d 956">82 F.3d 956, 961 (10th Cir. 1996); In re B & L Oil Co., 782 F.2d 155">782 F.2d 155, 159 (10th Cir. 1986) (cited approvingly for extent to which recoupment is available in bankruptcy in Reiter v. Cooper, 507 U.S. at 265 n.2 ); In re Centergas, Inc., 172 Bankr. 844, 849 (Bankr. N.D. Tex. 1994). To the extent that the object of inconsistent taxation was not a part of the same transaction, to that extent justice requires less insistently that it be treated consistently, and this is what explains the single-transaction requirement. There is no such connection between the rationale of equitable recoupment and the majority's expansive interpretation of the requirement that recoupment be defensive. Rather, the majority's reasoning prevents justice from being rendered in view of the one transaction as a whole and thereby thwarts the purpose of equitable recoupment, not only in this case but probably in future cases where such a result would be even more clearly unjust. iii. Barring recoupment would be inconsistent with tax precedentRespondent and the majority 152 would now have us believe that in tax cases Bull v. United States, supra, only eliminates to a very limited extent the requirement that equitable recoupment be defensive. Of course, under Bull v. United States, supra, and later recoupment tax cases, a taxpayer can't gain any greater credit from the Government under equitable recoupment than the Government seeks from him (just as the Government can't gain any greater credit than the taxpayer seeks from the Government). But the majority and I part company on their conclusion that equitable recoupment in favor of the taxpayer is further limited in that it can't, in combination with any other unrelated claims of the taxpayer, lead to any affirmative recovery by the taxpayer. Bull v. United States, supra, by allowing recoupment where the recouping party was technically the plaintiff, liberalized the requirement that recoupment could only be used defensively. It did so to prevent unjust enrichment of the Government. For the Government to retain both the estate tax and the income tax on the same fund was held to amount in law to a fraud on the taxpayer's rights and to be against morality and conscience. In limiting Bull v. United States, supra, 153 as the majority have done, they are thereby perpetuating unjust enrichment in the case at hand. The question is really one of the order of application: If we consider the adjustment that would result from recoupment as occurring before the allowance of credit for tax on prior transfers, then that adjustment doesn't cause affirmative recovery, which would only result later; rather, it merely cancels, in part, the Government's claim arising from the same transaction, item, or event. Only if we consider the adjustment from recoupment as occurring after the allowance of the credit for tax on prior transfers would it cause affirmative recovery. We aren't obliged to take that view of it, and the policy considerations argue strongly against so taking it. So long as petitioner is entitled to some unrelated credit, however small, there would, under respondent's reasoning, be some redetermined increased valuation of the shares at which petitioner would cease to be entitled to any more than partial recoupment, and another, lower but still increased, 241 valuation at which petitioner would cease to be entitled to any recoupment at all. The same would be true of any refund actions that might have 154 occurred if the estate had paid the deficiency determined by respondent and then sued for a refund. Under respondent's and the majority's approach, any limitation on recoupment might only become clear upon final disposition of a multi-issue case. And this limitation on equitable recoupment would result from the altogether fortuitous existence of some unrelated credit or other adjustments, in this case the credit for tax on prior transfers. Let me take another cut at what it means to say that the defense of equitable recoupment can't be used offensively, like a counterclaim, to generate an overpayment. Suppose we didn't have the previously taxed property credit problem. Suppose also that the estate had reported the value of the shares at $ 1,500 per share and there was no estate tax audit and the period of limitations expired on the assessment of an estate tax deficiency and the filing of an estate tax claim for refund. The Administration Trust, which reported its gain on the sale of the shares using the date-of-death value basis of $ 1,500 per share, then files an income tax claim for refund just before the period of limitations expires, contending that it should have used a basis 155 of $ 1,700 per share, and sues for the refund. The Government answers with a denial, but also asserts equitable recoupment. The District Court upholds the $ 1,700 date-of-death value, which means that the estate is entitled to an income tax refund of approximately $ 266,000. The Government says that means there is a time-barred deficiency in estate tax of approximately $ 957,000. Allowing recoupment means that the $ 266,000 refund claim is wiped out, but the statute of limitations bars the Government from collecting the balance of the estate tax deficiency of $ 691,000. If we were to allow an increase in the overpayment in our case, we would not breach the bar of the statute of limitations in the way the District Court would be doing if it allowed the Government to recover the balance of the deficiency in my hypothetical. The Government is already indebted to the taxpayer in our case for the amount of the unclaimed previously taxed property credit of more than $ 1 million ($ 1,152,649), and, because the Government has conceded that amount in the statutory notice, there's no statutory 242 bar on the taxpayer's recovering it as an overpayment in this case. If this Court had upheld in full 156 the estate's reporting position on the value of the shares at $ 1,505 per share, we would have jurisdiction to determine an overpayment in the full amount of $ 1,152,649, and to enter a decision in favor of the taxpayer in that amount. There is and would be no statute of limitations bar to our determining an overpayment in that full amount. All I'm proposing that we do now is reduce the smaller deficiency that arises from valuing the shares at $ 1,700 per share by the amount of the recoupment in order to compute the amount of the reduction of the overpayment that the taxpayer is already otherwise entitled to, and that's already in the picture as part of this case. To do so would not impair the sovereign immunity bar of the statute of limitations. Nothing in Bull v. United States, supra, indicates that we need consider anything other than the single transaction at issue when we set out to determine whether recoupment is being used defensively, and there is plenty of other authority to the effect that we should only consider that single transaction. As the Supreme Court said in Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 299 (1946): Equitable recoupment has never been thought 157 to allow one transaction to be offset against another, but only to permit a transaction which is made the subject of suit by a plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole.That sentence was cited at a critical point in United States v. Dalm, 494 U.S. at 611, to support the Supreme Court's central holding that equitable recoupment requires an independent basis for jurisdiction. By limiting recoupment as respondent wants, the majority, to that extent, are failing to do justice in view of the one transaction as a whole. iv. Barring recoupment would be inconsistent with other precedentIn Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 265 (1993), a bankruptcy case and the Supreme Court's latest pronouncement on recoupment, the Supreme Court reaffirmed Bull v. United States, 295 U.S. 247">295 U.S. 247243 (1935), 36159 and cited it for the proposition that recoupment claims are not barred by statutes of limitations so long as the main action is timely, and said that a bankruptcy defendant can meet a plaintiff-debtor's claim with a counterclaim arising out of the same transaction, "at least to the extent that the defendant merely seeks 158 recoupment." Reiter v. Cooper, 507 U.S. 258, 113 S. Ct. at 1218 & n.2. The Supreme Court went on to say that this did not result in preferential treatment of the creditor asserting recoupment, inasmuch as recoupment merely permits a determination of the just and proper liability on the main issue. Id. at 1218-1219 n.2. To take account of anything other than the same transaction in determining the amount of recoupment would be inconsistent with this argument, and indeed the Supreme Court made absolutely no mention of a further, unrelated amount owing to the plaintiff-debtor.37In Reiter v. Cooper, supra, the unrelated claim was properly ignored by the Supreme Court, because it couldn't have affected the outcome. In In re Greenstreet, Inc., 209 F.2d 660">209 F.2d 660 (7th Cir. 1954), a claim that the Court of Appeals for the Seventh Circuit chose to regard as unrelated was very much before the Court, which refused to allow that claim to have any effect on the amount of recoupment allowed. Instead, the claim belonging to the same transaction to which the recoupment counterclaim also belonged alone determined the extent to which recoupment was allowed. That is to say, only the single transaction was considered. 160 In In re Greenstreet, Inc., supra, the Government filed claim, in the bankruptcy proceedings of a manufacturer of Army clothing, for $ 302,500, the purchase price of property that it had furnished to the debtor for the manufacture of such clothing, and for an additional $ 68,279.72 damages for 244 the bankrupt's failure to complete the contract. The bankruptcy trustee in turn filed counterclaims amounting to $ 155,593.49, asserting certain liens and unsecured money demands against the property and the Government's general claim. The District Court held that it had jurisdiction over all the counterclaims, and the Government appealed this holding. The parties agreed that the counterclaims could cancel the Government's general claim for damages of $ 68,279.72. The issue in dispute was whether the counterclaims could also be asserted against the Government's claim for the reclamation of its property, so that the whole of the counterclaims could have effect. The Court of Appeals found that they could not be asserted to that extent, since the Government had not waived its sovereign immunity to that extent. In holding, in effect, that the property claim did not involve the same transaction, 161 the Court of Appeals gave a particularly narrow reading of the single-transaction requirement, especially for a bankruptcy case. That issue would almost certainly be decided differently today, 38162 so that there would be no question of limiting the recoupment. However, it is not Greenstreet's treatment of the single-transaction issue that makes it significant for the case at hand. Rather, In re Greenstreet, Inc. is a striking example of a refusal by a court to look beyond the single transaction in deciding what effect to give to recoupment as a defense. It is with this in mind that we should look at the language in In re Greenstreet, Inc. quoted by the majority (majority op. p. 6 n.8) against my view of the overpayment issue. There would have been no affirmative recovery by the debtor if all its counterclaims had been allowed, provided that one looks beyond the single transaction. After all, the Government's claims in total substantially outweighed the counterclaims. 245 In saying that there could be no affirmative recovery through recoupment, the Court of Appeals for the Seventh Circuit was clearly thinking of affirmative recovery with respect to the single transaction. It should further be noted that the Supreme Court in Reiter v. Cooper, supra, said that it basically made no difference whether recoupment was a defense or a counterclaim (according to the Supreme 163 Court, it was in fact a counterclaim in the context of that case, but the defendants' characterization of it as a defense was inconsequential, and the plaintiff's argument that, since it was a counterclaim, it could not be raised as a defense was denied). Reiter v. Cooper, 507 U.S. at 263; cf. FDIC v. Hulsey, 22 F.3d 1472">22 F.3d 1472, 1487 (10th Cir. 1994) (claims in recoupment are compulsory counterclaims under Fed. R. Civ. P. 13(a)). This suggests that it is a mistake to insist too much on recoupment's defensive nature in the case at hand. 39164 Faced with the issue of whether recoupment is subject to the limitations on setoff in the Bankruptcy Code, a later bankruptcy court decided, on the basis of Reiter v. Cooper, that recoupment was not so limited. It said further, by way of distinguishing the two: "recoupment speaks not simply to the net amount due from one party to the other computed by subtracting one claim from the other, but rather to the amount of the plaintiff's claim alone on a particular contract, transaction or event." In re Izaguirre, 166 Bankr. 484, 493 (Bankr. N.D. Ga. 1994). To the same effect, outside bankruptcy, see such cases as United States v. Tsosie, 92 F.3d 1037">92 F.3d 1037, , (10th Cir. 1996) (Indian land case); FDIC v. Hulsey, 22 F.3d 1472">22 F.3d 1472, 1487-1488 (10th Cir. 1994) (secured loan agreement); Frederick v. United States, 386 F.2d 481">386 F.2d 481, 488 (5th Cir. 1967) (suit on a note); Shipping Corp. of India, Ltd. v. Pan-Am. Seafood, Inc., 583 F. Supp. 1555">583 F. Supp. 1555, 1557246 (S.D.N.Y. 1984)165 (admiralty); United States v. Timber Access Indus. Co., 54 F.R.D. 36">54 F.R.D. 36 (D. Or. 1971) (logging contract). United States v. Timber Access Indus. Co., supra, is close to the point but not on all fours with our overpayment issue. The United States, as trustee for an Indian tribe, sued the defendant logger, asserting breaches of a logging contract, for $ 47,561.06. The defendant counterclaimed under the same contract, alleging that the Government owed it $ 109,870.85, and argued that, although it could not have full recovery on the counterclaim, it was entitled to a credit of $ 47,561.06 as recoupment and, beyond that, affirmative recovery of $ 10,000 under the Tucker Act, 28 U.S.C. sec. 1346(a)(2) (1994) ($ 10,000 being the jurisdictional limit on Tucker Act claims in the District Court 40). The Government argued that sovereign immunity barred any affirmative recovery by the defendant. The District Court agreed with the defendant and allowed an affirmative recovery to the extent of $ 10,000. However, it denied other, permissive counterclaims sought to be brought by the logger's surety, but only on the ground that these counterclaims were brought against the United States not in its capacity 166 as trustee for the Indian tribes, but in its own capacity, so that they were unauthorized under Fed. R. Civ. P. 13, because sovereign immunity operated with respect to these other counterclaims. The fact that no statute-of-limitations problem figures in United States v. Timber Access Indus. Co., supra, does not distinguish it from our case: There, the doctrine of recoupment was needed to support the defendant's main counterclaim against the Government's claim of sovereign immunity, whereas in our case recoupment is needed to support petitioner's defense against the bar of the statute of limitations. The fact that the defendant in United States v. Timber Access Indus. Co., supra, 167 could still, after the decision in the case, bring suit in the Court of Claims for the balance of its counterclaim means that to limit recoupment there didn't eliminate all opportunity for the defendant to obtain complete justice with respect to the transaction in issue, 247 whereas barring recoupment in our case would amount to denying complete justice. To allow an affirmative recovery arising from the same transaction to bar or limit recoupment (as the District Court in United States v. Timber Access Indus. Co., supra, refused to do) does less violence to the idea of doing complete justice with respect to the one transaction than would allowing an unrelated affirmative recovery (like that in our case with respect to the previously taxed property credit) to have such a limiting effect. Thus, there was more reason in United States v. Timber Access Indus. Co., supra, than there is in our case to limit recoupment by the amount of the affirmative recovery, and nevertheless the District Court didn't do so. United States v. Timber Access Indus. Co., supra, which is cited and discussed at some length in 6 Wright et al., Federal Practice & Procedure, sec. 1427, at 197-198 n.8 (2d ed. 1990), 168 illustrates the point that another affirmative recovery with its own independent jurisdictional basis, even when it arises from the same transaction from which a recoupment defense or counterclaim arises, does not bar or limit recoupment. It is appropriate to use these non-tax cases, and most especially Reiter v. Cooper, in the tax area. Reiter v. Cooper not only cited Bull v. United States at a crucial point in its argument, 507 U.S. at 265. It also used several recoupment cases outside both bankruptcy and tax to support the proposition that there is a "general principle of recoupment", which has force in the absence of explicit Congressional prohibition, id.; cf. United States v. Dewey Freight Sys., Inc., 31 F.3d 620">31 F.3d 620, 623 (8th Cir. 1994). Standard jurisdictional principles typically operate in the same fashion in tax as in all other areas of the law. United States v. Forma, 42 F.3d at 766 (citing United States v. Dalm, 494 U.S. at 608-611). So long as the recoupment claim is only allowed to offset the Government's claim from the transaction in issue, and not to exceed any amount determined to be owing to the Government that also arises from that transaction, all sensible requirements 169 are met. The statement of the Court of Appeals for the Second Circuit in a tax case that, despite sovereign immunity, a defendant may, without statutory authority, recoup on a counterclaim an amount equal to the principal claim, United States v. Forma, 42 F.3d at 764 (citing 248 United States v. United States Fidelity & Guaranty Co., 309 U.S. 506">309 U.S. 506, 511 (1940)), supports my view. 41170 ConclusionIn sum, in the circumstances of this case, equitable recoupment properly would only be allowed as an offset against (and only up to the amount of) the deficiency as we would have redetermined it in the absence of the previously taxed property credit. The previously unclaimed credit that respondent allowed has no bearing on the issue arising out of the date-of-death valuation of the shares, and should also be paid to petitioner. Thus, petitioner should be paid in the end the amount a = c - (d - r) (d >/= r), where a is the amount of the overpayment to be paid, c is the credit for the tax on prior transfers that respondent allowed in the statutory notice, d is the deficiency as we would have redetermined it if the credit had been claimed on the estate tax return or paid administratively, and r is the offset to that deficiency resulting from our application of equitable recoupment, which can't exceed the amount of that deficiency. I would find that respondent's overpayment argument doesn't prevent the application of equitable recoupment. This would allow us to consider 171 all the other issues, on which I would also find in favor of petitioner. Consequently, I would apply equitable recoupment in favor of petitioner. Footnotes. This case was reassigned to Judge Robert P. Ruwe↩ by order of the Chief Judge.1. Decedent Bessie I. Mueller resided and was domiciled in Port Huron, Michigan, at the time of her death, and her will was admitted to probate by the Probate Court of St. Clair County, Michigan. John S. Mueller, the personal representative in this case of decedent's estate and one of the two trustees of the Administration Trust, was a resident of Naples, Florida, when he filed the petition in this case. The estate's other personal representative and the other trustee of the Administration Trust is Milton W. Bush, Sr., an attorney who resides in Port Huron, Michigan. The Michigan National Bank, which was engaged by the two trustees as their agent upon the death of decedent, has its principal corporate office in Michigan. Throughout the time relevant to this case, the Administration Trust has been administered in Michigan.↩2. The record does not explain why the Trust used a basis that was $ 5 per share less than the amount petitioner reported as the fair market value of the shares in the estate tax return.↩3. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩4. This credit, which was not claimed on decedent's estate tax return, was for property received by decedent from the estate of her stepson Robert E. Mueller. Allowance of this previously unclaimed credit was appropriate in determining the amount of the deficiency. See sec. 6211.↩5. Both parties agree that there is no estate tax deficiency and that petitioner is entitled to a decision that it has overpaid its estate tax, regardless of any effect that the doctrine of equitable recoupment might have.↩6. The term "main action" is used to denote the timely claim as opposed to the time-barred claim upon which the recoupment defense is based. See Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 264 (1993); United States v. Dalm, 494 U.S. 596">494 U.S. 596, 605 (1990); Stone v. White, 301 U.S. 532">301 U.S. 532, 539 (1937); Bull v. United States, 295 U.S. 247">295 U.S. 247, 262 (1935); United States v. Forma, 42 F.3d 759">42 F.3d 759, 765↩ (2d Cir. 1994).7. After reviewing cases involving recoupment, the Court of Appeals for the Second Circuit stated: All of these cases conclude that "a party sued by the United States may recoup damages * * so as to reduce or defeat the government's claim * * * though no affirmative judgment * * * can be rendered against the United States." In re Greenstreet, 209 F.2d at 663. [United States v. Forma, supra↩ at 765.]8. With respect to the limited defensive nature of recoupment, the Court of Appeals for the Seventh Circuit stated: the government concedes that a party sued by the United States may recoup damages arising out of the same transaction, or where authorized, set off other claims, so as to reduce or defeat the government's claim. That this is a correct conception of the law is apparent from United States v. United States Fidelity & Guaranty Co., 309 U.S. 506">309 U.S. 506, at page 511 * * ; Bull v. United States, 295 U.S. 247">295 U.S. 247, at page 262 * ; United States v. Ringgold, 8 Peters 150">8 Pet. 150, 163-164 * , though no affirmative judgment over and above the amount of its claim can be rendered against the United States, United States v. Shaw, 309 U.S. 495">309 U.S. 495 * * [In re Greenstreet, Inc., 209 F.2d 660">209 F.2d 660, 663↩ (7th Cir. 1954).]9. Recoupment has been described as "the setting off against asserted liability of a counterclaim arising out of the same transaction. Recoupment claims are generally not barred by a statute of limitations so long as the main action is timely." Reiter v. Cooper, 507 U.S. at 264↩.10. See United States v. Dalm, 494 U.S. at 605, stating that in Bull v. United States, supra↩, "the proceeding between the executor and the Government was in substance an attempt by the Government to recover a debt from the estate."11. The combination of increasing the taxable estate and allowing the credit for prior transfers would produce the same result that we arrive at here -- petitioner has no additional estate tax liability; rather, petitioner has overpaid its estate tax and would be entitled to a refund.↩12. No suit or counterclaim can be brought against the United States where the subject of the suit or counterclaim is barred by the statute of limitations. This bar is jurisdictional in nature. A narrow exception is the availability of recoupment as a defense against an action brought by the United States. United States v. Dalm, supra↩ at 608.13. Equitable recoupment has been restricted to defending against an otherwise valid claim or cause of action. The Government's claim or cause of action here is its assertion that petitioner is liable for additional estate tax. "In federal tax litigation one's total income tax liability for each taxable year constitutes a single, unified cause of action, regardless of the variety of contested issues and points that may bear on the final computation." Finley v. United States, 612 F.2d 166">612 F.2d 166, 170 (5th Cir. 1980) (citing Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 598 (1948)). The same reasoning applies to the estate tax. There is no distinction conceptually between the nature of a cause of action arising from estate taxes on the one hand and one arising from a single year's income tax on the other. Estate of Hunt v. United States, 309 F.2d 146">309 F.2d 146, 148 (5th Cir. 1962); see also Huddleston v. Commissioner, 100 T.C. 17">100 T.C. 17, 25↩ (1993).14. In Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296, 301 (1946), the Supreme Court stressed the importance of a statute of limitations, stating: It probably would be all but intolerable, at least Congress has regarded it as ill-advised, to have an income tax system under which there never would come a day of final settlement and which required both the taxpayer and the Government to stand ready forever and a day to produce vouchers, prove events, establish values and recall details of all that goes into an income tax contest. Hence, a statute of limitation is an almost indispensable element of fairness as well as of practical administration of an income tax policy. We have had recent occasion to point out the reason and the character of such limitation statutes. "Statutes of limitation * * * are designed to promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared. The theory is that even if one has a just claim it is unjust not to put the adversary on notice to defend within the period of limitation and that the right to be free of stale claims in time comes to prevail over the right to prosecute them." Order of Railroad Telegraphers v. Railway Express Agency, 321 U.S. 342">321 U.S. 342, 348-9↩. * * 15. See United States v. Dalm, 494 U.S. at 605↩.16. See United States v. Timber Access Indus. Co., 54 F.R.D. 36">54 F.R.D. 36 (D. Or. 1971). The defendant was entitled to an affirmative recovery against the Government on a separate counterclaim; however, recoupment↩ against the Government was restricted to the amount that the Government was entitled to recover in the main cause of action initiated by the Government.17. See Evans Trust v. United States, 199 Ct. Cl. 98">199 Ct. Cl. 98, 106, 462 F.2d 521">462 F.2d 521, 526 (1972), stating: Furthermore, since the Government's asserted deficiency was settled by a determination that no deficiency existed, plaintiff is attempting to use recoupment not in its traditional form as a defense to an asserted deficiency, but as an independent ground for reopening years now closed by the statute of limitations.1. Mueller v. Commissioner, 101 T.C. 551">101 T.C. 551, 563-564 (1993) (Halpern↩, J., concurring).2. See majority op. p.3 note 1 for a summary of the places of residence of decedent and her personal representatives and the trustees of the Administration Trust.3. The beneficiaries of the Trust are three subtrusts: The first for the benefit of decedent's niece Mary M. Hanson and decedent's friend Jean Ehlinger and the two other subtrusts known as the Bessie I. Mueller Irrevocable Trusts A and B for the benefit of decedent's grandchildren: Justin R. Mueller, Anne E. Mueller, and Heidi M. Mueller.4. The noncharitable legatees of decedent's estate are decedent's sons John S. Mueller and James F. Mueller; decedent's two granddaughters by son John, Anne E. Mueller and Heidi M. Mueller; Bessie I. Mueller Irrevocable Trusts A (f/b/o grandson Justin R. Mueller) and B (f/b/o granddaughters Anne E. Mueller and Heidi M. Mueller); the Bessie I. Mueller Administration Trust; decedent's niece Mary M. Hanson; friend Jean M. Ehlinger; decedent's nephew William E. Pearson; and friend Harriet Suggs.↩5. The recipients of property in the decedent's gross estate participating in the apportionment of death taxes were: ↩Administration Trust71.9%Decedent's Estate3.4%James F. Mueller10.6%John S. Mueller10.6%E. B. Mueller Insurance Trust3.0%Decedent's Condo (sic instipulation)0.5%6. Decedent also exercised the same testamentary power to appoint 1,000 shares from the same Ebert B. Mueller Marital Trust to each of her sons, John S. Mueller and James F. Mueller.↩7. The gross estate also included the 2,000 shares appointed to the two sons under the testamentary general power of appointment, as well as 274 shares owned by the Ebert B. Mueller Life Insurance Trust. The apportionment of Federal estate tax to the sons, as set forth in note 5 supra↩, is attributable primarily to their receipt of shares pursuant to decedent's exercise of the power of appointment in their favor.8. The actual sale of the 1,500 shares acquired by the Administration Trust upon decedent's death was in fact carried out by the Comerica Bank as Trustee of the Ebert B. Mueller Marital Trust, but it was on behalf of the new owner, the Administration Trust. The gain realized upon the sale of the 1,500 shares was treated as distributable net income of the Administration Trust, and the Administration Trust included the gain realized on the sale of the 1,500 shares in its taxable income for 1986.9. This credit was for property received by decedent from the estate of Robert E. Mueller, her stepson.↩10. It's not clear from the parties' stipulation on this point whether they've taken into account the partially offsetting reduction in the credit for State death taxes that would result from the reduction in estate tax liability arising from the application of equitable recoupment. The answer to this question would have no effect on the outcome.↩11. United States v. Dalm, 494 U.S. 596">494 U.S. 596, 608 (1990), makes clear the further requirement, not in issue in this case, that there be a basis for jurisdiction in the case independent of equitable recoupment. In this case, the statutory notice and petition are clearly valid and were timely filed, and consequently we have independent jurisdiction over the deficiency originally determined by respondent (and the overpayment that we must now determine).12. Because the expiration of this 3-year period occurred later than the expiration of the 2-year period after the payment of the tax, that alternative date need not be considered. Sec. 6511(a) directs us to use the later date.↩13. Revoking Rev. Rul. 55-226, 1 C.B. 469">1955-1 C.B. 469↩.14. Academic commentators have almost invariably supported Herring-Bowcut against the Court of Claims. See Andrews, Modern-Day Equitable Recoupment and the "Two-Tax Effect": Avoidance of the Statutes of Limitation in Federal Tax Controversies, 28 Ariz. L. Rev. 595">28 Ariz. L. Rev. 595, 630-650 (1986); Willis, Some Limits of Equitable Recoupment, Tax Mitigation, and Res Judicata: Reflections Prompted by Chertkof v. United States, 38 Tax Law. 625">38 Tax Law. 625, 642-645↩ (1985).15. The taxpayer also argued for the refund under the statutory mitigation provisions, secs. 1311-1314, and the District Court also bought this argument, O'Brien v. United States, 582 F. Supp. 203">582 F. Supp. 203, 206-207 (C.D. Ill. 1984), under Chertkof v. United States, 676 F.2d 984">676 F.2d 984↩ (4th Cir. 1982). The Court of Appeals also reversed this conclusion.16. See Tierney, Equitable Recoupment Revisited: The Scope of the Doctrine in Federal Tax Cases after United States v. Dalm, 80 Ky. L.J. 95">80 Ky. L.J. 95, 100↩ n.15 (1992).17. See Commissioner v. Duberstein, 363 U.S. 278">363 U.S. 278, 289-290↩ (1960).18. In United States v. Dalm, 867 F.2d 305">867 F.2d 305 (6th Cir. 1989), revd. 494 U.S. 596">494 U.S. 596 (1990), the Sixth Circuit found all the requirements for equitable recoupment to be met except for the one, different factual issue of whether the Tax Court settlement already took account of the overpaid gift tax and remanded to the District Court to determine that issue. In reversing on the jurisdictional issue, the majority of the Supreme Court expressed no misgivings about the factual basis of the inconsistent tax treatment and indeed suggested that, had it not been for the jurisdictional issue, Mrs. Dalm could have had her refund: "Our holding today does not leave taxpayers in Dalm's position powerless to invoke the doctrine of equitable recoupment." United States v. Dalm, 494 U.S. at 610↩.19. The District Court in Minskoff v. United States, 349 F. Supp. 1146">349 F. Supp. 1146 (S.D.N.Y. 1972), affd. per curiam 490 F.2d 1283">490 F.2d 1283 (2d Cir. 1974), advanced alternative grounds for its correct result, and one of these may have been correct. The first and arguably correct one of these alternative grounds was that the estate had not proved that there was any factual inconsistency, still less its actual amount. Id. at 1150. The Court of Appeals, although it felt no need to decide the case on any but the first ground (fact as opposed to law), approved the District Court's reasoning about the estate's failure of proof in a footnote, Minskoff v. United States, 490 F.2d at 1285 n.1, and on this basis distinguished Boyle v. United States, 355 F.2d 233">355 F.2d 233 (3d Cir. 1965), where the sum at issue could not have been earned both before and after the death of the decedent. (The District Court had felt that Boyle was inconsistent with Rothensies v. Electric Storage Battery Co., 329 U.S. 296">329 U.S. 296 (1946), and had therefore refused to follow Boyle v. United States, supra.Minskoff v. United States, 349 F. Supp. at 1150 n.3.) With respect to this issue of proof, our case resembles Boyle, rather than Minskoff: Different valuations of a stock at the same time are inconsistent on their face, and there is no need for petitioner to prove anything on this score. The District Court's other alternative ground was that equities weren't on the side of the taxpayer, who had failed to report as income capital gain that clearly should have been reported, and that therefore the doctrine of equitable recoupment, being in the nature of an equitable defense, could not be invoked by a party lacking clean hands. Id. at 1150. As we shall see infra pp. 66-67, this is an aberrant view that courts generally don't follow, which may no longer be respondent's view, and which is incorrect. The Court of Appeals was silent on this issue in Minskoff↩.20. Our recent decision in Estate of Bartels v. Commissioner, 106 T.C. 430 (1996), furnishes additional implicit support for United States v. Herring, 240 F.2d 225">240 F.2d 225 (4th Cir. 1957), and United States v. Bowcut, 287 F.2d 654">287 F.2d 654 (9th Cir. 1961), as opposed to the contrary cases. In that case, which presented the Herring-Bowcut situation, respondent, consistently with the view announced in Rev. Rul. 71-56, 1 C.B. 404">1971-1 C.B. 404, didn't even raise the single-transaction requirement as an objection to our allowance of the taxpayer's equitable recoupment claim. Estate of Bartels v. Commissioner↩, at 433 n.4. We therefore found the single-transaction requirement not to be an obstacle to permitting equitable recoupment.21. The excursus in the text further sharpens the point of my observation in Fort Howard Corp. v. Commissioner, 103 T.C. 345">103 T.C. 345, 377 n.2 (1994) (Beghe, J., dissenting), that for tax purposes the connections that are important are not so much the logical connections arrived at by reference to the laws of thought and correct syllogistic reasoning as the "logic of events" that has to do with cause and effect relationships and necessary connections or outcomes.22. Cf. Willis, Some Limits of Equitable Recoupment, Tax Mitigation, and Res Judicata: Reflections Prompted by Chertkof v. United States, 38 Tax Law. at 640-641↩.23. I'm aware that it's not necessarily inconsistent that the same fund should be subjected to both income and gift tax, as the Code sections having to do with those two taxes are not construed in pari materia. Farid-Es-Sultaneh v. Commissioner, 160 F.2d 812 (2d Cir. 1947), revg. 6 T.C. 652">6 T.C. 652 (1946). That does not, however, gainsay a real inconsistency in our case, because both tax results depend upon the same matter of fact, the fair market value of the same shares at decedent's death. It would be inconsistent to hold those shares to have had one value for estate tax purposes and another for income tax purposes. There is a presumption that the estate tax value of an asset is correct and applies also to determine income tax basis. Hess v. United States, 210 Ct. Cl. 483">210 Ct. Cl. 483, 537 F.2d 457">537 F.2d 457, 463 (1976); Swift v. Wheatley, 538 F.2d 1009">538 F.2d 1009, 1010 (3d Cir. 1976); Levin v. United States, 373 F.2d 434">373 F.2d 434, 438 (1st Cir. 1967); Williams v. Commissioner, 44 F.2d 467">44 F.2d 467, 469 (8th Cir. 1930), affg. 15 B.T.A. 227">15 B.T.A. 227 (1929); Feldman v. Commissioner, T.C. Memo. 1968-19; sec. 1.1014-3(a), Income Tax Regs.; Rev. Rul. 54-97, 1 C.B. 113">1954-1 C.B. 113↩.24. "The Federal courts in many somewhat similar tax cases have sought to prevent inequitable results by applying principles variously designated as estoppel, quasi estoppel, recoupment, and set-off. For various reasons, mostly technical, these judicial efforts can not extend to all problems of this type. Legislation has long been needed to supplement the equitable principles applied by the courts and to check the growing volume of litigation by taking the profit out of inconsistency, whether exhibited by taxpayers or revenue officials and whether fortuitous or by design." S. Rept. 1567, 75th Cong., 3d Sess. 48 (1938), 1939-1 C.B. (Part 2) 779, 815; emphasis added.25. In light of the regulation stating that statutory mitigation is only available for inconsistencies involving solely the income tax, sec. 1311(a)-2(b), Income Tax Regs., and Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837">467 U.S. 837 (1984), which requires us to defer to that regulation if it is reasonable, see Reno v. Koray, 515 U.S. , , 115 S. Ct. 2021">115 S. Ct. 2021, 2023 (1995) (Chevron deference owed to interpretive rules), it would be unnecessary to decide whether, in the absence of the regulation and Chevron, Chertkof v. United States, 676 F.2d 984">676 F.2d 984, 987-992 (4th Cir. 1992), was correct in holding that statutory mitigation is also available to correct inconsistencies in application of estate tax and income tax. The weight of authority is to the contrary, see Hall v. United States, 975 F.2d 722 (10th Cir. 1992) (windfall profits tax); Ketteman Trust v. Commissioner, 86 T.C. 91">86 T.C. 91, 110 (1986)(gift tax); Provident Natl. Bank v. United States, 507 F. Supp. 1197">507 F. Supp. 1197 (E.D. Pa. 1981) (estate tax); see also, Willis, Correction of Errors Via Mitigation and Equitable Recoupment: Some People Still Do Not Understand, 52 Tax Notes 1421">52 Tax Notes 1421 (Sept. 16, 1991); Willis, Some Limits of Equitable Recoupment, Tax Mitigation, and Res Judicata: Some Reflections Prompted by Chertkof v. United States, 38 Tax Law. 625">38 Tax Law. 625↩ (1985).26. There is substantial authority that equitable factors can't block equitable recoupment, Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935); Fisher v. United States, 80 F.3d 1576">80 F.3d 1576, 1581 (Fed. Cir. 1996); Lovett v. United States, 81 F.3d 143">81 F.3d 143, 145 (Fed. Cir. 1996); United States v. Bowcut, 287 F.2d at 656-657; Dysart v. United States, 169 Ct. Cl. 276">169 Ct. Cl. 276, 340 F.2d 624">340 F.2d 624, 628-630 (1965); Holzer v. United States, 250 F. Supp. 875">250 F. Supp. 875, 878 (E.D. Wis. 1966), affd. per curiam 367 F.2d 822">367 F.2d 822 (7th Cir. 1966); see also McConnell, The Doctrine of Recoupment in Federal Taxation, 28 Va. L. Rev. 577">28 Va. L. Rev. 577, 579 (1942) (recoupment not entirely equitable in origin or nature). But see Fairley v. United States, 901 F.2d 691">901 F.2d 691, 694 n.4 (8th Cir. 1990); Wilmington Trust Co. v. United States, 610 F.2d at 714-715; Davis v. United States, 40 AFTR 2d 77-6189, at 77-6192, 77-1 USTC par. 13,195, at 87,274 (N.D. Tex. 1977); Minskoff v. United States, 349 F. Supp. at 1150↩.27. For the purpose of this discussion, changes in other credits can be and are ignored. See background statement, supra↩ pp. 34-35.28. "When its benefits are sought by the taxpayer, the function of the doctrine [of equitable recoupment] is to allow the taxpayer to reduce the amount of a deficiency recoverable by the Government by the amount of an otherwise barred overpayment of the taxpayer. * * Here no such situation exists. * * * Rather, the plaintiffs are attempting an extension of the doctrine of equitable recoupment to the case of a refund of taxes for an otherwise barred year." Brigham v. United States, 200 Ct. Cl. 68">200 Ct. Cl. 68, 470 F.2d 571">470 F.2d 571, 577↩ (1972).29. In any event, the language of Brigham v. United States, supra, on which respondent rely is dictum. The taxpayers in the cases consolidated in Brigham were seeking to use equitable recoupment (as well as mitigation) to recover time-barred income tax overpaid. The Court of Claims, having denied mitigation, went on to deny equitable recoupment, first on the ground that mitigation preempted equitable recoupment within its area of applicability. It then went on to observe that the taxpayers were not seeking to reduce deficiencies in later years, which it was conceded did not exist, but rather to extend equitable recoupment to a refund of taxes in an otherwise barred year. There was no independent basis for jurisdiction. The language is best taken as a somewhat less clear expression of the doctrine expressed much more clearly in United States v. Dalm, supra. The same is true of similar language in Evans Trust v. United States, 199, Ct. Cl. 98, 462 F.2d 521">462 F.2d 521, 526 (1972), quoted by the majority (majority op. p. 16), which is to be properly interpreted in the same way as the language of Brigham↩.30. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 598 (1948); Finley v. United States, 612 F.2d 166">612 F.2d 166, 170 (5th Cir. 1980); Estate of Hunt v. United States, 309 F.2d 146">309 F.2d 146, 148 (5th Cir. 1962); Huddleston v. Commissioner, 100 T.C. 17">100 T.C. 17, 25↩ (1993).31. "Income taxes are levied on an annual basis. Each year is the origin of a new liability and of a separate cause of action. Thus, if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year." [Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 598↩ (1948).]32. The issue in Montana v. United States, 440 U.S. 147">440 U.S. 147, 161 (1979), was whether a Government contractor, which had filed suit at the direction of the United States in Montana courts against the constitutionality of a Montana tax, had lost his case in the Montana Supreme Court, and then abandoned its appeal to the United States Supreme Court, was prevented by res judicata from filing a new suit, again at the direction of the United States and now in United States District Court, against the constitutionality of the same tax, with respect to different payments under it. As Commissioner v. Sunnen, supra, had previously been interpreted, res judicata would not have prevented suit. However, in Montana v. United States, the United States Supreme Court emphasized other language in Commissioner v. Sunnen, supra↩, about how the law had changed since the previous decision in deciding that res judicata prevented this new suit.33. "Moreover, if [the taxpayer] decides to remain in the District Court, the Government may--but seemingly is not required to--bring a counterclaim; and if it does, the taxpayer has the burden of proof." [Flora v. United States, 362 U.S. 145">362 U.S. 145, 166 (1960); fn. ref. omitted.] With respect to Flora v. United States, supra, it's interesting to observe that that case's central holding, that refund suits can only be brought when taxes have been paid in full, was, like Rothensies v. Electric Storage Battery Co., 329 U.S. 296 (1946), largely motivated by the desire not to divert large numbers of tax cases from this Court to the district courts. Flora v United States, 362 U.S. at 175-176. After United States v. Dalm, supra, and Mueller II, we won't divert tax cases to the district courts if we refrain from holding that the credit for prior taxes is part of the same claim or cause of action for the purpose of permitting equitable recoupment any more than we'll divert them by refusing to allow a narrow reading of the single-transaction issue (the issue in Rothensies v. Electric Storage Battery Co., supra↩) to block equitable recoupment. See infra pp. 42-60 discussing the single-transaction issue.34. The majority posits a different hypothetical case (majority op. pp. 11-12) in which the credit for prior death taxes is known and figures as an issue. But it assumes that a court would take that credit into account when deciding whether equitable recoupment is being used defensively and should therefore be allowed. In so assuming, the majority begs the question. There's no case law on point, and we can't be certain what such a court would decide. We're therefore free to decide which is the preferable rule, both for this hypothetical and for the case at hand (the issue is the same for both).35. The two cases are discussed at length, supra↩ pp. 42-44, 47-52, in the section on the single-transaction requirement.36. Equitable recoupment entered bankruptcy law under the authority of Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935). In re Monongahela Rye Liquors, Inc., 141 F.2d 864">141 F.2d 864, 869 (3d Cir. 1944). As in the tax area, recoupment is used in bankruptcy cases to prevent unjust enrichment. A debtor should not benefit from post-petition sales to a creditor under a contract without the burden of repaying the creditor's pre-petition overpayments under the same contract. In re Peterson Distrib., Inc., 82 F.3d 956">82 F.3d 956, 961 (10th Cir. 1996); In re B & L Oil Co., 782 F.2d 155">782 F.2d 155, 159 (10th Cir. 1986) (cited with approval for extent to which recoupment is available in bankruptcy in Reiter v. Cooper, 507 U.S. 258">507 U.S. 258, 265↩ n.2 (1993)). The prevention of unjust enrichment thought of in these terms is the real reason for the single-transaction requirement, both in bankruptcy, where it is also enforced, and in the tax area.37. This additional amount is disclosed in the opinion of the Bankruptcy Court in this case. In re Carolina Motor Express, 84 Bankr. 979, 981, 991 (Bankr. W.D.N.C. 1988). The Supreme Court only mentioned the debts owing under the main issue. Reiter v. Cooper↩, 507 U.S. 258, 113 S. Ct. at 1217.38. Cf. In re Pullman Constr. Indus., Inc., 142 Bankr. 280 (Bankr. N.D. Ill. 1992)(questioning In re Greenstreet, Inc., 209 F.2d 660">209 F.2d 660 (7th Cir. 1954), on the basis of later Seventh Circuit decisions about the single-transaction issue, making the test for deciding whether sovereign immunity is waived with respect to a counterclaim whether the counterclaim is a compulsory counterclaim to the claim in question, and holding on that basis that sovereign immunity had been waived with respect to the counterclaim), affd. sub nom. United States v. Pullman Constr. Indus., Inc., 153 Bankr. 539 (N.D. Ill. 1993), appeal dismissed sub nom. Pullman Constr. Indus., Inc. v. United States, 23 F.3d 1166">23 F.3d 1166 (7th Cir. 1994). Query whether if there has been such a liberalization of the single-transaction requirement for equitable recoupment in bankruptcy, there should not be a similar liberalization in the tax area, and whether the post-Rothensies v. Electric Storage Battery Co.↩ cases cited in the discussion of the single-transaction requirement do not demonstrate precisely such a development.39. In deciding in Reiter v. Cooper, supra, that it made no difference whether the recoupment was considered a counterclaim or defense, the Supreme Court cited 5 Wright & Miller, Federal Practice & Procedure, sec. 1275 (2d ed. 1990), according to which it is not clear whether setoffs and recoupments should be viewed as defenses or counterclaims. Reiter v. Cooper, 507 U.S. at 263. In In re Izaquirre, 166 Bankr. 484, 493 (Bankr. N.D. Ga. 1994), a bankruptcy court cited the reference in Reiter v. Cooper to Wright & Miller to conclude: "Although recoupment may be viewed as an offset to the extent it is viewed as a counterclaim, recoupment has a chameleon-like quality that also permits it to be viewed simply as a defense." In agreement that Reiter v. Cooper minimizes the importance of the distinction between defenses and counterclaims with respect to recoupment is Consolidated Rail Corp. v. Primary Indus. Corp., 868 F. Supp. 566↩ (S.D.N.Y. 1994).40. There is no such monetary limitation on contractual claims against the United States in the Court of Federal Claims, 28 U.S.C. sec. 1491 (1994), and the District Court in United States v. Timber Access Indus. Co., 54 F.R.D. 36 (D. Or. 1971), left open the possibility that the defendant logger could recover the balance of its counterclaim in the Court of Claims (as it was then called), 54 F.R.D. at 38-39↩. The District Court held that allowing the $ 10,000 recovery in the District Court would not be the prohibited splitting of the cause of action.41. United States v. Forma, 42 F.3d 759">42 F.3d 759, 767-768 & n. 11 (2d Cir. 1994), did not involve equitable recoupment, although that doctrine is discussed briefly. Rather, it involved an unrelated time-barred counterclaim by taxpayers in a suit where the United States originally sought to reduce tax assessments relating to the same years to judgment and then voluntarily agreed to the dismissal of its claims. The Court of Appeals held that there was no basis for jurisdiction over the counterclaim and therefore remanded the case to the District Court with a direction to dismiss the counterclaim. In the discussion of equitable recoupment, which the parties agreed was not available to the taxpayers in the case, there is mention that the single-transaction requirement was not satisfied. There is, however, no mention of any no-affirmative-recovery requirement, in the discussion of either equitable recoupment or the counterclaims.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623261/	H. P. BRAWNER AND A. L. BRAWNER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrawner v. CommissionerDocket No. 24471-84.United States Tax CourtT.C. Memo 1987-581; 1987 Tax Ct. Memo LEXIS 584; 54 T.C.M. (CCH) 1147; T.C.M. (RIA) 87581; November 23, 1987; As amended November 24, 1987 Joyce K. Hackenbrach and Lisa B. Petkun, for the petitioners. Dermont F. Kennedy, for the respondent. GERBERMEMORANDUM FINDINGS OF FACT AND OPINION GERBER, Judge: Respondent determined deficiencies in petitioners' Federal income taxes as follows: Addition to TaxYearDeficiencyUnder 6653(a)1976$ 5,467$ 019773,17215919782,38711919791,9839919801,3620The issues for our consideration are: (1) Whether petitioners are entitled to deductions for depreciation and other items, and investment tax credit attributable to their interest in the limited partnership, Vancom Films, Ltd.; (2) whether petitioners are liable for additions to tax pursuant to section 6653(a); (3) whether petitioners586 are liable for additional interest pursuant to section 6621(c); 1 and (4) whether petitioners are liable for damages pursuant to section 6673. 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. H. P. Brawner and A. L. Brawner, husband and wife, were residents of Media, Pennsylvania, at the time of filing the petition herein. Petitioners timely filed joint Federal income tax returns for the calendar years 1976, 1977, 1978, 1979 and 1980, using the cash receipts and disbursements method of accounting. During the years in issue, H. P. Brawner was a sales engineer and A. L. Brawner was a housewife. 2587 This controversy arose out of petitioner's 1976 purchase of a 3.8-percent limited partnership interest in Vancon Films, Ltd. (Vancon), and the deductions petitioners claimed as their distributive share of the losses and investment tax credit attributable to that interest. Sometime during the summer of 1975, Albert S. Pitts (Pitts), the sole partner of and a limited partner in Vancon, met Paul Freedman (Freedman) at Pitts' dentist's office. At that time, Pitts, a certified financial planner with approximately 15 years of experience in financial planning, was both president and owner of Executive Design Investments, a broker-dealer firm. Freedman was comptroller of Counselor Films, Inc. (CFI). 3 When Freedman learned that Pitts was a certified financial planner, Freedman informed Pitts that his company was interested in obtaining financing for five educational films, and inquired whether Pitts might be interested in pursuing the investment. Although the films were scripted at the time, they had not yet been produced. 588 In late August and again in early September 1975, Pitts met with Freedman and other officers of CFI, including Ralph Lopatin (Lopatin) and Steve Levine (Levine) 4 to discuss these films. Consequently, Vancon, a limited partnership, was formed under the laws of Pennsylvania. Vancon was established to purchase and market the five educational films. Interest in Vancon were properly registered to be sold under the laws of Pennsylvania. A total of 25 units were offered for sale at a price of $ 10,000 each, for a total capital of $ 250,000 to be received from investors. Each unit represented a 3.8-percent interest in capital and profits and losses; the general partner was entitled to the remaining 5 percent. Pitts was the sole general partner of Vancon, 5 and held a limited partnership interest as well. 6 Pitts, as general partner of Vancon, retained R. L. Stevens & Company, Inc. (RLS), a broker-dealer firm, to privately place units of Vancon by offering them to individuals as investments. 7RLS received a lump sum of $ 25,000 and the $ 5,000 previously589 paid to Pitts by CFI pursuant to a consulting arrangement for his services in Vancon's formation. 8 Robert Stevens and RLS and Pitts both sold units in Vancon and received a sales commission for each unit sold. 9 As of January 30, 1976, Pitts has sold two-thirds of all the units sold in Vancon. Pitts later became a vice-president of RLS. The production of the five educational films were completed in late 1975 for a cost of about $ 150,000. 10 The film production was done by Ralph Lopatin Productions, 590 Inc. (Lopatin Productions), 11 which sold the films to CFI for $ 150,000. 12 Each film was about 11 to 12 minutes in length, and used unknown casts. At the time of this purchase CFI was the distributor of 141 films, 58 of which it produced and owned and 83 of which it distributed for others. CFI's distribution services were primarily conducted through a sales force. In September 1975, Pitts entered into an option, on the behalf of Vancon, to purchase the five films. During December 1975, Pitts viewed unedited clips from the films. In January 1976, Vancon entered into a purchase agreement591 with CFI to acquire the five films for a total price of $ 700,000. 13 The purchase price was payable as follows: $ 170,000 in cash on or before the closing, and the balance ( $ 530,000) financed by two nonrecourse notes each bearing 6-percent interest per annum. 14 This financing method was unique to CFI. Vancon was obligated to pay the full purchase price; up to the date of trial no principal payments had been made on the notes. 15 Never before in the history of their existence had CFI sold films using nonrecourse financing. The five films were grouped into two series: the vandalism series "Fun or Dumb," 16 and the consumer education series "Kids and Cash." 17 Of the total purchase price, $ 420,000 was allocated to the vandalism series, and $ 280,000 to the consumer education series. 18 No evidence has been submitted to explain or support the markup of the films from the592 $ 150,000 sales price used late in 1975 (sale between Lopatin Productions and CFI) to the $ 700,000 assigned to the same films in the spring of 1976 (sale between CFI and Vancon). 19 Although Pitts knew that the production cost was $ 150,000, he did not make any inquiries about the average markup in the industry for films of this type. 20CFI, the sole distributor of Vancon's films, acted as the distributor for these films until CFI's bankruptcy in 1981. 593 As part of the purchase agreement, CFI agreed to use its best efforts to assist Vancon in obtaining the services of all its sales representatives to market the five films purchased by Vancon. 21 All of CFI's sales representatives entered into "sales representative agreements" with Vancon 22 agreeing to act as Vancon's sales representatives with respect to the vandalism and consumer education series. Each sales representative was to be paid a commission of 25 percent of the purchase price of each film sold. 23 The sales representative sold films of other companies, including [Text Deleted by Court Emendation] CFI. Prior to contacting the sales representatives, Pitts, who expected to rely significantly on the sales efforts of the representatives for the success of Vancon, did not investigate how many other lines of films a particular representative was carrying. The amount of time, if any, the representatives spent selling Vancon's films was unknown to Pitts, and he did not know nor did he make any attempt to insure that the sales representatives were supplied with demonstration copies. 594 Pitts, the general manager of Vancon and the individual responsible for the success of the partnership, had no prior experience in the acquisition or distribution of educational motion picture films or in the education of school children. Although the primary market for the films was public and private schools, Pitts had not knowledge of the total number of schools to which the films were targeted, nor did he know any of the purchasing agents for such schools. 24 Pitts did not know that the total sales volume for educational films was in 1976. He was unaware of whether there was an increase or decrease in sales in the educational film market on a yearly basis during 1976, 1977 and 1978. 25Potential limited partners of Vancon were given a private offering memorandum (Memorandum) to which was attached sales projections (Projections) for the vandalism and consumer education series. The Memorandum represented that investment in Vancon "should595 be considered only by investors who have income subject to Federal income tax at the rate of 50 percent or more and whose current net worth is not less than $ 200,000 * * * [and] is not appropriate for persons seeking a significant cash return on their investment." 26 (Emphasis added.) The Memorandum also represented that Pitts, the general partner, would receive a management fee of between $ 5,000 and $ 15,000 and made it clear that he had no prior experience in the acquisition or distribution of motion picture films or in the education of school children. The sales projections were prepared by Harvey Grossman of Silver & Company, a certified public accounting firm, from figures developed by Pitts and Freedman. 27 The principal purpose of the sales projections was to satisfy the requirements of the Pennsylvania Security and Exchange Commission to secure their permission to sell interests in Vancon. The cover statement accompanying the Memorandum clearly stated that the596 Projections were not intended to be predictions of actual or anticipated results of the partnership operations. 28 The Projections contained three varying sales levels of a minimum, an average and a maximum. These sales figures were purportedly based on CFI's experience in marketing its films and the number of school districts served by CFI's sales force. Petitioner purchased his interest in Vancon during 1976 for $ 10,000. The subscription for his unit was payable in two installments: one-half of the price was due upon subscription; the other one-half was payable on or before September 23, 1976. Petitioner's distributive share of Vancon's losses for the years 1976 through 1980 was $ 5,804, $ 6,913, $ 5,442, $ 4,478 and $ 2,579, respectively. Additionally, petitioner claimed an investment tax credit of $ 2,800 in 1976. Respondent disallowed the claimed losses and the597 investment tax credit asserting various alternative theories under which the claimed deductions would be disallowed. Respondent argues that petitioner's investment in Vancon lacked economic substance, was motivated solely by tax-avoidance and should be disregarded for tax purposes. Alternatively, respondent argues that Vancon, and consequently petitioner, was not engaged in the activity for a profit nor was it a trade or business for the years in issue. 29 Petitioners contend otherwise. OPINION Petitioners have the burden of proving that respondent's determinations are incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). To qualify for the claimed deductions and investment tax credit petitioners must show that Vancon's activities were a trade or business for the years involved, or at a minimum that their investment in Vancon was undertaken for the purpose of making a profit. See Beck v. Commissioner,85 T.C. 557">85 T.C. 557, 569 (1985),598 and the cases cited therein. Losses and Investment Tax CreditThe theories advanced by respondent for disallowing the claimed deductions and investment tax credit are overlapping and cumulative, therefore we have applied the approach set forth in Rose v. Commissioner,88 T.C. 386">88 T.C. 386 (1987), to the facts of the instant case. In Rose, a unified approach was used to analyze transactions which can be classified as "generic tax shelters." Under this approach the subjective (business purpose) and objective (economic substance) tests merge incorporating factors considered relevant in cases decided under section 183, as well as factors applied to transactions being tested for economic substance. In determining whether this transaction will be disregarded for income tax purposes we must first examine petitioners' motives for entering the transaction. Although taxpayers are generally free to structure their business transactions as they please, even if motivated by tax avoidance, such transactions will be disregarded for tax purposes if they are entered into without any economic, commercial or legal purposes other than hoped for tax benefits. Rice's Toyota World,599 Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 196 (1983), affd. 752 F.2d 89">752 F.2d 89 (4th Cir. 1985); Frank Lyon Co. v. United States,435 U.S. 561">435 U.S. 561 (1978); Grodt & McKay Realty, Inc. v. Commissioner,77 T.C. 1221">77 T.C. 1221, 1243 (1981). Petitioners contend that Vancon's activities, and consequently their investment in Vancon, were engaged in for a profit and that the deductions generated through losses and the investment tax credit were incidental to the business activities. We find this argument unconvincing and not supported in the record. Vancon purchased for $ 700,000 films that were produced for a total cost of $ 150,000. It also incurred administrative costs, agreed to pay its general manager, Pitts, a management fee of between $ 5,000 and $ 15,000, and contracted to pay each sales representative 25 percent of his or her total sales of the partnership's films. These facts reveal, without any in-depth analysis, that a profit could be anticipated only if Vancon could realistically expect estimated sales in excess of $ 1,000,000. Vancon, however, made no serious attempt to forecast any realistic sales. Vancon's general manager was600 totally unaware of the size of the potential market for the films and any competition that the films would face. More importantly, the sales projections that were sent to potential investors were prepared mainly to qualify interests in the partnership for sale under the Pennsylvania Security and Exchange requirements. The cover letter received by each potential investor, including petitioner, clearly warned the investors that the sales figures set forth in the projections were not to be considered as predictions of actual or anticipated sales. Furthermore, the Memorandum sent to the potential investors included the statement that the sales force for Vancon's films distributed and sold films produced and distributed by CFI and other companies; therefore, there could be no assurance that the sales force would aggressively or successfully distribute Vancon's films. It also included a suggestion that a more effective distribution of the films would result from hiring an independent national distributor. It also contained the warning that a great burden and responsibility for the success of the films would be on the general manager, an individual whose lack of qualifications was evident601 from the Memorandum. Additionally, the Memorandum contained the caveat that any investment in the partnership "should be considered only by investors who have income subject to federal income tax at the rate of 50% or more and whose current net worth is not less than $ 200,000" and that the investment was not appropriate for taxpayers seeking a significant cash return on their investment. In addition, the Memorandum warned that there was a significant risk of loss involved in the investment and that investors should be prepared and financially able to sustain a complete loss of their investment. The determination of profit-making intent is one of the facts to be resolved using all relevant surrounding facts and circumstances; no one factor is determinative. Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 34 (1979). In view of the above facts we find it difficult to comprehend how petitioners, or anyone else, could have an actual and honest objective for profit in regards to this activity. Petitioners' insistence on our acceptance of their argument that they, or Vancon, entered into this activity with the intent of making a profit strains all credulity. 30602 Petitioners' failure to establish that a transaction was motivated by a business purpose rather than by tax avoidance is not conclusive that the transaction will be disregarded for tax purposes. If an objective analysis of the transaction indicates that a reasonable possibility of profit existed apart from tax benefits, the transaction will not be classified as devoid of economic substance. Rice's Toyota World, Inc. v. Commissioner, supra at 203 n. 17; Frank Lyon Co. v. United States, supra at 583-584. An objective analysis of the transaction is made by applying the objective test. In applying this test we have held that the following factors are key indicators of the presence or lack of economic substance: (1) The presence or absence of arm's-length price negotiations; (2) the relationship between the sales price and the fair market value; (3) the structure of financing of the transaction; (4) whether there was a shifting of the benefits and burdens of ownership; and (5) the degree of adherence to the contractual terms. Rose v. Commissioner, supra at 410-411, and the cases cited therein. The transaction involved herein is devoid of any603 arm's-length price negotiations. The five educational films purchased by Vancon were produced by Lopatin Productions for a total cost of $ 150,000. Late in 1975, shortly after the films were completed they were sold to CFI, a company in which the owner of Lopatin Productions was the majority shareholder, for $ 150,000. In the spring of 1976, the films were sold to Vancon for $ 700,000. With respect to price negotiating, Pitts testified that he had no idea what the average markup was in the industry for films such as the ones involved in the instant case. Pitts made no inquiries as to such facts nor did he expend any time or effort trying to educate himself on the fair market value of such films. Pitts testified that even though they were aware of the production cost being $ 150,000, when the $ 700,000 purchase price was quoted, he accepted the price without any inquiries. This type of behavior does not support a finding of an arm's-length negotiation. Neither party made any effort to negotiate. Additionally, we find that the price of the films was grossly inflated. The films were not of exceptional quality; both the script writers and the cast were unknown. CFI, the sole604 distributor of the films, cautioned in the Memorandum that they could not ensure aggressive or successful distribution efforts for any of the films and stated this would have a direct impact on the anticipated success of the partnership. 31CFI suggested that it would be more advantageous to Vancon to secure an independent distributor. Mindful of these factors, CFI secured a cash payment of $ 170,000, upon execution of the sale, thus locking in their $ 20,000 profit on the front end of the transaction. The two nonrecourse notes executed for a total of $ 530,000 were added solely to inflate the purchase price, and consequently the basis of the films for purposes of depreciation and interest payment deductions, and the investment tax credit ultimately passed on to Vancon's partners. Although CFI was fully aware of the possible failure of the films, they were willing to take notes secured only by the films and any proceeds derived from film sales. We can only determine that CFI considered themselves as having secured a reasonably anticipated profit of $ 20,000, with any gains in excess of this to be "frosting on the cake." 605 The fact that this was the first and only transaction CFI financed using nonrecourse notes casts further doubt on the genuineness of the transaction. Furthermore, up to the date of trial no principal payments had been made on the notes and CFI made no efforts to collect such amounts. In light of all these surrounding facts we hold that this transaction is devoid of economic substance and will be, therefore, disregarded for income tax purposes. Additions to Tax - Section 6653(a)Respondent has determined additions to tax under section 6653(a) for the years 1977, 1978 and 1979 in the amounts of $ 159, $ 119 and $ 99, respectively. 32 Section 6653(a) provides for an addition to tax in the amount of 5 percent of any underpayment if any part of the underpayment "is due to negligence or disregard of rules or regulations * * ." Petitioners have the burden of proving that their underpayment of taxes was not the result of their negligence or intentional disregard of these rules and regulations. Courtney v. Commissioner,28 T.C. 658">28 T.C. 658, 669-670 (1957). Negligence, within the meaning of section 6653(a), is the lack of due care or failure to do what a reasonable and606 ordinarily prudent person would do under the circumstances. Neely v. Commissioner,85 T.C. 934">85 T.C. 934, 947 (1985). Petitioners did not testify at trial and the record will not support a finding that petitioners overcame the presumption of correctness attached to respondent's determination with respect to this addition to tax. Nothing in the record even suggests that petitioners sought any independent information about the investment of the return on this investment. The investment package presented the possibility of substantial deductions and a tax credit and this was petitioners' primary or sole purpose in "investing" in this activity. Such conduct on the part of petitioners supports a finding of negligence and intentional disregard of these rules and regulations. We hold that petitioners are liable for the additions to tax pursuant to section 6653(a) for the years 1977, 1978 and 1979. Additional Interest - Section 6621(c)Section 6621(c) provides, 607 in general, that the annual rate of interest shall be 120 percent of the established rate with respect to any substantial underpayment (exceeding $ 1,000) attributable to tax motivated transactions. The increased interest rate, where applicable, applies with respect to interest accruing after December 31, 1984, even though the transaction was entered into prior to the date of enactment of section 6621(c). Sec. 144(c), Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 682; Stanley Works v. Commissioner,87 T.C. 389">87 T.C. 389 (1986); Solowiejczyk v. Commissioner,85 T.C. 552">85 T.C. 552 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). The definition of a tax motivated transaction includes "any sham or fraudulent transaction." Sec. 6621(c)(3)(A)(v). 33 A sham or fraudulent transaction is a transaction that is devoid of economic substance and is disregarded, therefore, for income tax purposes. Inasmuch as we have determined that the transaction involved herein is devoid of economic substance and is to be disregarded for tax purposes, the "sham or fraudulent transaction" requirement of section 6621(c)(3)(A) has been met. See Patin v. Commissioner,88 T.C. 1086">88 T.C. 1086 (1987).608 We find that petitioners are liable for additional interest under section 6621(c). Damages - Section 6673Section 6673 provides: Whenever it appears to the Tax Court that proceedings before it have been instituted or maintained by the taxpayer primarily for delay, that the taxpayer's position in such proceeding is frivolous or groundless, or that the taxpayer unreasonable failed to pursue available administrative remedies, damages in an amount not in excess of $ 5,000 shall609 be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as a part of the tax. Respondent, by motion, requests that we award damages to the United States in the amount of $ 5,000. However, it must first appear to us that petitioners have instituted or maintained this proceeding primarily for delay or that petitioners' position in this proceeding is frivolous or groundless. We do not find these characteristics to be present in this case. Although we have found the transaction to be devoid of economic substance, we do not find petitioners' position to be frivolous or groundless. We have determined that petitioners lacked due care and did not take the steps an ordinary and prudent person would have taken with respect to claiming the deductions and investment tax credit attributable to their investment in Vancon. However, the lack of prudence does not convert petitioners' arguments into meritless contentions. Accordingly, we decline to award damages under section 6673. Based on the foregoing, Decision will610 be entered for respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as in effect during the years in issue, and all rule references are to the Tax Court Rules of Practice and Procedure. Subsec. (d) of sec. 6621 was redesignated as subsec. (c) and amended by sec. 1511(c)(1)(A)-(C), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2744. We use the reference to the Internal Revenue Code as redesignated and amended. ↩2. A. L. Brawner is a party to this action solely by filing a joint return with her husband, H. P. Brawner. All references to petitioner, singularly, are to H. P. Brawner. ↩3. As comptroller of CFI, Freedman was responsible for its financial management, budget preparation, and payment approval. Prior to joining CFI, Freedman had no knowledge or experience in the educational film business. He had worked in private practice as a certified public accountant. CFI was formed in 1972 as a distributor of educational films, and from 1970 through 1975 developed a good reputation for marketing educational films. As of Jan. 1976, CFI had 141 films for distribution. ↩4. At the time, Levine was the national marketing director and vice-president of CFI. Levine later became president of CFI. ↩5. Pitts, the sole general partner of Vancon, was permitted to engage in activities that were contrary to the interest of Vancon. ↩6. Pitts received the remaining 5-percent interest in capital and profits and losses in exchange for a cash contribution of $ 100. ↩7. The units were being offered solely through broker-dealers. ↩8. Although Pitts' firm, Executive Design Investments, Inc., had previously offered a different structuring of Vancon's formation and had agreed to act as broker-dealer in placing the units, no services in this capacity were rendered by either and no compensation received. ↩9. RLS paid Pitts the commission for the units he sold, individually. ↩10. The five films appeared in CFI's 1975 school year catalog which was distributed to potential customers. CFI agreed to provide, and did provide, prints to potential purchasers for preview purposes prior to the sale of the same films by CFI to Vancon. ↩11. Ralph Lopatin was president of Lopatin Productions and had extensive experience in film production. ↩12. Ralph Lopatin was the sole shareholder of Lopatin Productions, Inc., and was also the majority shareholder of Counselor Films, Inc. At the time of completion of the films involved herein, CFI had been in existence for 4 years. ↩13. The purchase agreement of Jan. 1976 was not funded until May 1976. ↩14. In the event of default on either note, the holder's sole recourse was to proceed against the film series to which the note related. ↩15. A total of $ 80,000 interest was paid on the notes which were due Mar. 31, 1976. ↩16. The films in this series focused on the effects of graffiti, arson and other forms of vandalism, and attempted to discourage students from engaging in said activities. ↩17. The two films in this series dealt with basic concepts of money management, saving and conservation of monetary resources. ↩18. Of the cash paid at the closing, $ 45,000 was allocated to the vandalism series and $ 25,000 was allocated to the consumer education series. An additional $ 60,000 was paid on the vandalism series and $ 40,000 on the consumer education series before Sept. 30, 1976. The balance of the purchase price was represented by two nonrecourse notes as follows: (1) $ 315,000 on the vandalism series, and (2) $ 215,000 on the consumer education series. ↩19. Freedman testified that the $ 700,000 purchase price was arrived at by taking an estimation of what CFI thought might be revenues from future sales using a 7 to 10-year projection. They did not do an exact present value calculation. ↩20. On cross-examination, Pitts testified that they did not negotiate the purchase price. They were told what the price was and they accepted it. ↩21. In a confidential memorandum CFI clearly stated that it owned, distributed and sold other education motion picture films to the same customers to which Vancon's films were directed. CFI also warned that because it owned and sold a substantially greater number of films than Vancon there was no assurance that Vancon's films would receive the same distribution energies and opportunities as if they were distributed by a company without any affiliation with CFI. ↩22. A total of 18 sales representatives who worked for CFI signed written agreements with Vancon. They worked as independent contractors for Vancon. ↩23. The "sales representative agreements" were effective from Dec. 26, 1975, and expired 1 year from that date. These agreements identified the sales territory to which each sales representative was assigned. None of the agreements were removed upon expiration. ↩24. CFI supplied Pitts with a mailing list of schools which identified approximately 1,450 schools or school systems. ↩25. Pitts was unaware of the competition Vancon's films would face and the success rate of any competing films. ↩26. The Memorandum also warned that there was a significant risk of loss involved in the investment, therefore investors should be prepared and able to sustain a complete loss of their investment. ↩27. At the time of preparing the figures for the sales projections, Freedman had only 5 months of experience with CFI and no previous experience in the educational movie business. ↩28. Pitts testified that the sales projections were intended to show the limited partners a range of income possibilities. ↩29. Respondent also contends that the price Vancon paid for the five films, a combination of cash and nonrecourse notes, exceeded the fair market value of the films, therefore the nonrecourse notes must be excluded from the films' basis for purposes of depreciation. ↩30. Petitioner contends that taking into account the $ 700,000 purchase price of the films, and assuming vigorous distribution efforts, it could reasonably be anticipated that the Vancon films would yield a profit. This contention ignores the information clearly set forth in the Memorandum which warns that CFI cannot ensure aggressive or successful distribution efforts. ↩31. By reason of simple deductive reasoning Pitts should have been aware of the impact these factors would have on the fair market value of the films. ↩32. Respondent did not determine additions to tax under sec. 6653(a) for the years 1976 or 1980. The record does not reflect any supporting reason; however, it does not affect our determination of this issue. ↩33. Sec. 6621(c)(3) provides, in pertinent part, as follows: (3) Tax motivated transactions. -- (A) In general. -- For purposes of this subsection, the term "tax motivated transaction" means -- (i) any valuation overstatement (within the meaning of section 6659(c)), (ii) any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8), (iii) any straddle (as defined in section 1092(c) without regard to subsections (d) and (e) of section 1092), (iv) any use of an accounting method specified in regulations prescribed by the Secretary as a use which may result in substantial distortion of income for any period, and (v) any sham or fraudulent transaction. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623263/	LAWYERS BUILDING CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. TRINITY BUILDINGS CORPORATION OF NEW YORK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. WHITEHALL IMPROVEMENT CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. GEORGE A. FULLER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MATERIALS DELIVERY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lawyers' Bldg. Corp. v. CommissionerDocket Nos. 81460, 81461, 81462, 81463, 81464.United States Board of Tax Appeals35 B.T.A. 540; 1937 BTA LEXIS 862; February 23, 1937, Promulgated 862 Petitioners, together with 10 other corporations, were affiliated. December 1, 1932, the Savoy-Plaza Corporation, a subsidiary affiliate, was adjudicated bankrupt. For the calendar year 1932, the parent of the affiliated group filed a so-called consolidated return, including the income of all affiliates except that of the Savoy-Plaza Corporation. All such affilates filed form 1122, authorizing a consolidated return and consenting to be bound by Regulations 78. The trustee in bankruptcy of the Savoy-Plaza Corporation failed to file form 1122 because, upon advice of counsel, it believed it could not legally do so, and, believing it was required to file a separate return for 1932, it did so. Held, the action of the respondent in computing the income taxes of each member of the affiliated group on a separate basis for that year is sustained. Revenue Act of 1932, sec. 141(a), (b), (c), and (d); sec. 52(a); Regulations 77, art. 392; Regulations 78, arts. 12 and 18. Allen G. Gartner, Esq., and Edward I. Sproull, C.P.A., for the petitioners. Chester A. Gwinn, Esq., for the respondent. LEECH541 OPINION. LEECH: These consolidated proceedings863 involve income tax deficiencies ficiencies proposed by respondent for the calendar year 1932 against the petitioners, as follows: Lawyers Building Corporation$3,406.01Trinity Buildings Corporation of New York62,491.15Whitehall Improvement Corporation20,335.09George A. Fuller Co.32,249.90Materials Delivery Corporation66.34The facts, which were stipulated, are briefly as follows: The petitioners, during the taxable year, were 5 affiliates in a group of 15 affiliated companies whose parent was the United States Realty & Improvement Co., a New Jersey corporation. A so-called consolidated return was filed by the latter corporation for the calendar year 1932, on behalf of itself and 13 of its affiliates, including the petitioners. Each of these 13 affiliates filed the prescribed form 1122. This form constituted the authorization and consent of the subsidiary corporations included in such return by which each subsidiary authorized the filing of such return by the parent, as agent, on its behalf, and consented to the provisions of the respondent's Regulations 78 governing consolidated returns of affiliated corporations. The Savoy-Plaza Corporation, 864 one of the affiliates, did not join in making the so-called consolidated return, for the reason that the corporation had been adjudicated a bankrupt on December 1, 1932, and the trustee in bankruptcy, believing, upon advice of its legal counsel, that it was required to file a separate return on behalf of the bankrupt corporation for the year 1932, refused to execute form 1122 on behalf of that corporation, and filed a separate return for that corporation for that year. During the 11-month period ender November 30, 1932, the Savoy-Plaza Corporation suffered a net operating loss of $1,500,837.29. On that date, the liabilities of the Savoy-Plaza Corporation exceeded its book assets by the sum of $3,917,070.61. The respondent determined the tax liability of each corporation, whose income was included in the so-called consolidated return filed, on a separate basis, The correctness of that action of the respondent is the sole issue in his proceeding. The "privilege" of affiliated corporations to have their income taxes computed upon a consolidated basis exists only by virtue of the conditional grant of that "privilege" by Congress. And, as this Board said in 865 Smith Paper Co.,31 B.T.A. 28">31 B.T.A. 28; affd., 78 Fed.(2d) 163; certiorari denied, 296 U.S. 627">296 U.S. 627: " * * petitioners, to enjoy its advantages, must bring themselves clearly within the specified conditions precedent to its grant. Rock Island, A. & L.R. Co. v. United States,254 U.S. 141">254 U.S. 141." 542 The Revenue Act of 1932 is controlling here. This statute, in so far as material at this point, is quoted in the margin. 1 By section 141(a) of that act, such a privilege was extended to affiliated corporations. Under the authority granted by that statute, the respondent promulgated Regulations 78, the material provisions of which appear in the margin. 2 The action of the respondent is 543 premised particularly upon article 18, which provides substantially, for present purposes, that, if there has been a failure to include in the consolidated return the income of any subsidiary, or a failure to file any of the forms required by these regulations, the tax liability of each member of the affiliated group shall be determined upon the basis of separate returns. Clearly, the petitioners were bound by these regulations since866 they filed form 1122, which was their formal consent to be so bound. Here, the income of the Savoy-Plaza Corporation was not included in the return for that year filed by the remaining members of the affiliated group nor did it file form 1122, consenting to be bound by Regulations 78 and authorizing the parent corporation to make a consolidated return on its behalf for the year in question, the filing of which, under Regulations 78, was made a condition precedent to the privilege of having the income taxes of the affiliated group computed upon a consolidated basis. 867 It may well be true, as argued by petitioners, that the bankruptcy of the Savoy-Plaza Corporation, which occurred on December 1, 1932, left that corporation thereafter as a mere "shell" and that such "shell" could not, in fact, be affiliated with the remaining members of the affiliation. See Houghton & Dutton Co.,26 B.T.A. 52">26 B.T.A. 52; Prosperity Co.,27 B.T.A. 28">27 B.T.A. 28; H. Liebes & Co.,23 B.T.A. 787">23 B.T.A. 787. However, obviously, at least for the period in 1932 preceding December 1, the date of the bankruptcy of the Savoy-Plaza Corporation, that corporation was a member of the affiliated group within the provisions of section 141(d), supra.That fact brings the Savoy-Plaza Corporation within the requirements of section 141, supra, just as effectively as though that undisputed affiliation continued throughout the year. This is so since section 141(a), supra, provides that "The making of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) * * ; and the868 making of a consolidated return shall be considered as such consent." Petitioners do not question the validity of the regulations. Nor do they deny, at least very emphatically, that they are controlled by 544 those regulations. The burden of their argument apparently is that the regulations quoted do not cover the situation presented here, where an affiliate became bankrupt during the taxable year. They argue that the respondent has construed these regulations in their effect on both the situation where the parent of an affiliated group becomes bankrupt during the taxable year (see G.C.M. 12207, C.B. XII-2) and where the subsidiary affiliate became bankrupt during such year (see G.C.M. 12208, C.B. XII-2). In the first General Counsel's memorandum mentioned, it was ruled that the trustee of the parent corporate bankrupt could file a consolidated return providing the requirements of Regulations 78 were met. In the second memorandum the ruling was: Where a group of corporations is affiliated within the meaning of section 141(d) of the Revenue Act of 1932, and a subsidiary company is in the hands of a trustee in bankruptcy or a receiver, who869 is operating the property or business of the company and is, therefore, required to make returns for the corporation under section 52(a) of that Act, the income of such a subsidiary company may be included in a consolidated return for the affiliated group, provided the trustee in hankruptcy or the receiver, as the case may be, executes Form 1122 and consents to the provisions of Regulations 78 governing the making of consolidated returns. Petitioners contend that in these two memoranda the respondent has construed the regulations covering the case here to mean that the trustee in bankruptcy for the Savoy-Plaza Corporation had an absolute right to file a separate return covering the year in controversy and that the filing of such a return complied with the mandatory requirements of the controlling Revenue Act of 1928, section 52(a) and Regulations 77, article 392, construing the same, both of which, so far as are here material, are quoted in the margin. 3 That is to say, petitioners' argument is that, under the regulations governing the right of petitioners to have their income taxes for 545 1932 computed on a consolidated basis, as such regulation is construed by the respondent, 870 the trustee in bankruptcy for the Savoy-Plaza Corporation was mandatorily required or, at least was permitted to file a separate return for the bankrupt corporation for that year without affecting the right of the other members of the affiliation to have their income taxes computed on a consolidated basis. 871 Aside from the effect of such a construction of this regulation by the respondent, we disagree with the petitioners' construction of the meaning of the two General Counsel's memoranda, supra.Clearly, under section 52(a), supra, which is a Federal statute as is the Bankruptcy Act, the trustee in bankruptcy for the Savoy-Plaza Corporation was required to make the income tax return for that corporation for 1932 "in the same manner and form as corporations are required to make." The respondent so construed that section in his appropriate Regulations 77, article 392, included in the margin. In our judgment, the only effect of General Counsel's Memorandum 12208, supra, was to clarify the situation in providing that where a subsidiary affiliate Became bankrupt during the taxable year, the trustee in bankruptcy of that affiliate could do as the corporation would have done had bankruptcy not intervened, namely, file a separate return or join in a consolidated return for the affiliated group provided it formally consented to the provisions of Regulations 78 controlling the filing of consolidated returns. 872 It may well be that the trustee in bankruptcy for the Savoy-Plaza Corporation was advised and believed that it was required by law to file a separate return for the year 1932 and was similarly prevented from executing form 1122 authorizing the parent to file a consolidated return on its behalf and consenting to be found by Regulations 78 applying to consolidated returns. But a mistake of law does not excuse. Fletcher American National Bank,33 B.T.A. 453">33 B.T.A. 453. This record does not disclose that the Federal District Court having jurisdiction of the bankruptcy proceedings involving the Savoy-Plaza Corporation denied the trustee in bankruptcy of that corporation permission to file form 1122 or join in the so-called consolidated return of the affiliates of that corporation. It is not revealed that the trustee asked for such permission. In view of the fact that this record shows that no liability would, in fact, have been assumed by the trustee, by the execution of that form or the joining in the so-called consolidated return as filed, it may well be doubted that such permission would have been denied. In any event, the Savoy-Plaza Corporation was a member of the affiliated873 group with petitioners during 1932, at least for the period preceding December 1 of that year. The other members of that group, including petitioners, consented to be bound by the regulations 546 governing the filing of consolidated returns. The so-called consolidated return of the affiliated group failed to include the income of the Savoy-Plaza Corporation for that year, and the trustee in bankruptcy for that corporation failed to file form 1122 consenting to be bound by Regulations 78 and authorizing the parent company of the affiliated group to file a consolidated return on its behalf, as provided by Regulations 78. This failure to comply with those regulations made mandatory the computation by the respondent of the income taxes for the year 1932 of each member of the affiliated group on a separate basis. The deficiencies here resulted from such computation. They are affirmed. Effect will be given to the stipulated adjustments in the settlement under Rule 50. Reviewed by the Board. Decision will be entered under Rule 50.Footnotes1. SEC. 141. CONSOLIDATED RETURNS OF CORPORATIONS. (a) PRIVILEGE TO FILE CONSOLIDATED RETURNS. - An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year in lieu of separate returns. The making of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) (or, in case such regulations are not prescribed prior to the making of the return, then the regulations prescribed under section 141(b) of the Revenue Act of 1928 in so far as not inconsistent with this Act) prescribed prior to the making of such return; and the making of a consolidated return shall be considered as such consent. In the case of a corporation which is a member of the affiliated group for a fractional part of the year the consolidated return shall include the income of such corporation for such part of the year as it is a member of the affiliated group. (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 an affiliated group of corporations making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be determined, computed, assessed, collected, and adjusted in such manner as clearly to reflect the income and to prevent avoidance of tax liability. (c) COMPUTATION AND PAYMENT OF TAX. - In any case in which a consolidated return is made the tax shall be determined, computed, assessed, collected and adjusted in accordance with the regulations under subsection (b) (or, in case such regulations are not prescribed prior to the making of the return, then the regulations prescribed under section 141(b) of the Revenue Act of 1928 in so far as not inconsistent with this Act) prescribed prior to the date on which such return is made; except that for the taxable years 1932 and 1933 there shall be added to the rate of tax prescribed by sections 13(a), 201(b), and 204(a), a rate of 3/4 of 1 per centum. (d) DEFINITION OF "AFFILIATED GROUP." - As used in this section an "affiliated group" means one or more chains of corporations connected through stock ownership with a common parent corporation if - (1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations. As used in this subsection the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. ↩2. ART. 12. Making Consolidated Return and Filing Other Forms. (a) Consolidated Return Made by Common Parent.A consolidated return shall be made on Form 1120 by the common parent corporation for the affiliated group. Such return shall be filed at the time and in the office of the collector of the district prescribed for the filing of a seperate return by such corporation. (b) Authorizations and Consents Filed by Subsidiaries.Each subsidiary must prepare two duplicate originals of Form 1122, consenting to these regulations and authorizing the common parent corporation to make a consolidated return on its behalf for the taxable year and authorizing the common parent corporation (or, in the event of its failure, the Commissioner or the collector) to make a consolidated return on its behalf (as long as it remains a member of the group), for each year thereafter for which, under article 11(a), the making of a consolidated return is required. One of such forms shall be attached to the consolidated return, as a part thereof; and the other shall be filed, at or before the time the consolidated return is filed, in the office of the collector for the district prescribed for the filing of a separate return by such subsidiary. No such consent can be withdrawn or revoked at any time after the consolidated return is filed. * * * ART. 18. Failure to Comply with Regulations. (a) Exclusion of a Subsidiary from Consolidated Return.If there has been a failure to include in the consolidated return the income of any subsidiary, or a failure to file any of the forms required by these regulations, notice thereof shall be given the common parent corporation by the Commissioner, and the tax liability of each member of the affiliated group shall be determined on the basis of separate returns unless such income is included or such forms filed within the period prescribed in such notice, or any extension thereof, or unless under article 11 a consolidated return is required for such year. * * * ↩3. SEC. 52. CORPORATION RETURNS. (a) Requirement. - Every corporation subject to taxation under this title shall make a return, stating specifically the items of its gross income and the deductions and credits allowed by this title. The return shall be sworn to by the president, vice president, or other principal officer and by the treasurer or assistant treasurer. In cases where receivers, trustees in bankruptcy, or assigness are operating the property or business of corporations, such receivers, trustees, or assignees shall make returns for such corporations in the same manner and form as corporations are required to make returns. Any tax due on the basis of such returns made by receivers, trustees, or assignees shall be collected in the same manner as if collected from the corporations of whose business or property they have custody and control. * * * ART. 392. Returns by receivers.↩ - Receivers, trustees in dissolution, trustees in bank ruptcy, and assignees, operating the property or business of corporations, must make returns of income of such corporations on Form 1120. Notwithstanding that the powers and functions of a corporation are susporation are suspended and that the property and business are for the time being in the custody of the receiver, trustee, or assignee, subject to the order of the court, such receiver, trustee, or assignee stands in the place of the corporate officers and is required to perform all the duties and assume all the liabilities which would devolve upon the officers of the corporation were they in control. * * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623266/	LAWRENCE F. FINKELMAN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Finkelman v. CommissionerDocket Nos. 13875-82, 20074-86, 20075-86United States Tax CourtT.C. Memo 1994-158; 1994 Tax Ct. Memo LEXIS 159; 67 T.C.M. (CCH) 2657; April 14, 1994, Filed 159 Lawrence F. Finkelman, pro se. For respondent: Ronald M. Rosen. GERBERGERBERMEMORANDUM OPINION GERBER, Judge: These consolidated cases were the subject of orders to show cause why decisions should not be entered in accord with a test case, Finkelman v. Commissioner, T.C. Memo 1989-72">T.C. Memo. 1989-72, affd. without published opinion 937 F.2d 612">937 F.2d 612 (9th Cir. 1991), cert. denied 112 S. Ct. 1291">112 S. Ct. 1291 (1992). By means of notices of deficiency, respondent determined the following deficiencies, additions to tax, and increased interest: Additions to Tax and Increased Interest IncomeSec.Sec.Sec.Sec.YearTax 6653(a)6653(a)(1) 6621(d)6651(a)1976$ 413-- -- ---- 19773,963-- -- ---- 19783,227-- -- ---- 19795,382$ 269.10--3 -- 19809,964498.20-- 3 -- 198111,433-- 2 $ 571.653 -- 1982 19,131-- 2 456.553 $ 620.60160 Petitioners conceded the income tax deficiencies for each year and respondent has conceded all additions to tax, but not the increased interest under section 6621(c), 2 formerly 6621(d) and currently repealed (for convenience we use section 6621(c)). The remaining issue for our consideration is whether petitioners are liable for increased interest under section 6621(c) for the taxable years 1979 3 through 1982. BackgroundIn Finkelman v. Commissioner, supra (test case), five representative partnerships' transactions were selected by the parties from a group of related partnerships with similar real estate transactions. Lawrence F. Finkelman (petitioner) 161 invested $ 15,000 in one of the partnerships. Petitioner is the son of Sol Finkelman, the promoter of the real estate partnerships and taxpayer in the test case. Petitioner, an aerospace engineer with special expertise in computers, was involved in the promotion of the real estate partnerships to the extent that he created a computer model or program in connection with the financial details of the transactions. Petitioner invested $ 15,000 in the "Greenville" partnership. Prior to investing, he analyzed the numerical aspects of the transaction based upon his view of the possible variations in the option price and other factors. Petitioner relied upon the value placed on the realty by his father, the promoter, and did not independently value or verify the underlying value of the real property which was the subject of each partnership. Petitioner's analysis would not have afforded the same results if the value of the underlying realty was less than the amount designated by the promoter, because a large portion of the tax benefit was attributable to depreciation based on the basis of the realty. After petitioner purchased the Greenville partnership interest, he received 1-percent162 interests in many of the partnerships organized and promoted by his father. 4 Petitioner did not thoroughly investigate the numerical aspects of the partnerships in which he received 1-percent interests; instead, he thought they appeared the same or similar to the first investment. Although petitioner paid no consideration for all but one of the partnerships in which he was a partner, he nevertheless claimed tax deductions in connection with all of them. Prior to his $ 15,000 investment, petitioner consulted his certified public accountant, who was also an investor in some of these partnerships. Petitioner's accountant was not consulted regarding the 1-percent163 interests petitioner received from his father. DiscussionSection 6621(c) provided for 120 percent interest on a substantial underpayment attributable to a tax motivated transaction. Amongst the "tax motivated" transactions defined in section 6621(c)(3)(A) were "(i) any valuation overstatement (within the meaning of section 6659(c)) * * and (v) any sham or fraudulent transaction." We held in the test case that section 6621(c) was applicable "Because the underpayments * * * were attributable to valuation overstatements and transactions lacking in economic substance and profit objective" under section 6621(c)(3)(A)(i) and (v). Finkelman v. Commissioner, T.C. Memo 1989-72">T.C. Memo. 1989-72. Here, petitioner seeks to show cause for relief from section 6621(c) interest because of "a reasonable basis for the valuation or adjusted basis claimed on the return and * * * such claim was made in good faith" as was permitted under section 6659(e). In essence, petitioner contends that if he shows a reasonable basis for the valuation, then section 6621(c) should not apply. Petitioner further argues against the imposition of increased interest under section 6621(c) on164 the theory that it should not be imposed in a situation where the partnership interest is gifted to a partner. Respondent contends that petitioner is not entitled to relief from section 6621(c) for reasonable cause. The memorandum opinions upon which respondent relies are: Cranfill v. Commissioner, T.C. Memo 1988-478">T.C. Memo. 1988-478, and Williams v. Commissioner, T.C. Memo. 1988-6. In Cranfill it was noted that the language of section 6621(c) does not provide for a reasonable cause exception and that section 6659(c) was referenced in section 6621(c) for definitional purposes and not incorporated by reference into section 6621(c). Similar observations were made in Williams. Petitioner, citing Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo 1988-408">T.C. Memo. 1988-408; and Todd v. Commissioner, 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912">89 T.C. 912 (1987), argues that (1) "the § 6621(c) penalty can be waived if the taxpayer shows a reasonable basis for the valuation overstatement and that taxpayer acted in good 165 faith" and (2) "that whenever the I.R.S. totally disallows a deduction or credit, the I.R.S. may not penalize the taxpayer for a valuation overstatement * * * [and] because the understatement is not attributable to a valuation overstatement per § 6659, § 6621(c) may not be applied." Respondent argues that even if we were to hold that petitioners were entitled to and did show reasonable cause with respect to the valuation overstatement or if section 6659 was not applicable because of the disallowance of petitioners' deductions, that would address only our section 6621(c)(3)(A)(i) holding in Finkelman v. Commissioner, supra. Accordingly, petitioner would continue to be liable for the additions to tax for increased interest under section 6621(c)(3)(A)(v) attributable to "any sham or fraudulent transaction." We agree with respondent's analysis and find it unnecessary to consider petitioner's analysis of Heasley v. Commissioner, supra, and Todd v. Commissioner, supra, and their effect, if any, upon these cases. Finally, we consider petitioner's claim that the section 6621(c) increased*166 interest should not be imposed in a situation where the partnership interest is gifted to a partner. On this point petitioner argues that the increased interest is punitive in nature and should not be "applied to a free gift." We find this portion of petitioner's argument to be a non sequitur. Section 6621(c) addresses tax motivated transactions. It is irrelevant whether a taxpayer purchased or was the donee of an interest in a tax motivated transaction. Instead, it is the claim of tax benefits from the asset or interest which is the object of the section 6621(c) definition. Petitioner advances no support for his position, and, indeed, we are aware of none. To reflect concessions of the parties, Appropriate orders and decisions will be entered.Footnotes1. Cases of the following petitioners are consolidated herewith: Lawrence F. Finkelman, docket No. 20074-86, and Lawrence F. Finkelman and Laura Finkelman, docket No. 20075-86.↩3. Interest payable at 120 percent of adjusted rate pursuant to sec. 6621(b) of interest accruing on a deficiency attributable to a substantial tax-motivated underpayment beginning after Dec. 31, 1984. See sec. 301.6621-2T A-10, Temporary Proced. and Admin. Regs., 49 Fed. Reg. 50393 (Dec. 28, 1984↩).2. Plus 50 percent additional interest due on deficiency determined pursuant to sec. 6653(a)(2).↩1. The year 1982 involves Lawrence F. and Laura Finkelman. All other tax years concern Lawrence F. Finkelman only.↩2. Section references are to the Internal Revenue Code in effect for the periods under consideration.↩3. Although the parties (especially respondent) presented their arguments in these cases with the implication that sec. 6621(c) is involved in all tax years, we find that it is not in issue for 1976, 1977, and 1978.↩4. Petitioner's father promoted 48 real estate partnerships. The exact number of 1-percent partnership interests petitioner received from his father without consideration is not clear from this record. It is determined in the notices of deficiency, however, that petitioner received at least ten 1-percent interests in different partnerships from his father.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623267/	EDITH M. O'DONNELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.O'Donnell v. CommissionerDocket No. 79980.United States Board of Tax Appeals35 B.T.A. 251; 1937 BTA LEXIS 903; January 12, 1937, Promulgated 903 1. ESTATE TAX - NET ESTATE. - Held, in computing value of the net estate respondent erred in disallowing, under section 303(a)(1), Revenue Act of 1926, deduction of valid claims against the estate contracted bona fide and for an adequate and full consideration in money or money's worth, in excess of the value of assets of the estate available for the payment of such claims. Prior decisions followed. 2. STATUTORY CONSTRUCTION. - The Board may not construe a statute, plain and unambiguous in terms, so as to supply what is conceived to be an omission leading to mischievous and absurd results, by adding thereto in effect an additional or limiting provision. Crooks v. Harrelson,282 U.S. 55">282 U.S. 55; United States v. Goldenberg,168 U.S. 95">168 U.S. 95. Charles S. Fettretch, Esq., for the petitioner. Ralph F. Staubly, Esq., for the respondent. HILL 251 This is a proceeding for the redetermination of the liability of the petitioner, under sections 315(b) and 316 of the Revenue Act of 1926, for a deficiency in estate tax of $93,610.40, alleged to be due from the estate of George K. O'Donnell, deceased. The sole issue904 is whether respondent erred in disallowing as deductions, in computing the value of the net estate, the aggregate amount of funeral expenses and debts of the decedent which constituted valid claims against the estate, contracted bona fide and for an adequate and full consideration in money or money's worth, in excess of the value of the assets of the estate available for the payment of such claims. FINDINGS OF FACT. Petitioner is an individual, residing in the Borough of Manhattan, New York City. The decedent, George K. O'Donnell, died March 18, 1933. Petitioner received $732,681.66 as a beneficiary of insurance on the life of the decedent, which amount was included by respondent in the value of the gross estate. The funeral expenses of George K. O'Donnell, deceased, amounted to $862.25, and were paid by the petitioner, and the amount thereof was fair and reasonable. The following debts of said George K. O'Donnell, deceased, were contracted bona fide and for an adequate and full consideration in money or money's worth and were valid claims against his estate, and such claims were paid by the petitioner out of insurance proceeds 252 received by her as a beneficiary905 of insurance taken out by the decedent upon his life: American Seal-Kap Corporation of Delaware, balance due bydeceased as per books$13,476.01Dr. M. J. Fien, professional services20.00Doctors Hospital, board, etc25.00Katherine Hayes, nurse16.00Anne J. Carrigg, nurse8.00Dr. John E. Hammett, professional services305.00Dr. Lewis Stevenson, professional services200.00Earl Benham, tailor170.00Abbotts Dairies, Inc., promissory note of deceased, withinterest to March 18, 193325,325.00First Mortgage Securities Corporation on account ofjudgment against decedent (item 4 of obligations listedin stipulation III)7,500.00Total47,045.01At the time of his decease, said George K. O'Donnell was personally obligated to each of the following named creditors in the amounts hereinafter stated, and each of said liabilities of the decedent was contracted by him bona fide for an adequate and full consideration in money or money's worth, and was a valid claim against his estate: Collector of internal revenue, 1st dist., New York$902.46City of New York, 1930 personal tax759.63Great Neck Trust Co13,796.87First Mortgage Securities Corporation73,469.34Great Neck Trust Co. and/or Robert J. Kiesling1,476.06Barclay's Bank1,850.00Milton P. Kupfer1,300.00Harry Winston2,263.80Chelsea Second National Bank, Atlantic City, N.J2,508.90American Auction Sales Co150.00National Dairy Products Corporation26,353.21The Beach Club, Palm Beach, Florida10,885.00Normandie National Securities Corporation4,501.17Chase National Bank9,000.00Great Neck Trust Co10,116.67A. L. Rankin250.00Total159,583.11906 Prior to his death, said George K. O'Donnell, deceased, was in sole control of two corporations, the Egroe Corporation and Washington Co., Ltd. He was the president of both corporations at the time of his death. He owned all of the common stock of Washington Co., Ltd., and 196 shares of the preferred stock thereof out of a total of 200 shares issued and outstanding, the remaining four shares of preferred stock having been used to qualify the directors. All of the stock of the Egroe Corporation was owned by said Washington Co., 253 Ltd. The obligations of said corporations, hereinafter set forth, were evidenced by promissory notes which were given to the respective creditors. The obligations were contracted by said corporations bona fide for an adequate and full consideration in money or money's worth. The creditors required the decedent to, and the decedent did, either endorse or guarantee the payment of said notes, and the obligations of the decedent, as the endorser or guarantor on the notes, constitute valid and legal claims against the estate of the deceased. Both of said corporations were absolutely insolvent and without any assets at the time of the death of907 the decedent: The Egroe Corporation to National Dairy Products Corporation$3,550.50Washington Co., Ltd., to Chase National Bank220,638.81Washington Co., Ltd., to National Safety Bank & Trust Co91,384.64Washington Co., Ltd., to National Safety Bank & Trust Co12,188.95Washington Co., Ltd., to Royal Bank of Canada145,679.81Washington Co., Ltd., to Royal Bank of Canada2,202.94The Egroe Corporation to Bank of Great Neck23,482.50The Egroe Corporation to Burne & Bowman, Inc2,716.74Total501,844.89Subsequent to the death of the decedent, the American Seal-Kap Corporation of Delaware and the First Mortgage Securities Corporation each threatened to commence legal proceedings to collect from the petitioner the amount of their claims out of the insurance moneys received by the petitioner, and, because of such threatened proceedings, petitioner made the two payments of $13,476.01 and $7,500, respectively, to these creditors set forth above. At the time decedent borrowed from Abbotts Dairies, Inc., the sum of $25,000, decedent, with the permission of the petitioner, deposited with said creditor, as security, jewelry belonging to petitioner which908 was then worth more than the amount of the loan, and after the death of the decedent, petitioner, in order to secure the return of her jewelry, paid to Abbotts Dairies, Inc., $25,000, plus interest thereon at 6 percent from January 1, 1933, to the date of payment. Under the laws of the State of New York, where decedent resided at the time of his death, life insurance payable to a specific beneficiary is not subject to the payment of the debts of the decedent, nor of the charges against his estate. At the date of his death, the decedent owned certain shares of corporate stock which possessed a total value, as determined by respondent in computing the deficiency tax set forth in the deficiency notice, of $55,573. Said shares of stock, together with a credit balance of $38.34 with the Chase National Bank, constituted all the property of value of which decedent died possessed. All of said shares of stock had been deposited by the decedent with certain 254 of the creditors enumerated above, as collateral security for the payment of such obligations. OPINION. HILL: Petitioner's decedent died leaving assets subject to the payment of funeral expenses and claims against909 the estate in the total amount of $55,611.34. The parties have stipulated, and we have so found, that the funeral expenses amounted to $862.25, which amount was fair and reasonable, and that there were valid claims against the estate, contracted bona fide and for an adequate and full consideration in money or money's worth, in the total amount of $708,473.01, or an aggregate of funeral expenses and claims in the amount of $709,335.26. Respondent disallowed the deductions claimed for funeral expenses and debts of the decedent in excess of the amount of $55,611.34, representing the value of the assets subject to the payment of such items. Petitioner received the proceeds of certain policies of insurance on the life of the decedent, and concedes that she is liable for whatever estate tax deficiency may be due, but contends that the deficiency should be computed by allowing as deductions from the gross estate the full amount of the funeral expenses and claims as stipulated by the parties and set out in our findings of fact above. Under the laws of the State of New York, where decedent died, the life insurance received by petitioner was not subject to the payment of decedent's debts910 nor of the charges against his estate. The Revenue Act of 1926, in so far as pertinent here, is quoted in the margin. 1The question presented in this case has heretofore been considered and decided by us, in harmony with petitioner's contention, in ; ; . See also . However, in the instant proceeding, respondent presents a new thesis with such insistence as to merit specific consideration911 and discussion. While respondent does not argue that the deductions in controversy do not come within the letter of the quoted statute, he says that it is an established rule of statutory construction that the 255 intent of the legislature should govern; that the intendment of the Federal estate tax statute is to impose an excise upon the donative transfer of property at death; that in addition to exemptions, including $40,000 of insurance proceeds received by a specific beneficiary, there is excluded from the measure for the tax property set aside for public and charitable uses, as well as all property which does not pass as a gratuity, leaving as the measure for the tax only the property which passes from the decedent to others as a gift. Respondent, therefore, argues in effect that to allow the deductions claimed by the petitioner would be to permit a corresponding amount of property to pass from decedent to another as a gift without being taxed, which would defeat the object and purpose of the statute and lead to an absurdity. In 912 , the collector there urged substantially the same argument as is presented by the Commissioner here. In rejecting such theory, the Court in part said: It is urged, however, that, if the literal meaning of the statute be as indicated above, that meaning should be rejected as leading to absurd results, and a construction adopted in harmony with what is thought to be the spirit and purpose of the act in order to give effect to the intent of Congress. The principle sought to be applied is that followed by this court in * . But a consideration of what is there said will disclose that the principle is to be applied to override the literal terms of a statute only under rare and exceptional circumstances. The illustrative cases cited in the opinion demonstrate that, to justify a departure from the letter of the law upon that ground, the absurdity must be so gross as to shock the general moral or common sense. Compare 913 . And there must be something to make plain the intent of Congress that the letter of the statute is not to prevail. . * * * But an application of the principle so nearly approaches the boundary between the exercise of the judicial power and that of the legislative power as to call rather for great caution and circumspection in order to avoid usurpation of the latter. * * * It is not enough merely that hard and objectionable or absurd consequences, which probably were not within the contemplation of the framers, are produced by an act of legislation. Laws enacted with good intention, when put to the test, frequently, and to the surprise of the lawmaker himself, turn out to be mischievous, absurd, or otherwise objectionable. But in such case the remedy lies with the lawmaking authority, and not with the courts. [Citing authorities.] The effect of respondent's argument is that we should supply what he conceives to be an omission in the statute by adding the provision that the net estate914 should be determined by deducting claims, within the limitations stated, only to the extent of the value of the assets or property available to pay them. In , the Court commented on this point as follows: The primary and general rule of statutory construction is that the intent of the lawmaker is to be found in the language that he has used. He is 256 presumed to know the meaning of words and rules of grammar. The courts have no function of legislation, and simply seek to ascertain the will of the legislator. It is true there are cases in which the letter of the statute is not deemed controlling, but the cases are few and exceptional, and only arise when there are cogent reasons for believing that the letter does not fully and accurately disclose the intent. No mere omission, no mere failure to provide for contingencies, which it may seem wise to have specifically provided for, justify any judicial addition to the language of the statute. Respondent's contentions can not be sustained, and on authority of the decisions hereinabove cited, his action in the instant case is reversed. Judgment will915 be entered under Rule 50.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 - (1) Such amounts for funeral expenses, administration expenses, claims against the estate, * * to the extent that such claims * * * were incurred or contracted bona fide and for an adequate and full consideration in money or money's worth, * * * as are allowed by the laws of the jurisdiction * * * under which the estate is being administered * * *. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623268/	CHARLES F. PARSONS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Parsons v. CommissionerDocket No. 91990.United States Board of Tax Appeals42 B.T.A. 1114; 1940 BTA LEXIS 902; October 30, 1940, Promulgated 902 The salary received by the petitioner as an associate justice of the Supreme Court of the Territory of Hawaii during the calendar years 1934 and 1935 under an appointment made in 1931 is subject to Federal income tax. Antonio Perry, Esq., and E. R. Cameron, C.P.A., for the petitioner. B. H. Neblett, Esq., for the respondent. SMITH 1114 OPINION. SMITH: This is a proceeding for the redetermination of deficiencies in income tax for 1934 and 1935 in the amounts of $526.13 and $255.35, respectively. The question in issue is whether the salary of the petitioner, as associate justice of the Supreme Court of the Territory of Hawaii for the years 1934 and 1935, is liable to Federal income tax. The proceeding is submitted upon the pleadings, upon certain exhibits admitted in evidence, and upon a signed stipulation of facts incorporated herein by reference. The petitioner is a citizen of the United States and a resident of the city and county of Honolulu, Territory of Hawaii. 1115 During the calendar year 1926 the petitioner was appointed by the President of the United States, by and with the advice and consent of the Senate, 903 an associate justice of the Supreme Court of the Territory of Hawaii, and duly qualified for and entered upon the duties of that office during October 1926. The petitioner was reappointed to that office on February 23, 1931, and duly qualified under the reappointment on March 11, 1931. During the period March 11, 1931, to August 17, 1935, the petitioner performed the duties of his office and received from the Federal Government a salary of $10,000 per annum set therefor by Act of May 29,1928, chapter 904, sections 1 and 2, 45 Stat. 997, except that during the effective period of the Economy Act of June 30, 1932, chapter 314, 47 Stat. 382, 401, as amended, which began July 1, 1932, and ended March 31, 1935, percentage deductions were made from the petitioner's fixed salary. The amounts of salary actually received by the petitioner from the Treasurer of the United States during the years 1934 and 1935 for services performed as an associate justice were $9,208.32 in 1934 and $6,152.77 in 1935. The petitioner duly filed with the collector at Honolulu returns of annual net income for the calendar years 1934 and 1935 and included therein as items of gross income, and also as deductions, 904 the above stated amounts of $9,208.32 and $6,152.77, respectively. The respondent in his determination of the deficiencies herein for the calendar years 1934 and 1935 included the said amounts of $9,208.32 and $6,152.77 in petitioner's gross income, but disallowed their deduction. The deficiencies herein result entirely from such adjustments. The only issue in this proceeding is whether the salary received by the petitioner as an associate justice of the Supreme Court of the Territory of Hawaii during the years 1934 and 1935 is subject to income tax. In his income tax returns for 1934 and 1935 the petitioner included jis salary in gross income but deducted it from the gross income in determining net income. The respondent restored it to net income in the determination of the deficiencies involved herein, stating in his deficiency notice, which forms the basis for this proceeding: Salary received as associate justice of the Supreme Court of the Territory of Hawaii, is held by this office to be taxable income since Justices of the Supreme Court of the Territory of Hawaii are not judges of inferior courts of the United States within the meaning of article III, section 1, 905 of the United States Constitution. The petitioner submits that his salary is exempt from Federal income tax in accordance with paragraph 3 of section 80 of the Organic Act of the Territory of Hawaii, which provides: The salaries of all officers other than those appointed by the President shall be as provided by the legislature, but those of the chief justice and the justices 1116 of the supreme court and judges of the circuit courts shall not be diminished during their term of office. He submits that this provision of the organic act is traceable through mesne enactments to Article III, section 1, of the Constitution of the United States, which provides: The Judicial Power of the United States shall be vested in one Supreme Court and in such inferior courts as the Congress may from time to time ordain and establish. The Judges, both of the Supreme and inferior courts shall hold their offices during good behavior, and shall, at stated times, receive for their services, a compensation which shall not be diminished during their continuance in office. He further submits that the courts of Hawaii, following opinions of the Supreme Court of the United States (906 Pollock v. Farmers' Loan & Trust Co.,157 U.S. 429">157 U.S. 429; Evans v. Gore,253 U.S. 245">253 U.S. 245; and Miles v. Graham,268 U.S. 501">268 U.S. 501), have held, in Robertson v. Pratt and Waimea Sugar Co. v. Pratt, 13 Hawaii, 590; and Frear v. Wilder, 25 Hawaii, 603, 607, that the salaries of the judges of the Supreme Court of the Territory of Hawaii are not subject to the Hawaiian income tax, upon the ground that such a tax would operate to diminish their compensation within the purview of paragraph 3 of section 80 of the Organic Act of the Territory of Hawaii; that this was the law governing the issue herein presented at the time the petitioner received his salary in 1934 and 1935. He further submits that the respondent has not subjected to Federal income tax the salaries of the justices of the Supreme Court of the Territory of Hawaii received prior to 1934. In O'Malley v. Woodrough,307 U.S. 277">307 U.S. 277, decided May 22, 1939, the Supreme Court had before it the question as to whether the salary of a judge of one of the United States Circuit Courts of Appeal was subject to income tax under907 section 22(a) of the Revenue Act of 1934, which provides in part: * * In the case of Presidents of the United States and judges of courts of the United States taking office after June 6, 1932, the compensation received as such shall be included in gross income; and all Acts fixing the compensation of such Presidents and judges are hereby amended accordingly. In its opinion the Supreme Court held that the salary of the judge in question, who had entered upon the duties of office after June 6, 1932, was subject to income tax, saying: * * * Congress has committed itself to the position that a non-discriminatory tax laid generally on net income, is not, when applied to the income of a federal judge, a diminution of his salary within the prohibition of Article III, § 1 of the Constitution. * * * The facts in the instant case are that the petitioner entered upon the duties of his office prior to June 6, 1932. It is therefore argued that the salary received by him in 1934 and 1935 is exempt from income tax. It is not necessary in this proceeding to determine whether the salary of a judge of a constitutional court entering upon the duties of his 1117 office prior to908 June 6, 1932, is subject to income tax in 1933 and 1934. We have not that question before us. The Supreme Court of the Territory of Hawaii is not a "constitutional" court within the meaning of Article III, section 1, of the Constitution. It is a "legislative" court created under Article IV, section 3, clause 2 of the Constitution, which vests in Congress the power to "dispose of and make all needful rules and regulations respecting the territory or other property belonging to the United States." See O'Donoghue v. United States,289 U.S. 516">289 U.S. 516. Congress clearly has the power under that provision of the Constitution to make any changes which it desires with respect to the terms of office or the salary of justices of a legislative court. It may diminish their compensation if it chooses to do so. It is furthermore to be noted that the petitioner's compensation for the years 1933, 1934, and 1935 was reduced by the Economy Act of June 30, 1932, chapter 314; 47 Stat. 382, 401, as amended. That act expressly exempted from its provisions "(* * * judges whose compensation may not, under Constitution, be diminished during their continuance in office)." The petitioner's*909 compensation was diminished under the provisions of that act because the diminution thereof was not prohibited by the Constitution of the United States. Charles F. Hatfield,38 B.T.A. 245">38 B.T.A. 245, involved the question whether the salary of a judge of the United States Court of Customs and Patent Appeals was subject to income tax for the years 1934 and 1935. There, as here, the judge entered upon the duties of his office prior to June 6, 1932. There, as here, the judge was a member of a legislative court and not of a constitutional court, within the meaning of Article III, section 1, of the Constitution of the United States. We held that his salary was subject to income tax. All that we said there is equally applicable here. Upon the theory of that case it must be held that the salary of the petitioner received as an associate justice of the Supreme Court of the Territory of Hawaii during the years 1934 and 1935 is subject to income tax. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623269/	RALPH SEIBLY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSeibly v. CommissionerDocket No. 30276-89United States Tax CourtT.C. Memo 1991-125; 1991 Tax Ct. Memo LEXIS 143; 61 T.C.M. (CCH) 2201; T.C.M. (RIA) 91125; March 20, 1991, Filed 143 Decision will be entered for the respondent. George D. Humphreys, for the petitioner. William Reese, for the respondent. RUWE, Judge. RUWEMEMORANDUM OPINION Respondent determined a deficiency in petitioner's 1983 Federal income tax and additions to tax as follows: Additions to TaxDeficiencySec. 6651(a) 1Sec. 6653(a)(1)Sec. 6653(a)(2)Sec. 6661$ 10,000$ 1,736$ 1,23150 percent of$ 2,500the interest dueon $ 10,000The issues for decision are: (1) Whether petitioner may claim a deduction for bad debts under section 166; (2) whether petitioner is liable for an addition to tax under section 6651(a)(1) for failure to timely file his 1983 Federal income tax return; (3) whether petitioner is liable for an addition to tax under section 6653(a)(1) 144 and (2) for negligence or intentional disregard of the rules and regulations; and (4) whether petitioner is liable for an addition to tax under section 6661 for a substantial understatement of his Federal income tax. 2Some 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 Bakersfield, California, at the time he filed his petition in this case. For purposes of convenience, we are combining our findings of fact and opinion for each issue. Petitioner bears the burden of proof on each of the issues for decision. 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);145 Rule 142(a). Issue 1. The Bad Debt DeductionPetitioner deducted $ 180,000 for nonbusiness bad debts on schedule D of his 1983 Federal income tax return. The claimed bad debts consisted of $ 150,000 due from a Mr. Ruszker and $ 30,000 due from a Mr. Ashmore. Although not readily apparent from the record, respondent's pretrial memorandum explains that respondent disallowed $ 18,000 of the claimed $ 150,000 bad debt and all of the claimed $ 30,000 bad debt. The result of the bad debt disallowances was to increase taxable income by $ 19,200. 3 The petition claims error only with respect to the $ 30,000 disallowance. 146 Petitioner relies on two checks to substantiate the purported $ 30,000 loan. One check is dated March 20, 1979, payable to "U.L.C., Inc. Charter #125 Trust Acct & Lewis Ashmore, Carl Shriver, & Jennifer King," in the amount of $ 27,500. A second check dated February 23, 1979, is payable to "Louis Ashmore," in the amount of $ 2,500. Also in the record, is a document dated February 20, 1981, which contains the following language: This is a confirmation agreement of a prior understanding-- That Dr. Ralph Seibly has subscribed to 75 investment units in ULC #125 Documentary Film project "Modesto Messiah" and will be honored as per the Subscription Agreement given to all other subscribers and/or investors, to be distributed by Clifford Cox, CPA & Trustee of the project. This consideration is offered because of his original investment was of a high risk factor.This document bears the purported signature of "Lewis L. Ashmore, individually" and is also signed on behalf of "Universal Life Church, Inc. #125, Lewis L. Ashmore, President." Neither petitioner nor Mr. Ashmore testified at trial. Section 166(d)(1) allows a taxpayer who is not a corporation to treat the 147 loss resulting from a nonbusiness debt which becomes worthless during the taxable year as a loss from the sale or exchange of a capital asset held for not more than one year. Section 166(d)(2) defines a nonbusiness bad debt as a debt other than a debt created or acquired in connection with a trade or business or a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. In order for a taxpayer to treat a loss resulting from a nonbusiness debt as a capital loss, the taxpayer must demonstrate that a debtor-creditor relationship existed between the taxpayer and the debtor and that the debt became worthless in the year in which the taxpayer claims the capital loss treatment. Secs. 1.166-1(c) and 1.166-5(a)(2), Income Tax Regs.Petitioner's accountant and return preparer was the only witness who testified at trial. He testified that the aforementioned documents were among the documents he reviewed in preparing petitioner's Federal income tax return. The accountant gave no testimony regarding the exact nature of the agreement between petitioner, Mr. Ashmore, and the Universal Life Church. He also had no direct knowledge of the financial circumstances148 of Mr. Ashmore or Universal Life Church #125 or their ability in 1983 to repay the purported $ 30,000 loan. The evidence fails to satisfy petitioner's burden of proving that a debtor-creditor relationship existed and that the debt became worthless in the year in which the deduction was claimed. Accordingly, we hold for respondent on this issue. Issue 2. Addition to Tax for Failure to Timely FilePetitioner was granted an extension for filing his Federal income tax return until August 15, 1984. Petitioner filed his 1983 Federal income tax return with the Internal Revenue Service Center in Fresno, California. The return was signed by petitioner on October 15, 1984, mailed on October 16, 1984, and received by the service center on October 17, 1984. Thus, the return is treated as filed on October 17, 1984. Emmons v. Commissioner, 92 T.C. 342">92 T.C. 342, 347 (1989), affd. 898 F.2d 50">898 F.2d 50 (5th Cir. 1990). Section 6651(a)(1) imposes an addition to tax upon a taxpayer who fails to file a timely return, unless the taxpayer shows that his failure to file was due to reasonable cause and not due to willful neglect. This is essentially a question of fact, and149 the burden of proof is on petitioner. Horton v. Commissioner, 86 T.C. 589">86 T.C. 589, 597 (1986); Rule 142(a). Petitioner did not appear at trial to explain his late filing, and has failed to meet his burden of proof. Issue 3. Addition to Tax for Negligence or Intentional Disregard of the Rules and RegulationsSection 6653(a)(1) imposes a 5-percent addition to tax if any part of any underpayment of tax is due to negligence or intentional disregard of the rules and regulations. Section 6653(a)(2) provides for a separate addition to tax equal to 50 percent of the interest payable under section 6601 on the portion of the underpayment attributable to the negligence or intentional disregard of the rules and regulations. Negligence within the meaning of section 6653(a) has been defined as the "failure to do what a reasonable and ordinarily prudent person would do under the circumstances." Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioner offered no evidence to indicate that he did not fail to do what a reasonable and ordinarily prudent person would do under the circumstances. On brief, petitioner does not argue that he was not negligent150 and seemingly concedes this issue. Accordingly, we hold for respondent on this issue. Issue 4. Addition to Tax for Substantial Understatement of Income Tax LiabilityPetitioner reported a tax liability of $ 13,039 on his 1983 Federal income tax return. Respondent determined a deficiency in the amount of $ 10,000 and an addition to tax under section 6661 in the amount of $ 2,500. Section 6661 imposes an addition to tax in an amount equal to 25 percent of the amount of any underpayment attributable to a substantial understatement of income tax. Pallottini v. Commissioner, 90 T.C. 498 (1988). 4 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(b)(1). The amount of the understatement is equal to the excess of the amount of tax required to be shown on the return for the tax year less the amount of the tax shown on the return. Woods v. Commissioner, 91 T.C. 88">91 T.C. 88, 94 (1988). *151 We have sustained the adjustments giving rise to respondent's deficiency determination and petitioner presented no evidence that any exceptions contained in section 6661 apply. Accordingly, we sustain respondent's determination that petitioner is liable for the additions to tax under section 6661. Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. At trial, the parties seemed to also consider respondent's disallowance of a $ 2,000 depreciation deduction to be in issue. We note, however, that paragraph 4 of the petition concedes this adjustment and petitioner's brief concedes that no evidence was offered to meet petitioner's burden of proof that this disallowance was in error.↩3. The connection between the total bad debt deductions which were disallowed ($ 48,000) and the resulting increase in taxable income is not explained in the record. However, the entire bad debt deduction claimed on the return was used to offset reported long-term capital gains, 40 percent of which was required to be included in taxable income. Disallowance of $ 48,000 of bad debt deductions would increase long-term capital gains by $ 48,000. Forty percent of $ 48,000 equals $ 19,200.↩4. The Omnibus Reconciliation Act of 1986, Pub. L. 99-509, sec. 8002(a), 100 Stat. 1874, 1951, increased the section 6661(a) addition to tax to 25 percent of the underpayment attributable to a substantial understatement for additions to tax assessed after October 21, 1986.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623270/	Estate of Charles Juster, Deceased, Leon Juster, Executor, Petitioner, v. Commissioner of Internal Revenue, RespondentJuster v. CommissionerDocket No. 49398United States Tax Court25 T.C. 669; 1955 U.S. Tax Ct. LEXIS 2; December 30, 1955, Filed 2 Decision will be entered under Rule 50. Held that the value of the residuary trust to decedent's wife, and therefore the value of the marital deduction, under sections 812 (e) (1) (A) and 812 (e) (1) (E) (i), Internal Revenue Code of 1939, is to be computed after deduction for the Federal estate tax chargeable to decedent's estate. Robert H. Preiskel, Esq., for the petitioner.James J. Quinn, Esq., for the respondent. Bruce, Judge. BRUCE 669 Respondent has determined a deficiency in estate tax in the amount of $ 5,285.90.Although the full amount of the deficiency was placed in issue in the petition, specific error was not raised as to certain of the item adjustments and they were not discussed at the hearing or on briefs and are accordingly deemed conceded.By amended petition petitioner claims an overpayment3 of estate tax on the ground that in determining the marital deduction as allowed by section 812 (e) (1) (A), Internal Revenue Code of 1939, the value of the residuary trust to decedent's wife is not chargeable with any 670 portion of the Federal estate tax. Claim is also made for a further deduction for attorneys' fees and related expenses incurred, or to be incurred in connection with this proceeding.The question presented is whether the value of the residuary trust to decedent's wife, and therefore the value of the marital deduction, under sections 812 (e) (1) (A) and 812 (e) (1) (E) (i) of the Internal Revenue Code of 1939, is to be computed without reduction for any part of the Federal estate tax chargeable to the Estate of Charles Juster.A recomputation under Rule 50 will be required to make adjustments for any allowable costs of this proceeding.FINDINGS OF FACT.The facts were stipulated and are incorporated herein by this reference.The decedent, Charles Juster, a resident of New York State, died testate September 11, 1949. His son, Leon Juster, was appointed executor by the Surrogate's Court of New York County, New York, on October 13, 1949. Minnie Juster was the4 wife of decedent at the date of death. Petitioner filed a Federal estate tax return with the collector of internal revenue for the third district of New York.By paragraph Second through paragraph Twelfth of his will decedent made various specific and general bequests.In paragraph Thirteenth decedent directed that the residue of his estate be divided into two parts: One to be held in trust for his wife with income to her for life and with an unlimited and unqualified power in her to appoint the remainder to herself or to her estate; the other part to be divided among his children.Paragraph Twenty-first of decedent's will provides:I direct that all legacies, bequests and devises by this my last Will and Testament created shall be free from any legacy, succession, transfer, estate or inheritance tax and that every such tax shall be paid out of the principal of my estate.OPINION.There is no question, nor does the respondent dispute, that the residuary trust to decedent's wife qualifies for the marital deduction under section 812 (e) (1) (A) of the Internal Revenue Code of 1939. 1 The question presented is whether the value 671 of the residuary trust to decedent's wife, 5 and therefore the value of the marital deduction, under sections 812 (e) (1) (A) and 812 (e) (1) (E) (i), 2 is to be computed without reduction for any part of the Federal estate tax chargeable to the Estate of Charles Juster. The parties are in agreement that the law of the State of New York is determinative of this question. See Estate of Rosalie Cahn Morrison, 24 T. C. 965; Riggs v. Del Drago, 317 U.S. 95">317 U.S. 95; Rogan v. Taylor, 136 F. 2d 958.6 Petitioner argues that the value of the residuary trust to the surviving spouse is to be determined without taking into account the Federal estate tax chargeable to the estate. Specifically petitioner contends that paragraph Twenty-first of decedent's will contains an ineffective direction against apportionment of tax under section 124 of the Decedent Estate Law (1949) of New York 3 in that it is ambiguous and self-contradictory. In such case, petitioner concludes, the residuary trust in question, being entitled to an exemption under the taxing statute, passes free of all taxes. Respondent argues that this paragraph clearly evidences the decedent's intention that the named taxes be paid out of the corpus or body of his estate prior to the distribution of the estate. Both parties have directed their particular 672 attention to the words "principal of my estate" as used in paragraph Twenty-first.7 Section 124 of the New York Decedent Estate Law (1949) commands proration of taxes "except in a case where a testator otherwise directs in his will." The direction by the testator against the apportionment provided by this section must be clear and unambiguous. In re Mills' Estate, 64 N. Y. S. 2d 105, affd. 70 N. Y. S. 2d 746, affd. 297 N. Y. 1012, 80 N. E. 2d 535. In our view paragraph Twenty-first of the decedent's will contains such a direction. Language similar to that used in this paragraph, including the phrase "principal of my estate," was held in In re Liebovitz's Estate, 94 N. Y. S. 2d 30, to be a clear direction against apportionment, with respect to benefits passing under the will involved. In re Pepper's Estate, 307 N.Y. 242">307 N. Y. 242, 120 N. E. 2d 807, cited by petitioner, is distinguishable. There the court found the language of the will involved contained inconsistent directions and therefore did not contain a clear and unambiguous direction against the statutory apportionment.As an alternative petitioner8 argues that even if paragraph Twenty-first is construed as an effective direction with respect to apportionment under the New York statute, it is to be construed as providing that only specific and general bequests are to pass free of tax and that all taxes are to be paid out of the residue. Thus construed its only effect would be to charge the wife's share with 50 per cent of the taxes attributable to nonresiduary bequests; all taxes attributable to the residue would be chargeable to the nonmarital share of the residue and the net value of the marital share and therefore the marital deduction would be one-half of the residuary estate computed prior to any reduction for tax less 50 per cent of the taxes attributable to the specific and general bequest. In support of this contention petitioner cites In re Bayne's Will, 102 N. Y. S. 2d 525; In re Pratt's Estate, 123 N. Y. S. 2d 425; In re Campe's Estate, 129 N. Y. S. 2d 362, 130 N. Y. S. 2d 458; In re Matte's Estate, 130 N. Y. S. 2d 270, affd. 137 N. Y. S. 2d 836; In re Hoffman's Estate, 138 N. Y. S. 2d 492.9 In each of those cases the court found that the testator therein had directed that all taxes be paid from the residue of the estate. No such construction can be placed on the paragraph here involved.Decedent has directed his executors to pay all named taxes out of the "principal" of his estate and that all legacies, bequests, and devises go free and clear of those taxes. "Principal" is defined by Webster's New International Dictionary of the English Language, 2d ed., 2. b, as follows: "Of an estate * * * of a decedent, in general the corpus, or main body of the estate * * ." Black's Law Dictionary, 4th ed., defines it as "The corpus or capital of an estate in contradistinction to the income * " We conclude, therefore, that 673 the decedent intended that all named taxes be paid from the main body of his estate before distribution to any of the beneficiaries.None of the other provisions of the will indicate in any way that the decedent intended an interpretation contrary to the ordinary and natural meaning of the words of paragraph Twenty-first. Paragraphs First and Second provide for the payment of debts and funeral and administrative expenses out of the corpus of10 the estate, and a fund for a tombstone. Paragraphs Third through Twelfth contain specific and general bequests. Paragraph Thirteenth provides for a division of the residue, one-half to be held in trust for decedent's wife and one-half to be divided among his children. Paragraphs Fourteenth through Twenty-sixth contain the appointments of executors and trustees and provide for the powers to be conferred upon them in the administration of the estate and the trusts.Acceptance of petitioner's argument would in effect give decedent's wife something more than he directed. As pointed out in Rogan v. Taylor, supra, it would present the analogous result of allowing deduction from gross estate as a marital deduction, of a sum which in effect goes not to decedent's wife, but to the collector of internal revenue. Decedent directed that she receive one-half of the residue. The residue of an estate is that which is left after the payment of debts and other charges, including taxes, against the estate and of specific and general bequests. Whetmore v. St. Luke's Hospital, 9 N. Y. S. 753; In re Hamlin, 172 N. Y. S. 787,11 affd. 226 N. Y. 407, 124 N.E. 4">124 N. E. 4, certiorari denied 250 U.S. 672">250 U.S. 672; In re Paine's Estate, 41 N. Y. S. 2d 408; cf. Estate of Rosalie Cahn Morrison, supra.We recognize that payment of taxes from the estate before distribution is in effect a diminution of the residue; however, it was decedent's direction that his wife share only in the residue and we are unable to find that "residue" as used in the will has a meaning other than that indicated above. Therefore we decide this issue for respondent and further find that there is no overpayment of estate tax as claimed by petitioner.For the reasons previously stated,Decision will be entered under Rule 50. Footnotes1. SEC. 812. NET ESTATE.For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate --* * * (e) Bequests, Etc., to Surviving Spouse. -- (1) Allowance of marital deduction. -- (A) In General. -- An amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate.↩2. SEC. 812. NET ESTATE.For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate -- * * (e) Bequests, Etc., to Surviving Spouse. -- (1) Allowance of marital deduction. -- * * (E) Valuation of interest passing to surviving spouse. -- In determining for the purposes of subparagraph (A) the value of any interest in property passing to the surviving spouse for which a deduction is allowed by this subsection --(i) there shall be taken into account the effect which a tax imposed by this chapter, or any estate, succession, legacy, or inheritance tax, has upon the net value to the surviving spouse of such interest; and↩3. Sec. 124. Appointment of federal and state estate taxes; executor or administrator to deduct taxes from distributive shares. 1. Whenever it appears upon any accounting, or in any appropriate action or proceeding, that an executor, administrator, temporary administrator, trustee or other person acting in a fiduciary capacity, has paid a death tax levied or assessed under the provisions of article ten-c of the tax law, or under the provisions of the United States revenue act of nineteen hundred twenty-six, as amended by the United States revenue act of nineteen hundred twenty-eight, or under any death tax law of the United States hereafter enacted, upon or with respect to any property required to be included in the gross estate of a decedent under the provisions of any such law, the amount of the tax so paid, except in a case where a testator otherwise directs in his will, and except in a case where by written instrument executed inter vivos direction is given for apportionment within the fund of taxes assessed upon the specific fund dealt with in such inter vivos instrument, shall be equitably pro-rated among the persons interested in the estate to whom such property is or may be transferred or to whom any benefit accrues. Such proration shall be made by the surrogate in the proportion, as near as may be, that the value of the property, interest or benefit of each such person bears to the total value of the property, interests and benefits received by all such persons interested in the estate, except that in making such proration allowances shall be made for any exemptions granted by the act imposing the tax and for any deductions allowed by such act for the purpose of arriving at the value of the net estate; * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623271/	APPEAL OF HOME LAUNDRY CO.Home Laundry Co. v. CommissionerDocket No. 6047.United States Board of Tax Appeals4 B.T.A. 45; 1926 BTA LEXIS 2383; April 22, 1926, Decided Submitted January 28, 1926. 2383 Wm. H. Lawrence, Esq., for the taxpayer. Bruce A. Low, Esq., for the Commissioner. 45 Before STERNHAGEN, LANSDON, and ARUNDELL. The Commissioner determined deficiencies in income taxes for the years 1919 to 1922, inclusive, in the amount of $4,516.50. So much of the deficiencies as are in dispute arose from the disallowance of a portion of the salary paid to Mary A. Lotz, vice president and treasurer of the petitioner. FINDINGS OF FACT. The petitioner was incorporated May 1, 1917, under the laws of the State of Maryland, and during the taxable years in controversy operated a laundry in Baltimore. Prior to incorporation the business was operated for a number of years as a partnership under the name now used by the corporation. Capital stock in the amount of $30,000 was issued, 178 shares being owned by Joseph Lotz, president of the petitioner, and 120 shares by Mary A. Lotz, vice president and treasurer. The amount of the original capital outlay was $2,000, which amount was increased by permitting the earnings to remain in the business. 46 During the years in question petitioner had about 50 employees; it operated six wagons and five2384 automobile trucks, had approximately 3,500 customers, and did an annual business of about $100,000. John Lotz was the president and general manager of the petitioner during the years 1919 to 1922, inclusive, and devoted all of his time to the business. The corporate minutes of April 5, 1917, contain the following: Upon motion duly made and seconded and unanimously carried the salary of Joseph Lotz as president was fixed at $25 a week, the salary of Mary E. Lotz as vice-president and treasurer, with the additional allowance of $30 for household expenses was fixed at $25 per week until other [wise] determined by the Board of Directors of this company. An agreement was signed by Joseph and Mary A. Lotz under date of April 3, 1917, which reads as follows: This agreement was entered into in duplicate the 3rd of April, 1917, by and between Joseph and Mary A. Lotz, husband and wife, of Highland Town, Baltimore City, Maryland, that as president of said corporation Joseph Lotz shall receive the salary of $25 per week, that as vice-president and treasurer of the said corporation Mrs. Mary A. Lotz shall receive a salary of $25 per week, and also $30 per week to be withdrawn2385 for household expenses to be paid to the said Mary A. Lotz, in addition to the said salary. The arrangement set forth above was not followed by the petitioner. On January 1, 1919, by order of the president, the salary of Mary A. Lotz was increased from $55 to $65 a week. On January 1, 1920, the president increased the salary of Mrs. Lotz to $90 a week, and on February 4, 1921, her salary was increased to $100 a week, by order of the president. The salry of the president was increased from $25 to $50 a week on January 1, 1920. The idea of operating a laundry originated with Mrs. Lotz, and during the early days of petitioner's existence she devoted all of her time to its success and was largely responsible for its growth and prosperity. With the success of the business assured, Mrs. Lotz devoted less time to the details, did less manual labor than formerly, and, during the taxable years in question, spent only a portion of each day at the laundry. Her home was located only a few feet from the plant and it was convenient for her to come over from time to time during the day, as occasion demanded, and this was her practice. Her duties consisted of supervising the assorting2386 of the laundry as it came in and investigating and settling complaints, and, during periods when her husband was sick, she took active charge and managed the business. The sums paid to Mrs. Lotz for salary were reported by her in her income-tax returns and tax paid thereon. *47 The amount paid to Mrs. Lotz by the petitioner during the taxable years 1919 to 1922, inclusive, was compensation and constitutes an allowable deduction from petitioner's gross income for the respective years in which paid. Order of redetermination will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623272/	WILLIAM A. AND GAYLE T. COOK, DONORS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCook v. CommissionerNo. 257-99United States Tax Court115 T.C. 15; 2000 U.S. Tax Ct. LEXIS 45; 115 T.C. No. 2; July 25, 2000, Filed 45 To reflect the foregoing, An Order will be issued denying petitioners' Motion for Partial Summary Judgment and granting respondent's Motion for Partial Summary Judgment. H and W, husband and wife, each created two trusts intended to qualify as grantor retained annuity trusts (GRAT's) under sec. 2702, I.R.C. The grantor in each trust retained an annuity for a stated number of years. If the grantor dies before the expiration of the stated term of years and is survived by a spouse, the annuity continues for the spouse until the earlier of his or her death or the expiration of an additional specified term. If the grantor dies before the expiration of the stated term of years and is not survived by a spouse, the term of the annuity ends upon the death of the grantor. In each trust, the grantor has reserved the power to revoke the interest of the spouse. Ps contend that the value of the remainder interest in each GRAT, of which the grantor made a taxable gift, is the value of the transfer in trust, reduced by the actuarially determined46 value of a dual-life annuity under sec. 7520, I.R.C. R contends that the remainder value is to be calculated by deducting the actuarially determined value of a single-life annuity. HELD: Because the spousal interests in each GRAT are not fixed and ascertainable at the inception of the GRAT and are therefore contingent, and because the retained interests in each GRAT may extend beyond the shorter of a term of years or the period ending upon the death of the grantor, the retained interests in the GRAT's are to be valued as single-life annuities. See secs. 25.2702-3(d)(3) and 25.2702-2(a)(5), Gift Tax Regs. George N. Harris, Jr., and Juan D. Keller, for petitioners.Stewart Todd Hittinger, for respondent. Nims, Arthur L., III NIMS16 OPINIONNIMS, JUDGE: This matter is before the Court on the parties' cross-motions for partial summary judgment, filed pursuant to Rule 121. The parties seek a summary adjudication regarding the same matter; i.e., the proper application of section 2702 to four grantor retained annuity trusts (GRAT's). There is no genuine47 issue of material fact to preclude a decision on such matter. We therefore proceed to decide the legal issues that the parties' motions present.Unless otherwise indicated, all section references are to sections of the Internal Revenue Code, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.BACKGROUNDPetitioners resided in Bloomington, Indiana, at the time their petition was filed with the Court.The following is a summary of the relevant facts. They are stated solely for the purpose of deciding the pending cross-motions for partial summary judgment, and they are not findings of fact for this case. See Fed. R. Civ. P. 52(a); Rule 1(a).THE CREATION OF THE TRUSTSOn June 7, 1993, petitioner William A. Cook (Mr. Cook) created the William A. Cook 1993 grantor retained annuity trust and transferred 12,600 shares of Class A common stock of Cook Group, Inc., to such trust. On the same day, petitioner Gayle T. Cook (Mrs. Cook) created the Gayle T. Cook 1993 grantor retained annuity trust and transferred 12,600 shares of Class A common stock of Cook Group, Inc., to such trust.On August 30, 1995, Mr. Cook created the William A. Cook 1995 grantor48 retained annuity trust and transferred 14,360 shares of Class A common stock of Cook Group, Inc., effective August 31, 1995, to such trust. On the same day, Mrs. Cook 17 created the Gayle T. Cook 1995 grantor retained annuity trust and transferred 11,300 shares of Class A common stock of Cook Group, Inc., effective August 31, 1995, to such trust.Petitioners were named as cotrustees for each of the GRAT's. Each GRAT also provides that it is intended to be a grantor retained annuity trust, paying a qualified annuity interest under section 2702(b)(1), and that the trust instrument should be interpreted accordingly. Further, each GRAT specifies that the trustee shall amend the trust if necessary to satisfy the requirements of the law in order to ensure that the annuity interest qualifies as a qualified annuity interest under section 2702(b).THE 1993 GRAT'sEach of the 1993 GRAT's provides for annual payments equal to 23.999 percent of the initial value of the trust corpus, referred to in each GRAT as the Annuity Amount. The Annuity Amount is to be paid to the grantor for a term of 5 years or until the grantor's earlier death. During that time, no distribution of trust income or principal49 may be made to any other person.Each of the 1993 GRAT's also provides that if the grantor survives the 5-year term, then the remaining trust property shall be used to establish a separate trust for the grantor's son. However, if the trust ends by reason of the grantor's death before the expiration of the 5-year term, all remaining trust property shall be disposed of under a Contingent Marital Annuity Trust (CMAT) intended to qualify for the Federal estate tax marital deduction for the grantor's estate. Under the CMAT, the grantor's spouse will receive any Annuity Amount that would have been paid to the grantor if the grantor had survived the remainder of the 5-year term of the GRAT. Upon the earlier of the expiration of the 5-year term or the death of the grantor's spouse, the remaining trust assets will be used to establish a separate trust for the grantor's son.Mr. Cook's 1993 GRAT provides that Mrs. Cook would have certain powers to appoint income and principal of the GRAT to and among the grantor's son, Carl, members of his family, "and Charities", but that any exercise of such powers would not take effect unless Mr. Cook survived the term of the 18 GRAT. Mr. Cook's 1993 GRAT50 also provides that Mrs. Cook would have certain powers of appointment with respect to the income and principal of the CMAT, but the GRAT mandates that no distributions may be made from the CMAT to any other person during the life of Mrs. Cook.Mrs. Cook's 1993 GRAT provides that Mr. Cook would have certain powers of appointment with respect to the income and principal of the CMAT, but the GRAT also states that no distributions may be made from the CMAT to any other person during the life of Mr. Cook.Each of the 1993 GRAT's is irrevocable in all respects except that the grantor retains the right to revoke the designation of his or her spouse as the successor annuitant. If the grantor should revoke the spouse's designation as the successor annuitant, then the terms of the trust agreement are to be applied as if the spouse had predeceased the grantor.THE 1995 GRAT'sEach of the 1995 GRAT's provides for annual payments, referred to as the Annuity Amount, to be paid to the grantor during the Annuity Term. The Annuity Term for Mr. Cook's 1995 GRAT is 3 years, and the Annuity Term for Mrs. Cook's 1995 GRAT is 5 years. In the case of Mr. Cook's 1995 GRAT, the Annuity Amount is the fair51 market value of the initial assets of such trust as of the date of transfer, as finally determined for Federal tax purposes, multiplied by .3175, .3810, and .4572, for year 1 through year 3, respectively. In the case of Mrs. Cook's 1995 GRAT, the Annuity Amount is the fair market value of the initial assets of such trust as of the date of transfer, as finally determined for Federal tax purposes, multiplied by .168940, .202728, .2432736, .2919283, and .3503139, for year 1 through year 5, respectively.Each of the 1995 GRAT's provides that during the Annuity Term of the trust no distribution of trust income or principal may be made to any person other than the grantor.If the grantor of each 1995 GRAT survives the Annuity Term, then any remaining trust property, after payment of the Annuity Amount, shall be used to establish a separate trust for the grantor's son. If, however, either of the 1995 GRAT's ends by reason of the death of the grantor and the 19 grantor is survived by his or her spouse, then the remaining trust property shall be disposed of under a CMAT.Each of the 1995 GRAT's provides for annuity payments under the CMAT to the grantor's spouse, referred to as Spousal Annuity52 Amounts, for the shorter of a term of years (3 years under Mr. Cook's 1995 GRAT and 5 years under Mrs. Cook's 1995 GRAT) after the grantor's death or until the spouse's earlier death. The Spousal Annuity Amount that would be payable to the grantor's spouse under the CMAT during the initial 3 years under Mr. Cook's 1995 GRAT and during the initial 5 years under Mrs. Cook's 1995 GRAT is the same "Annuity Amount that would have been determined with respect to * * * [the grantor] if * * * [the grantor] had survived." Under the CMAT provisions, no distributions may be made from the CMAT to any other person during the spouse's life. The spouse has a testamentary power of appointment with respect to any remaining trust property, including any remaining payments of the Spousal Annuity Amount or of income.Each 1995 GRAT is irrevocable except that the grantor retains the right to revoke the designation of his or her spouse as the successor annuitant. If the grantor revokes the spouse's designation as the successor annuitant, then the terms of the trust agreement are to be applied as if the spouse had predeceased the grantor.PETITIONERS' GIFT TAX RETURNSEach petitioner timely filed53 a Federal gift tax return for the taxable years 1993 and 1995. Each petitioner reported the value of the transfers to their respective GRAT's by subtracting from the value of the transferred property the value of an annuity based on two lives successively; i.e., the value of a stream of fixed annual payments for the shorter of either a term of years (5 years for both of the 1993 GRAT's and Mrs. Cook's 1995 GRAT, and 3 years for Mr. Cook's 1995 GRAT) or a period ending upon the death of the last to die of the grantor and the grantor's spouse.THE NOTICES OF DEFICIENCYRespondent issued notices of deficiency to Mrs. Cook for the taxable years 1993 and 1995 determining deficiencies in 20 Federal gift taxes in the amounts of $ 2,789,609 and $ 4,850,271, respectively. Respondent issued notices of deficiency to Mr. Cook for the taxable years 1993 and 1995 determining deficiencies in Federal gift taxes in the amounts of $ 3,271,125 and $ 4,446,282, respectively. A portion of the deficiency for each year and for each petitioner is attributable to respondent's analysis of the retained annuity in each trust, and a determination that the value of the annuity retained by each grantor should be54 calculated based on the shorter of a fixed term or the earlier death of the grantor.DISCUSSIONI. GENERAL RULESSection 2501 imposes a tax for each calendar year on the transfer of property by gift by any taxpayer. Pursuant to section 2512, the value of the transferred property as of the date of the gift "shall be considered the amount of the gift". Generally, where property is transferred in trust but the donor retains an interest in such property, the value of the gift is the value of the property transferred, less the value of the donor's retained interest. See sec. 25.2512-5A(e), Gift Tax Regs.; sec. 25.2512-5T(d)(2), Temporary Gift Tax Regs., 64 Fed. Reg. 23224 (Apr. 30, 1999). However, if the gift in trust is to a family member (as defined in section 2704(c)(2)), the value of the gift is determined subject to the limitations of section 2702. See id.In the case at bar, petitioners assert that each grantor's retained interest is to be valued as a single annuity based on two lives, referred to as a dual-life annuity. Respondent asserts that each grantor's retained interest is to be valued as a single-life annuity. Valuation of a retained interest as a dual-life55 annuity produces a greater retained value than valuation as a single-life annuity, and correspondingly reduces the amount of the taxable gift of the remainder. Respondent disagrees with this result.As pertinent herein, section 2702 provides: SEC. 2702. SPECIAL VALUATION RULES IN CASE OF TRANSFERS OF INTERESTS IN TRUSTS. (a) Valuation Rules. -- (1) In general. -- Solely for purposes of determining whether a transfer of an interest in trust to (or for the benefit of) a member of the 21 transferor's family is a gift (and the value of such transfer), the value of any interest in such trust retained by the transferor or any applicable family member * * shall be determined as provided in paragraph (2). (2) Valuation of retained interests. -- (A) In general. -- The value of any retained interest which is not a qualified interest shall be treated as being zero. (B) Valuation56 of qualified interest. -- The value of any retained interest which is a qualified interest shall be determined under section 7520 [providing for use of valuation tables prescribed by the Secretary for annuities, life interests, etc.]. (3) Exceptions. -- (A) In general. -- This subsection shall not apply to any transfer -- (i) if such transfer is an incomplete gift, * * * * * * (B) Incomplete gift. -- For purposes of subparagraph (A), the term "incomplete gift" means any transfer which would not be treated as a gift whether or not consideration was received for such transfer. (b) Qualified Interest. -- For purposes of this section, the term "qualified interest" means -- (1) any interest which consists of the right to receive fixed amounts payable57 not less frequently than annually, (2) any interest which consists of the right to receive amounts which are payable not less frequently than annually and are a fixed percentage of the fair market value of the property in the trust (determined annually), and (3) any noncontingent remainder interest if all of the other interests in the trust consist of interests described in paragraph (1) or (2).Beyond the definitions of "qualified interest" contained in section 2702(b), regulations promulgated under section 2702 define, and expand, "qualified interest" in the following manner: Qualified interest means a qualified annuity interest, a qualified unitrust interest, or a qualified remainder interest. RETENTION OF A POWER TO REVOKE A QUALIFIED ANNUITY INTEREST (OR UNITRUST INTEREST) OF THE TRANSFEROR'S SPOUSE IS TREATED AS THE RETENTION OF A QUALIFIED ANNUITY INTEREST (OR UNITRUST INTEREST). [Sec. 25.2702-2(a)(5), Gift Tax Regs.; emphasis added.]A "qualified annuity58 interest" is "an irrevocable right to receive a fixed amount", "payable to (or for the benefit of) the holder of the annuity interest for each taxable year of the term." Sec. 25.2702-3(b)(1)(i), Gift Tax Regs. A fixed amount is either a stated dollar amount or a fixed fraction or percentage (not to exceed 120 percent of the fixed fraction or percentage payable in the preceding year) of the initial fair market value of the property transferred to the trust as 22 finally determined for Federal tax purposes. See sec. 25.2702-3(b)(1)(ii), Gift Tax Regs. In either case, a fixed amount must be payable periodically but not less frequently than annually. See id.The trust instrument must also prohibit distributions from the trust to or for the benefit of any person other than the holder of the qualified annuity interest during the term of the qualified interest. See sec. 25.2702-3(d)(2), Gift Tax Regs. The term of the annuity interest must be fixed by the trust instrument for the life of the term holder, for a specified term of years, or for the shorter (but not the longer) of those periods. See sec. 25.2702-3(d)(3), Gift Tax Regs.For purposes of section 2702, a transfer of an interest in59 property with respect to which there are one or more term interests is treated as a transfer in trust. See sec. 2702(c)(1). A term interest is one of a series of successive (as contrasted with concurrent) interests. See sec. 25.2702-4(a), Gift Tax Regs.II. APPLICATIONAs previously stated, section 2702 contains special valuation rules for transfers of interests in trusts to family members. In this case, we proceed on the assumption that each trust creates interests which consist of the right to receive fixed amounts which are payable at least annually, as required by section 2702(b)(1), and that the remainder interest created for the son (a "member of the family" under sections 2702(e) and 2704(c)(2)), is noncontingent, as required by section 2702(b)(3). Consequently, the value of any interest retained by the grantor or "any applicable family member" must be determined under the special valuation rules of section 2702. As provided in section 2702(a)(2)(A), the value of any retained interest "which is not a qualified interest shall be treated as being zero."Respondent agrees that each grantor's retained annuity to the extent it is for a term of years or the grantor's earlier death60 constitutes a qualified interest. Respondent, however, challenges the provision of each trust which continues the annuity for the spouse, if the spouse survives the grantor, for the remaining term of the trust or until the spouse's earlier death. 23 We agree with respondent that as to each trust, the interest retained in favor of the grantor's spouse, whether viewed as an independent interest or as an expansion of the grantor's interest, is not qualified and therefore must be valued at zero. Thus, we reject petitioners' contention that they are entitled to value each grantor's retained interest as an annuity based on two lives.We first consider the nature of the spousal interests themselves. In the trusts before us, the spousal interests are contingent upon surviving the grantor, so they may never take effect. We, however, do not believe section 2702 permits a transferor to reduce the value of a remainder interest by the simple expedient of assigning a value to a retained interest which may, in fact, never take effect.As indicated above, the regulations provide that "The governing instrument must fix the term of the annuity or unitrust interest." Sec. 25.2702-3(d)(3), Gift Tax Regs. 61 We construe this language to require that the term be fixed and ascertainable at the creation of the trust. The regulations contain two examples which illustrate this requirement, as follows: EXAMPLE 5. A transfers property to an irrevocable trust, retaining the right to receive 5 percent of the net fair market value of the trust property, valued annually, for 10 years. If A dies within the 10-year term, the unitrust amount is to be paid to A's estate for the balance of the term. A's interest is a qualified unitrust interest to the extent of the right to receive the unitrust payment for 10 years or until A's prior death. EXAMPLE 6. The facts are the same as in Example 5, except that if A dies within the 10-year term the unitrust amount will be paid to A's estate for an additional 35 years. The result is the same as in Example 5, because the 10-year term is the only term that is fixed and ascertainable at the creation of the interest. [Sec. 25.2702-3(e), Example (5) and Example (6), Gift Tax Regs.]In each of these examples, only the retained62 interest for the shorter of a term of years or the transferor's life is fixed and ascertainable at the creation of the interest, and is therefore a qualified interest under section 2702. In Example (5) and Example (6) above, the unitrust interests that may be paid to A's estate are both contingent upon A's death before the completion of the 10-year fixed term, and are therefore not qualified interests. In the trusts before us, the spousal interests are not fixed and ascertainable at the creation 24 of the trusts but, rather, are contingent in each case upon the spouse's surviving the grantor. For this reason, the spousal interests are not qualified interests and therefore must be valued as zero under section 2702(a)(2)(A).Legislative history reflects that Congress was "concerned about potential estate and gift tax valuation abuses", specifically, "undervaluation of gifts valued pursuant to Treasury tables." 136 Cong. Rec. S15629, S15680-S15681 (daily ed. Oct. 18, 1990). As explained by the lawmakers in the context of trusts and term interests in property: "Because the taxpayer decides what property to give, when to give it, and often controls the return on the property, use of Treasury63 tables undervalues the transferred interests in the aggregate, more often than not." Id. at S15681. Hence, a statute was enacted which Congress intended would "deter abuse by making unfavorable assumptions regarding certain retained rights." Id. at S15680.This congressional purpose is advanced by a rule which ensures that only value that is fixed and ascertainable at the creation of the trust, and therefore is not contingent, may reduce the value of the gift of the remainder. In contrast, if gifts in trust may be reduced by the value of spousal interests which are contingent and which in fact never take effect, the retained interests have the potential for overvaluation and the gift of the remainder for undervaluation. We are satisfied that such would be contrary to the intent of section 2702.Moreover, even if we were to assume that the spousal interests here, standing alone, were qualified, the retained annuities to the extent based on two lives would fail to achieve qualified status for an additional reason. As previously noted, the regulations provide that retention of a power to revoke a qualified annuity interest (or unitrust interest) of the transferor's spouse is treated64 as the retention of a qualified annuity interest (or unitrust interest). See sec. 25.2702-2(a)(5), Gift Tax Regs. In each of the trusts under scrutiny, however, if the interest over which the grantor has retained a power to revoke is treated as an interest retained by the grantor, the requirement of section 25.2702-3(d)(3), Gift Tax Regs., that the term of the annuity must be the lesser of a term of years or the life of the term holder has not been met. Under the trust terms the spousal interests 25 create the possibility that the retained annuity will extend beyond the life of the term holder; i.e., the grantor. Section 25.2702-3(d)(3), Gift Tax Regs., precludes this result.In contrast, the regulations contain examples of how revocable spousal annuity or unitrust interests may meet the standards of qualified interests under section 2702(b)(1) and sections 25.2702-1 and 25.2702-2, Gift Tax Regs. Section 25.2702- 2(d)(1), Example (6) and Example (7), Gift Tax Regs. (hereinafter Examples 6 and 7), demonstrates both how a revocable spousal interest may be properly fixed and ascertainable and how the total retained interest of the grantor and spouse may satisfy65 the durational requirement. Examples 6 and 7, which illustrate petitioners' noncompliance with these standards, are as follows: EXAMPLE 6. A transfers property to an irrevocable trust, retaining the right to receive the income for 10 years. Upon expiration of 10 years, the income of the trust is payable to A's spouse for 10 years if living. Upon expiration of the spouse's interest, the trust terminates and the trust corpus is payable to A's child. A retains the right to revoke the spouse's interest. Because the transfer of property to the trust is not incomplete as to all interests in the property (i.e., A has made a completed gift of the remainder interest), section 2702 applies. A's power to revoke the spouse's term interest is treated as a retained interest for purposes of section 2702. Because no interest retained by A is a qualified interest, the amount of the gift is the fair market value of the property transferred to the trust. EXAMPLE 7. The facts are the same as in Example 6, except that both the term interest retained by66 A and the interest transferred to A's spouse (subject to A's right of revocation) are qualified annuity or unitrust interests. The amount of the gift is the fair market value of the property transferred to the trust reduced by the value of both A's qualified interest and the value of the qualified interest transferred to A's spouse (subject to A's power to revoke).In Example 6, the transfer of property to the trust is not incomplete as to all interests in the property and section 2702 therefore applies (i.e., the gift of the remainder is a completed gift), but the retained interests -- both A's and the spouse's -- are nevertheless not qualified interests because the retained rights are rights to receive trust income, not annuity or unitrust amounts.Conversely, in Example 7, A's interest and the revocable spousal interest are deemed to meet the requirements for qualified status. Under section 25.2702-2(a)(5), Gift Tax Regs., A's power to revoke the spouse's interest is treated as 26 an interest retained by A. The interests of both A and his or her spouse, at the creation of the trust, are fixed and ascertainable, and not contingent upon67 A's death. A is deemed to have retained interests, the total term of which is 20 years. Both interests are thus properly taken into account in valuing the remainder.Therefore, because the spousal interests in each GRAT in the case before us are not fixed and ascertainable at the inception of the GRAT, and are therefore contingent, and because the retained interests may extend beyond the shorter of a term of years or the period ending upon the death of the grantor, we hold that the retained interests in the trusts at issue here are to be valued as single-life annuities. See secs. 25.2702-3(d)(3) and 25.2702-2(a)(5), Gift Tax Regs. We sustain respondent's determinations to that effect.We have considered other arguments made by the parties, and to the extent not addressed, we find them to be unconvincing, irrelevant, or moot.To reflect the foregoing, An Order will be issued denying petitioners' Motion for Partial Summary Judgment and granting respondent's Motion for Partial Summary Judgment.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623273/	WILLIAM AND GEORGEANE S. POPLAR, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPoplar v. CommissionerDocket No. 19346-88United States Tax CourtT.C. Memo 1995-337; 1995 Tax Ct. Memo LEXIS 343; 70 T.C.M. (CCH) 168; July 26, 1995, Filed 343 Decision will be entered under Rule 155. For petitioners: Gino Pulito. For respondent: John Aletta. ARMENARMENMEMORANDUM FINDINGS OF FACT AND OPINION ARMEN, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b) and Rules 180 et seq. 1Respondent determined deficiencies in, and additions to, petitioners' Federal income taxes for the taxable years 1980, 1981, and 1983 as follows: Additions to TaxSec. Sec. Sec. Sec. YearDeficiency6653(a) 6653(a)(1)6653(a)(2)6659(a) 1980$ 4,800.00$ 240-- --$ 1,440.0019814,230.42--$ 211.5311,269.1619832,837.70--141.892851.31344 Respondent also determined that petitioners are liable for the increased rate of interest under section 6621(c), formerly section 6621(d), for each of the taxable years in issue. Petitioners have conceded the deficiencies in income taxes. Accordingly, the only issues for decision are whether petitioners are liable for: (1) Additions to tax for negligence under sections 6653(a), 6653(a)(1), and 6653(a)(2); (2) additions to tax for a valuation overstatement under section 6659(a); and (3) the increased rate of interest under section 6621(c). FINDINGS OF FACT Some of the facts have been stipulated, and they are so found. At the time that the petition was filed, petitioners resided in Amherst, Ohio. By Order dated January 11, 1994, the Court granted respondent's motion for sanctions and imposed sanctions on petitioners under Rule 104(c). The Court took this action because of petitioners' failure to comply with the Court's Order dated November 29, 1993, granting respondent's motion to compel responses to respondent's interrogatories and directing petitioners to provide answers to said interrogatories. 2 Therefore, only extremely limited testimony was offered by petitioners at trial, 345 and our record is limited to that testimony, to the Stipulation of Facts (and the exhibits attached thereto), to respondent's expert witness report, and to the testimony of respondent's expert witness. Petitioner William Poplar (petitioner) obtained a bachelor's degree from Ohio State University and an MBA from the University of Dayton. During 1983, petitioner was employed as an engineer. During that same year, petitioner Georgeane S. Poplar was employed as a school teacher. Prior to December 23, 1983, petitioners entered into a joint venture with John and Margaret Petrasek, using the name Petrasek & Poplar Joint Venture. Saxon Energy Corporation (Saxon) was a corporation formed in 1981 to lease energy management systems to the public. See Schillinger v. Commissioner, T.C. Memo. 1990-640,346 affd. per order 1 F.3d 954">1 F.3d 954 (9th Cir. 1993)(discussing the Saxon Energy program in some detail). Petitioners obtained no documents pertaining to their prospective Saxon investment 3 from anyone other than Thomas A. Graham (Graham) of Graham & Associates, Inc. (Graham & Associates). The documents received from Graham by petitioners included a document entitled "Frequently Asked Questions About the Energy Brain/Fuel Optimiser Equipment Leasing Program" and another document entitled "Saxon Energy Corp. Energy Brain/Fuel Optimiser Equipment Leasing Program Information Memorandum" (the Information Memorandum). Both documents contained limited information regarding the energy management systems and a comparatively extensive amount of information regarding the potentially favorable tax consequences of leasing such a system. On December 23, 1983, petitioner completed a document entitled "Lessee's Qualification Questionnaire". On347 that same date, Graham completed a document entitled "Business Advisor's Questionnaire". An Agreement of Lease (the lease) was entered into on December 23, 1983, between petitioners as lessees and Saxon as lessor, for a one-half interest in an Energy Brain/Fuel Optimiser System A-1 (the Energy Brain System), an energy management device. The term of the lease was 20 years. The other one-half interest in the Energy Brain System was leased by John and Margaret Petrasek. Under the terms of the lease, petitioners were required to pay, and did in fact pay, an advanced guaranteed rental for the period December 31, 1983 through December 31, 1984 in the amount of $ 6,750 for their one-half interest in the Energy Brain System. Afterwards, a document entitled "Election to Pass Investment Tax Credits from Lessor to Lessee" was executed by petitioners. This document was not signed by any Saxon representative. A Certificate of Insurance for the Petrasek & Poplar Joint Venture's Energy Brain System named Saxon as the insured. The policy expiration date was December 1, 1984. Petitioners also received an insurance binder for the Energy Brain System which reflected coverage on their investment through348 December 1, 1984. Petitioners never intended to use the Energy Brain System themselves. Instead, petitioners were to engage a management company, which would locate an end-user. The end-user would pay for the Energy Brain System by splitting the amount of energy savings with petitioners. The management company was to retain a fee of 15 percent of petitioners' share of the energy savings and remit the balance to petitioners. Petitioners were then required to pay Saxon 75 percent of the remaining net income. Susan Haselhorst (Ms. Haselhorst) is an expert in the fields of energy management systems, design engineering evaluation methods, and energy system modeling. She prepared a study for respondent entitled "An Assessment of the Fair Market Value and the Profit Potential of the Energy Brain 1983A, 1 through 4" (the Study). The preparation of the Study took 120 hours and utilized four experts who hold degrees in areas such as engineering and accounting. The cost of conducting the Study was approximately $ 15,000. In evaluating the fair market value and the profit potential of the Energy Brain System, Ms. Haselhorst considered, among other things, the Information Memorandum and other349 promotional literature, the terms of the lease entered into by petitioners and Saxon, and publicly available trade catalogues and magazines. She also had an opportunity to examine an Energy Brain/Fuel Optimiser System A-1, as well as energy management systems being marketed by other companies. On the basis of the Study, Ms. Haselhorst concluded that the fair market value of the Energy Brain System did not exceed $ 795. She also concluded, on the basis of the Study, that over a 10-year period an individual leasing the Energy Brain System would incur an economic loss of $ 50,000. Petitioners do not dispute these conclusions. We think the conclusions are supportable and we adopt them as our own. See Schillinger v. Commissioner, supra.During 1982 and 1983, there were many products comparable to the Energy Brain System being marketed because of the nation's energy conservation needs. Energy management systems were available at the retail level for prices ranging from a few hundred dollars to hundreds of thousands of dollars. The variation in prices of energy management systems was the result of differences in the number of functions controlled by 350 each such system. For example, a more elaborate system would control heating, air conditioning, lighting, and ventilation. Such a system would likely also serve other purposes, such as security, fire protection, and various other monitoring functions. The Energy Brain System controlled only heating, a fact that was indicated in the Information Memorandum. Accordingly, it would properly have been considered a relatively low-end model. Petitioners timely filed their income tax returns for the taxable years 1980, 1981, and 1983. On Form 3468 (Computation of Investment Credit) attached to their 1983 income tax return, petitioners claimed a value of $ 102,500 for their one-half interest in the Energy Brain System. On the basis of that valuation, they claimed an investment credit of $ 10,250. 4Petitioners also attached a Schedule C in respect of their Saxon investment to351 their 1983 return. On the Schedule C, petitioners claimed as deductions a number of expenses, including lease expenses of $ 6,750. Petitioners reported no gross receipts or sales in respect of the Saxon investment on the Schedule C. On a Form 1045, Application for Tentative Refund, filed with respondent, petitioners claimed investment credit carrybacks pertaining to their Saxon investment to the taxable years 1980 and 1981 in the amounts of $ 4,800.00 and $ 4,230.42, respectively. As previously indicated, petitioners concede the deficiencies in income taxes for the taxable years in issue. We need therefore only decide whether petitioners are liable for: (1) Additions to tax for negligence; (2) additions to tax for a valuation overstatement; and (3) the increased rate of interest under section 6621(c). OPINION Petitioners bear the burden of proof as to each of the additions to tax and as to the increased rate of interest. Rule 142(a); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972). By failing to comply with respondent's discovery request and the Court's Order directing them to provide answers to respondent's interrogatories, petitioners have increased352 the burden on themselves immeasurably. As a consequence of their intractability during the discovery process, petitioners deprived themselves of the opportunity to introduce more than a limited amount of evidence at trial. We begin with the additions to tax for negligence, the primary issue in this case. Section 6653(a) for 1980 and section 6653(a)(1) for 1981 and 1983 impose an addition to tax in the amount of 5 percent of the underpayment if any portion of the underpayment is due to negligence or intentional disregard of the rules or regulations. For 1981 and 1983, section 6653(a)(2) imposes an addition to tax in an amount equal to 50 percent of the interest due on the portion of the underpayment attributable to negligence. Negligence is defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). In order to prevail on the issue of negligence, petitioners are obliged to prove that their actions in connection with the Saxon transaction were reasonable in light of their experience and the nature of the investment. See Henry Schwartz Corp. v. Commissioner, 60 T.C 728, 740 (1973).353 Within this framework, petitioners may prevail if they reasonably relied on competent professional advice. Freytag v. Commissioner, 501 U.S. 868">501 U.S. 868 (1991). As indicated in their brief, "Petitioners dispute the additions to tax since they reasonably relied on the financial, investment and tax advice given to them by individuals who held themselves out to the public as experts in these areas." However, in order for reliance on professional advice to excuse a taxpayer from additions to tax for negligence, the reliance must be reasonable, in good faith, and based upon full disclosure. Freytag v. Commissioner, supra.When considering the negligence addition, we evaluate the particular facts of each case, judging the relative sophistication of the taxpayer, as well as the manner in which the taxpayer approached the investment. The limited record in this case indicates that petitioners never obtained information regarding the Energy Brain System from anyone other than Graham. Accordingly, the record supports a conclusion that petitioners chose to rely on Graham. The record in this case, however, is wholly inadequate to permit354 us to conclude that petitioners' reliance was reasonable, was in good faith, and was based on full disclosure. No evidence was introduced that would enable us to determine petitioners' level of sophistication with respect to investment decisions, nor was any evidence introduced that would enable us to determine why petitioners chose to rely solely upon Graham rather than conduct an independent investigation, either on their own or through a disinterested adviser, of the Energy Brain System and its value as an investment. Consequently, we are bound to sustain respondent's determination with respect to the additions to tax for negligence for each of the taxable years in issue. We turn now to the addition to tax for a valuation overstatement. Such an addition to tax may be imposed if an underpayment of tax attributable to a valuation overstatement equals or exceeds $ 1,000. Sec. 6659(a), (d). A valuation overstatement exists if the value of any property or the adjusted basis of any property claimed on a return is 150 percent or more of the amount determined to be the correct amount of such valuation or adjusted basis. Sec. 6659(c)(1). In the event that the reported value exceeds 250355 percent of the correct value, an addition to tax of 30 percent of the underpayment of tax attributable to such overstatement is imposed. Sec. 6659(b). Section 6659 does not apply, however, to underpayments of tax that are not attributable to valuation overstatements. Todd v. Commissioner, 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912">89 T.C. 912 (1987)(where taxpayers were not entitled to claimed investment tax credits because property was not placed in service during the years in issue, the underpayment was not attributable to a valuation overstatement). On their 1983 income tax return, petitioners claimed a value of $ 102,500 for their one-half interest in the Energy Brain System. On the basis of that valuation, petitioners claimed an investment tax credit of $ 10,250 and utilized $ 1,219.58 of that amount to reduce their reported income tax liability for 1983 to zero. They also claimed as deductions a number of expenses relating to the Saxon investment, including lease expenses of $ 6,750. On a Form 1045, Application for Tentative Refund, filed with respondent, petitioners claimed investment credit carrybacks pertaining to their 356 Saxon investment to the taxable years 1980 and 1981 in the amounts of $ 4,800.00 and $ 4,230.42, respectively. On the basis of respondent's expert's Study, we have concluded that the fair market value of the Energy Brain System did not exceed $ 795. Therefore, petitioners' valuation of the Energy Brain System constitutes a valuation overstatement. Sec. 6659(c)(1). We must now decide whether the deficiency in income tax for each of the taxable years in issue is attributable to the valuation overstatement. Sec. 6659(a); see, e.g., Gilman v. Commissioner, 933 F.2d 143">933 F.2d 143, 151 (2d Cir. 1991), affg. T.C. Memo. 1990-205; Massengill v. Commissioner, 876 F.2d 616">876 F.2d 616, 619-620 (8th Cir. 1989), affg. T.C. Memo 1988-427">T.C. Memo. 1988-427; Todd v. Commissioner, supra; Urbanski v. Commissioner, T.C. Memo. 1994-384. 5357 Part of the deficiency for 1983, as well as the deficiencies for 1980 and 1981, resulted from the disallowance of the investment tax credits claimed by petitioners with respect to their 1983 Saxon investment. Nonetheless, as discussed below, we hold that no part of the deficiency for any of the years in issue is attributable to the valuation overstatement because a valid election to transfer the investment tax credits from lessor to lessee was never executed. Sec. 48(d)(1); Todd v. Commissioner, supra; Kerry v. Commissioner, 89 T.C. 327">89 T.C. 327 (1987); sec. 1.48-4(f), Income Tax Regs.After paying an advanced guaranteed rental fee of $ 6,750 for their one-half interest in the Energy Brain System for the period December 31, 1983 through December 31, 1984, petitioners executed a document entitled "Election to Pass Investment Tax Credits from Lessor to Lessee". This document, however, was not signed by any Saxon representative. Section 48(d)(1) provides, in relevant part: A person * * who is a lessor of property may (at such time, in such manner, and subject to such conditions as are provided by regulations prescribed by the Secretary) elect * 358 * to treat the lessee as having acquired such property * * The regulations promulgated under section 48(d)(1) provide, also in relevant part: The election of a lessor with respect to a particular property (or properties) shall be made by filing a statement with the lessee, signed by the lessor and including the written consent of the lessee, containing the following information * * [Sec. 1.48-4(f), Income Tax Regs.; emphasis added].Although petitioners attempted to execute an election in accord with section 48(d), no Saxon representative signed the form entitled "Election to Pass Investment Tax Credits from Lessor to Lessee". In Kerry v. Commissioner, supra, the Court held that in the absence of strict compliance with the regulations, a valid election to transfer the investment tax credit from lessor to lessee could not occur. Because the regulations require that the lessor actually sign a statement electing to transfer the investment tax credit to the lessee, no valid election was made in this instance. Accordingly, the disallowance of petitioners' claimed investment tax credit with respect to the 1983 Saxon transaction 359 must be based upon the fact that no valid election occurred. Consequently, the underpayments resulting from the disallowance of the investment tax credits are not attributable to the valuation overstatement which exists for each of the years in issue. Sec. 6659(a); Todd v. Commissioner, supra.In view of the foregoing, we do not sustain respondent's determination that petitioners are subject the addition to tax under section 6659(a). We note, however, that "Congress is, of course, * * free to change the result in cases such as this by imposing additions to tax or additional interest on underpayments attributable to transactions 'accompanied by a valuation overstatement'". Todd v. Commissioner, 89 T.C. 912">89 T.C. 912, 921-922 (1987), affd. 862 F.2d 540">862 F.2d 540 (5th Cir. 1988). Finally, section 6621(c) provides for an increased rate of interest with respect to any underpayment in excess of $ 1,000 which is "attributable to 1 or more tax-motivated transactions". Sec. 6621(c)(1) and (2). The increased rate of interest applies to interest accruing after December 31, 1984. See DeMartino v. Commissioner, 88 T.C. 583">88 T.C. 583, 589 (1987),360 affd. 862 F.2d 400">862 F.2d 400 (2d Cir. 1988)(the increased rate of interest applies to interest accruing after December 31, 1984, even though the transaction in question was entered into before the date of enactment of section 6621(c)). Respondent determined that petitioners were liable for increased interest because the underpayments for the years in issue were attributable to a tax-motivated transaction. Petitioners failed to produce any evidence to counter respondent's determination. Indeed, the factual evidence introduced supports the conclusion that the underpayments for the years in issue are attributable to a tax-motivated transaction. See section 6621(c)(3)(A)(v), (B); section 301.6621-2T, Temporary Proced. & Admin. Regs.; 49 Fed. Reg. 50390 (Dec. 28, 1984). Nevertheless, we are unable to sustain in full respondent's determination. Rather, we hold that petitioners are liable for the increased rate of interest only in respect of that portion of the underpayment for 1983 that is attributable to the disallowed Schedule C deductions. 6 Petitioners are not liable for the increased rate of interest for either 1980 and 1981 or on that 361 portion of the underpayment for 1983 that is attributable to the disallowed investment credit. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 857-860 (1989). To reflect our disposition of the disputed issues, as well as petitioners' concessions, Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩1. 50 percent of the statutory interest due on the amount of the deficiency attributable to negligence in the amount of $ 4,230.42 for 1981.↩2. 50 percent of the statutory interest due on the amount of the deficiency attributable to negligence in the amount of $ 2,837.70 for 1983.↩2. The Court's Order dated Nov. 29, 1993, expressly warned petitioners that if they did not fully comply with its provisions, the Court would impose sanctions pursuant to Rule 104, which could include dismissal of the case and entry of decision against them.↩3. We use the term "investment" solely for the sake of convenience.↩4. Of this amount, petitioners utilized $ 1,219.58 on their 1983 return in order to reduce their reported income tax liability for that year to zero.↩5. Sec. 6659 applies to returns filed after Dec. 31, 1981. When an item carried back from a later year (such as 1983) to an earlier year (such as 1980 or 1981) is "attributable to" the adjustments in the later year, sec. 6659 may be applied to returns filed before Jan. 1, 1982. Nielsen v. Commissioner, 87 T.C. 779↩ (1986).6. We assume that the portion of the underpayment for 1983 that is attributable to the disallowed Schedule C deductions exceeds $ 1,000, but we leave such matter to the parties as part of their Rule 155 computation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623274/	JERRY D. COONS and MARILYN M. COONS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCoons v. CommissionerDocket No. 1896-80.United States Tax CourtT.C. Memo 1983-777; 1983 Tax Ct. Memo LEXIS 13; 47 T.C.M. (CCH) 767; T.C.M. (RIA) 83777; December 27, 1983. Gerald G. Hawley, for the petitioners. Scott W. Gray, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined a $12,930 deficiency in petitioners' 1975 Federal income taxes. The ultimate issue is whether petitioner may file amended returns for his 1975 taxable year, and for his solely owned Subchapter S corporation's fiscal years ending July 31, 1975 and July 31, 1976. Resolution of this issue turns on whether petitioner, Jerry D. Coons, improperly characterized various transactions between himself and his wholly owned Subchapter S corporation during calendar year 1975. Petitioner has not contested the correctness of respondent's deficiency determination and he apparently concedes that in the event we hold that he may not file amended returns the deficiency determined by respondent is correct. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Jerry D. Coons (hereinafter petitioner) and Marilyn M. Coons, husband and wife, resided in Tucson, Arizona, when they filed their petition in this case. They timely filed joint Federal income tax returns for15 the years in issue with the Internal Revenue Service Center, Ogden, Utah. Throughout the years in issue, petitioner was president and sole shareholder of Automotive Parts and Machine, Inc. (hereinafter Automotive), an accrual basis taxpayer operating on a fiscal year ending July 31. Automotive was organized under the laws of Arizona during November 1970. In August 1971, petitioner loaned Automotive $29,130.11 at ten percent interest on terms calling for monthly interest and principal payments of $150 for ten years followed by a final balloon payment of the balance due. In February 1973, petitioner loaned Automotive an additional $4,000 at ten percent interest, payable in one lump sum of principal and interest ten years from the date the note was executed. During its fiscal years ending July 31, 1973, 1974, and 1975, Automotive elected to be taxed as a small business corporation under the provisions of Subchapter S. 116 On July 28, 1975, a special meeting of Automotive's Board of Directors was held during which the following resolution was adopted: RESOLVED that the corporation terminate its Subchapter S standing effective July 31, 1975; that the President's salary be raised to $3,000 per month beginning August 1, 1975; [and] that the President be given a salary bonus of $14,000 for the year 1975 * * . On July 29, 1975, a check in the amount of $14,000 was issued to petitioner; however, the total bonus including state and Federal income tax withholdings amounted to $18,400. On its U.S. Small Business Corporation Income Tax Return (Form 1120S) for the fiscal year ending July 31, 1975, Automotive deducted $39,640 in compensation paid to petitioner, which amount included the total bonus of $18,400. In addition, Automotive reported the following amounts as income distributions to petitioner: DateCheck No.Amount8-31-74No. 4009$ 5,000.009-9-74No. 402619,500.009-9-74No. 99645,500.0012 74No. 1024025.001-14-75No. 41885,000.004-75No. 43145,235.0040,260.00On its Form 1120 for the fiscal year ending July 31, 1976, Automotive deducted17 $30,835 in compensation paid to petitioner. In addition, Automotive reported the following income distributions to petitioner: DateCheck No.Amount10-13-75No. 11105$21,000.0010-13-75No. 454715,000.00$36,000.00At the time these income distributions were made, petitioner's accountant thought they were distributions of previously taxed income that would generate no taxable income to petitioner pursuant to section 1375(d) and (f). 2During 1978, Revenue Agent Janet Guenzi audited Automotive's returns for the fiscal years ending July 31, 1975 and July 31, 1976. As a result of this examination, respondent determined that Automotive made a $28,404 taxable dividend distribution to petitioner during its fiscal year ending July 31, 1975. 3 During March 1978, Ms. Guenzi advised petitioner of the proposed adjustment to his 1975 personal income tax return. Approximately six months later, during late September and early October 1978, petitioner filed amended returns for Automotive's fiscal years ending July 31, 1975 and18 July 31, 1976, and for his 1975 income tax return 4 to correct alleged errors that had come to light following respondent's audit. On Automotive's amended return for its fiscal year ending July 31, 1975, petitioner recharacterized the following amounts, which originally had been reported as income distributions, as repayment of principal on petitioner's outstanding loans to Automotive: DateCheck No.Amount8-31-74No. 4009$ 5,00012-74No. 1024251-14-75No. 41885,0004-75No. 43145,235$15,26019 In addition, petitioner recharacterized the $18,400 bonus he received during July 1975 as an advance against the bonus due for the following corporate fiscal year beginning August 1, 1975. As a result of these changes, petitioner reduced by $18,400 the deduction for officers' salaries claimed by Automotive during its fiscal year ending July 31, 1975, and increased Automotive's deduction for officers' salaries by $18,400 during its fiscal year ending July 31, 1976. In effect, these changes increased Automotive's net income for the fiscal year ending July 31, 1975, by $18,400 and correspondingly decreased Automotive's net income for the fiscal year ending July 31, 1976. To reflect Automotive's increased net income for the fiscal year ending July 31, 1975, petitioner filed an amended return on which he reported an additional $18,400 in taxable income during his 1975 calendar year, 5 and he remitted an additional $8,250 in tax when he filed the amended return. The net20 effect of the changes proposed by petitioner in Automotive's amended returns is to eliminate the $28,404 taxable dividend determined by respondent. 6 Respondent has not accepted the amended returns filed on behalf of petitioner or Automotive contending that the original returns accurately and completely reported the various transactions between petitioner and Automotive. Consequently, the amended returns and petitioner's $8,250 remittance have been held in abeyance pending the outcome of this case. 21 OPINION We must decide whether petitioner may file amended returns for his 1975 taxable year and for Automotive's fiscal years ending July 31, 1975 and July 31, 1976. Respondent argues that the original returns filed for petitioner's 1975 taxable year and Automotive's fiscal years ending July 31, 1975 and July 31, 1976, properly characterized all of the transactions between petitioner and Automotive. Accordingly, respondent maintains that the amended returns were filed merely to avoid the $28,404 dividend that results if the original returns are accepted as filed. Petitioner, on the other hand, argues that the original returns reflect several mistakes that only came to light after respondent's audit was completed and a proposed deficiency was asserted, and that he properly filed amended returns to correct these errors. Based on the record herein, we believe that the original returns properly characterized the transactions between petitioner and Automotive and petitioner may not file amended returns. 7 Respondent's deficiency determination, therefore, must be sustained. 22 Generally, while taxpayers may file amended returns in a variety of circumstances, there is no absolute right to file amended returns. Pacific National Co. v. Welch,304 U.S. 191">304 U.S. 191 (1938); Goldstone v. Commissioner,65 T.C. 113">65 T.C. 113 (1975). Amended returns are normally accepted where one of the following factual situations exists: "(1) The amended return was filed prior to the date prescribed for filing a return; (2) the taxpayer's treatment of the contested item in the amended rturn was not inconsistent with his treatment of that item in his original return; or (3) the taxpayer's treatment of the item in the original return was improper and the taxpayer elected one of several allowable alternatives in the amended return." Goldstone v. Commissioner,supra at 116.In the instant case, petitioner attempted to file amended returns approximately three years after the original returns were due, and he sought to recharacterize various payments in a manner inconsistent with his treatment of the items on his original return. Consequently, to be allowed to file amended returns, petitioner must show that his treatment of the payments between himself23 and Automotive were improperly characterized on his original return, and that he has properly characterized them on his amended returns. Goldstone v. Commissioner,supra.With regard to the bonus "for the year 1975," declared by Automotive's Board of Directors in a special meeting on July 28, 1975, we hold that it was properly deducted in Automotive's fiscal year ending July 31, 1975, as reported on the original corporate return for that year. Automotive, as an accrual basis taxpayer, must deduct an expense during "the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy." Section 1.461-1(a)(2), Income Tax Regs. Since the specific amount of the bonus was declared on July 28, 1975, all events had occurred on that date, and the deduction is properly allocable to Automotive's fiscal year ending July 31, 1975. Petitioner has also sought to recharacterize four payments totalling $15,260 from dividend distributions, as reported on the original returns, to loan repayments, as reported on the amended returns. Based on the record herein, we believe that the original24 returns properly reported the four payments to petitioner and that petitioner's attempts to recharacterize the income distributions is an ex post facto effort merely to avoid the deficiency determined by respondent. 8 As petitioner stated on brief, "when faced with the proposed assessment supported by authority which had been proffered by the Government, any taxpayer would be provided with the incentive to carefully assess and reanalyze all entries and information which might mitigate the effect of the proposed assessment." This, clearly, is what petitioner has attempted to do, and equally clearly, is what the Supreme Court sought to prohibit in Pacific National Co. v. Welch,supra.The issue in Pacific National was whether the taxpayer, who employed the defferred payment method to compute sales profit on his original return, was entitled to file a claim for refund two years later utilizing the installment method. In holding the taxpayer was bound by the reporting method reflected25 on his original return, the Supreme Court stated: Change from one method to the other, as petitioner seeks, would require recomputation and readjustment of tax liability for subsequent years and impose burdensome uncertainties upon the administration of the revenue laws. It would operate to enlarge the statutory period for filing returns (sec. 53(a)) to include the period allowed for recovering overpayments (sec. 322(b)). There is nothing to suggest that Congress intended to permit a taxpayer, after expiration of the time within which return is to be made, to have his tax liability computed and settled according to the other method. * * * [Pacific National Co. v. Welch,supra at 194.] Both of the reasons cited by the Supreme Court for the denial of the taxpayer's attempt to change the method of reporting sales income are applicable in the instant case. To allow petitioner to reclassify income distributions as loan repayments or to treat the $18,400 bonus as an advance which chameleonically becomes a bonus in a subsequent tax year, would impose tremendous uncertainty in the administration of the revenue laws. When petitioner's and Automotive's returns*26 were filed petitioner had chosen to characterize four payments as income distributions. To allow petitioner to alter this treatment merely because it would mitigate the deficiency determined by respondent would subject the Commissioner to endless disputes with taxpayers over the proper characterization of any payment that could subsequently be recharacterized to the taxpayer's benefit. Moreover, the changes attempted by petitioner would affect petitioner's taxable income for both 1975 and 1976 because they alter the amount of taxable income earned by Automotive during each of those years, which income petitioner must report in his individual return pursuant to section 1373. Consequently, petitioner may not file amended returns for himself or Automotive and respondent's deficiency determination must be sustained. To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. The Subchapter S Revision Act of 1982, Pub. L. No. 97-354, 96 Stat. 1969, significantly altered the rules applicable to electing small business corporations for tax years beginning after 1982. For a discussion of the provisions of Subchapter S prior to the 1982 amendment, see Prescott v. Commissioner,T.C. Memo. 1983-709↩.2. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue.↩3. This dividend distribution was calculated (with figures rounded to the nearest dollar) as follows: ↩Automotive's Income &PreviouslyDistribution TransactionsTaxed IncomeRetained Earnings 7-31-72$36,537$24,0991120S Income 7-31-7434,273Less: Amounts distributed within2-1/2 months considereddistribution of prior year( § 1375(f))8-31-74$5,0009-9-7419,5009-9-745,50030,000Remaining Previously TaxedIncome for 7-31-744,2734,2731120S Income 7-31-7517,856Less: Distributions ofcurrent year's income12-74251-755,0004-755,23510,260Balance Previously TaxedIncome for 7-31-757,596Distributions made within2-1/2 months after endof 7-31-7510-7521,00010-7515,00036,000Distribution exceeding immediateprior year's taxableincome is dividend to extent thereis available earnings and profits( §§ 301, 316)28,404Remaining previously taxed income$28,3724. Petitioner's 1975 amended return was not signed by petitioner or his spouse.↩5. Petitioner apparently did not file an amended return for his 1976 calendar taxable year reporting Automotive's reduced net income as reflected on its amended return for the fiscal year ending July 31, 1976.↩6. Petitioner's taxable dividend for calendar year 1975, calculated according to the figures on Automotive's amended returns, is as follows: ↩Automotive's Income &PreviouslyDistribution TransactionsTaxed Income$24,009.001120S Income 7-31-7434,273.00Less: Amounts distributed within2-1/2 months considereddistribution of prior year( § 1375(f))9-9-7419,500.009-9-745,500.0025,000.00Remaining Previously TaxedIncome for 7-31-749,273.009,273.001120S Income 7-31-7536,256.35Less: Distributions ofcurrent year's income0Balance Previously TaxedIncome for 7-31-7536,256.35Distribution made within2-1/2 months after endof 7-31-7510-7521,00010-7515,00036,000.00Remaining amount available fordistribution from taxable yearending 7-31-75256.35Remaining previously taxed income$33,372.007. The crux of the problem is that petitioner's accountant was unaware that under section 1.1375-4(a), Income Tax Regs., a corporation terminating its Subchapter S election may not distribute previously taxed income as a nondividend distribution during the first taxable year to which the termination applies, or during any subsequent year. Section 1.1375-6(a), Income Tax Regs., does, however, permit a distribution of the immediately preceding year's undistributed taxable income if the distribution is made within 2 1/2 months after the termination year. Thus, when petitioner's accountant caused Automotive to distribute $36,000 to petitioner within 2 1/2 months after the termination of Automotive's Subchapter S election $28,404 was treated as a dividend distribution out of Automotive's retained earnings and $7,596 was treated as a distribution out of the preceding year's undistributed taxable income. Sections 301, 316. Section 1.1375-4(a), Income Tax Regs.↩ All of petitioner's efforts to recharacterize various transactions were directed toward increasing Automotive's taxable income for its fiscal year ending July 31, 1975, (the immediate preceding taxable year) so that the $36,000 distribution made within 2 1/2 months thereof would be a nontaxable distribution to the extent of that year's undistributed taxable income. Sections 1373, 1375(d) and (f).8. We note that the proposed loan repayments reflected on the amended returns appear to be contrary to the terms of the loan agreements between petitioner and Automotive.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623275/	WILLIAMSON VENEER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Williamson Veneer Co. v. CommissionerDocket Nos. 8841, 22369, 31642.United States Board of Tax Appeals10 B.T.A. 1259; 1928 BTA LEXIS 3912; March 9, 1928, Promulgated 3912 1. Where the petitioner incurred expense incident to the installation and equipment of a saw mill and electric motor in the year 1919, but continued to use same during 1919 and part of the year 1920, and then abandoned and discontinued its use, such expenditure can not be deducted as a loss from 1919 income. 2. Loss resulting from the destruction by fire in 1920 of a warehouse not allowed as a deduction for lack of evidence. 3. Premiums on life insurance of its president paid by petitioner, while the policies were assigned to a creditor as collateral security for a loan, are not deductible as an ordinary and necessary business expense. G. Harvey Porter, C.P.A., for the petitioner. W. Frank Gibbs, Esq., for the respondent. MILLIKEN 1259 These proceedings, which were consolidated for hearing and decision, result from the determination by respondent of deficiencies for the years 1919, 1920, 1923, 1924 and 1925, in the respective amounts of $1,140.92, $1,120.37, $661.15, $3,022.26 and $1,600.22. It was stipulated at the hearing of this cause that the net income of $30,213.17 for the year 1923 should be reduced by the amount of $20,111.53. 3913 Error is claimed concerning the year 1919 in that the respondent refused to allow as a deduction for said year the sum of $1,200.86, representing the cost of a saw mill and motor purchased in the year and discharded as useless in the year of purchase. Error is claimed concerning the year 1920 in that the respondent refused to allow as a deduction for said year the sum of $2,605.68, representing a loss resulting from the destruction by fire of a warehouse and the reconstruction of a new warehouse. Error is claimed concerning the years 1923, 1924 and 1925 in that the respondent refused to allow as a deduction for said years the respective sums of $4,765.82, $4,950.92 and $5,023.99, paid by petitioner as premiums on life insurance policies covering the life of the president of petitioner. FINDINGS OF FACT. The petitioner is a Maryland corporation with its principal office in Baltimore, and is engaged in the lumber business. During the World War it had contracts with the United States Government for the manufacture of walnut gunstocks, and when these contracts were 1260 canceled by the Government soon after the signing of the Armistice, November 11, 1918, it had3914 left on hand a large quantity of unused walnut timber. This unused walnut timber was not suitable for the petitioner's regular business demands, and in order to prepare and market it the petitioner installed a saw mill and electric motor for the special purpose of sawing up this walnut timber into marketable shapes and forms. This saw mill and motor were installed soon after the signing of the Armistice, November 11, 1918, and used for eighteen months or two years thereafter in sawing the walnut lumber. When this was completed the use of the mill and motor was discontinued and they were left standing on the petitioner's property, but were never scrapped, dismantled, or sold. There is no evidence of the cost of either the saw mill or motor. In the conduct of its business the petitioner had a warehouse at High Point, N.C., which was built on the right of way of the High Point, Thomasville and Denton Railroad. It was the mere tenant at will of the railroad company and in the lease it was provided that the lease could be terminated by the lessor on ninety days' notice and requiring the removal of the warehouse. The original warehouse was destroyed by fire in 1920 and was replaced3915 by one identical with the original building, which was used by petitioner until November, 1927, when the railroad company terminated the tenancy and required the removal of the warehouse. There is no evidence as to the cost of the original building, the amount of fire insurance thereon, or of the cost of the new or reconstructed building. In order to secure bank credit for loans made to petitioner certain policies of insurance upon the life of petitioner's president, Dwight W. Williamson, were assigned to the bank and pledged as collateral security for the loans. The policies named the insured's wife as the beneficiary, but upon her death the insured's estate was substituted as beneficiary. For this use of these policies, the petitioner paid the premiums thereon as follows: 1923, $4,765.82; 1924, $4,950.92; and 1925, $5,023.99. OPINION. MILLIKEN: There is no proof as to the cost of the saw mill and electric motor which petitioner seeks to have deducted as a loss from 1919 income, and, in addition thereto, it sufficiently appears from the evidence that both were used during the year 1919 and a great portion of the year 1920. The machinery was never junked, dismantled, nor3916 sold, but was left standing on petitioner's yard. So far as the record shows it may be yet useful and valuable. The mere fact that its use was discontinued is not conclusive proof that it is useless 1261 or without value. Under these facts the action of the respondent was correct and is approved. The cost of the warehouse built upon the right of way of the railroad company can not be allowed as a loss deduction from 1920 income, as there is no proof of the cost of the building or the amount of loss sustained. We also do not know the year in which the warehouse was erected. Based upon the opening statement of the representative of the petitioner, it appears a loss is claimed represented by the difference between the cost of the warehouse when erected less the sum received by way of insurance, with the resultant figure to be further increased by the cost of erecting a new warehouse to take the place of the one destroyed by fire. Even assuming we were supplied with the necessary facts upon which to base an opinion, it is sufficient to state the latter contention is without merit. The remaining claim of petitioner is relative to the deduction for life insurance premiums3917 paid by it on the life of its president. The facts upon which a decision must be based are very meager and if adequate might justify a more extensive consideration of the question at issue. The petitioner was very much in need of a bank loan and in order to secure same secured from its president and his wife certain life insurance policies which were assigned and pledged to the bank as security, the petitioner paying the premiums pending payment of the loan. The Revenue Acts of 1921 and 1924 both provide in section 215(a)(4) that no deduction shall be allowed in respect of - Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy. The insurance involved here was upon the life of petitioner's president and in our opinion the petitioner was indirectly a beneficiary during the time the policies were being used as collateral to its loan. It was because of this assignment and pledge to the bank that petitioner was enabled to obtain credit and funds for the operation of its business, 3918 which it sorely needed. The respondent did not err in refusing the deductions claimed for the years in question. Compare , , , , and , affirmed by the . 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/4623278/	City Title Insurance Company v. Commissioner.City Title Ins. Co. v. CommissionerDocket No. 49775.United States Tax CourtT.C. Memo 1955-233; 1955 Tax Ct. Memo LEXIS 107; 14 T.C.M. (CCH) 939; T.C.M. (RIA) 55233; August 19, 1955107 Held, petitioner's reinsurance reserve in the amount of $27,701.25, accumulated from June 1, 1938 to May 31, 1945, is properly includible in computing the reinsurance reserve to be deducted from its underwriting income in the year 1945 since, pursuant to the New York Insurance Law, as amended, such sum constitutes unearned premiums within the meaning of section 204(b)(5) of the 1939 Code. Home Title Guaranty Co., 15 T.C. 637">15 T.C. 637 (1950), followed. Henry Halpern, Esq., 26 Court Street, Brooklyn, N. Y., for the petitioner. Ellyne E. Strickland, Esq., for the respondent. RICEMemorandum Opinion RICE, Judge: This proceeding involves deficiencies in income and excess profits taxes in the respective amounts of $7,256.69 and $491.70 determined by the respondent for the year 1945. The only issue is whether a reserve for reinsurance in the amount of $27,701.25 against premiums received from June 1, 1938 to May 31, 1945, was properly deductible by petitioner as unearned premiums, within the meaning of section 204(b)(5) of the 1939 Code, 1 in computing its income for the year 1945. 108 All of the facts were stipulated, are so found, and are incorporated herein by this reference. At all times here material, petitioner was a New York corporation with its principal office in Brooklyn, New York. It kept its books and filed its tax returns on the accrual basis for the calendar year 1945 with the collector of internal revenue for the first district of New York. Petitioner is engaged in the business of insuring titles to real estate. It is subject to taxation as an insurance company other than a life or mutual insurance company under section 204 of the 1939 Code. Its principal activities consist of examining and insuring titles to real estate. It issues guaranteed searches of title and receives fees for conveyances and surveys, but it does not issue abstracts of title. It receives interest on obligations of the United States which it owns. From June 1, 1938 to May 31, 1945, pursuant to section 434 of the New York Insurance Law, petitioner set up and accumulated a premium reserve in the amount of $27,701.25 on premiums collected by it during that period. No part of this reserve was allowed as a deduction to the petitioner in the determination of its income tax liability109 for any of the years prior to the taxable year 1945. See City Title Ins. Co. v. Commissioner, 152 Fed. (2d) 859 (C.A. 2, 1946). In 1945, section 434 of the New York Insurance Law was amended by Chapter 635 of the New York Laws of 1945. Such amendment provided that every title insurance company should establish, segregate, and maintain a reinsurance reserve which, for all intents and purposes, should constitute unearned premiums. Such reserve was to consist, among other items, of the reserve required to be established prior to June 1, 1945. Pursuant to such amended law, petitioner established a reserve consisting of the aforementioned $27,701.25 and an additional reserve for the period from June 1 to December 31. 1945, of $4,893.72. On its income tax return for 1945, petitioner deducted such total reserve in the amount of $32,594.97 from its underwriting income. Respondent determined that the amount of $27,701.25 did not constitute a proper deduction and determined the deficiencies herein. He argues on brief that the amount in question did not constitute unearned premiums within the meaning of section 204(b)(5) of the Code. The facts of this case are identical with110 those before us in Home Title Guaranty Co., 15 T.C. 637">15 T.C. 637 (1950), wherein we held that both the reinsurance reserve accumulated by the taxpayer title company prior to May 31, 1945, as well as the reserve accumulated between that date and December 31, 1945, pursuant to the New York Insurance Law as amended in 1945, represented unearned premiums within the meaning of section 204(b)(5). Our decision in that case is controlling here. See also Early v. Lawyers Title Ins. Corporation, 132 Fed. (2d) 42 (C.A. 4, 1942), and Title & Trust Co., 15 T.C. 510">15 T.C. 510 (1950), affd. 192 Fed. (2d) 934 (C.A. 9, 1951). We decline to follow I.T. 3798, 1 C.B. 127">1946-1 C.B. 127, and Revenue Ruling 151, 2 C.B. 222">1953-2 C.B. 222, which are to the contrary. Decision will be entered for the petitioner. Footnotes1. SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL. * * (b) Definition of Income, Etc. - In the case of an insurance company subject to the tax imposed by this section - * (5) Premiums earned. - "Premiums earned on insurance contracts during the taxable year" means an amount computed as follows: From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623280/	APPEAL OF BUENA VISTA HARDWOOD CO.Buena Vista Hardwood Co. v. CommissionerDocket No. 2603.United States Board of Tax Appeals3 B.T.A. 503; 1926 BTA LEXIS 2632; January 30, 1926, Decided Submitted October 26, 1925. 2632 Upon the evidence, held, that the deduction allowed for the amortization of facilities acquired for the production of vessels for the transportation of articles or men contributing to the prosecution of the war should be taken in 1918. P. M. MacCutcheon, C.P.A., for the taxpayer. J. W. Fisher, Esq., for the Commissioner. TRAMMELL504 Before GRAUPNER, TRAMMELL, and PHILLIPS. This is an appeal from the determination of a deficiency in income and profits taxes for the fiscal year ended March 31, 1919, in the amount of $1,056.03. The deficiency is due to the fact that the Commissioner disallowed a deduction, claimed by the taxpayer in its return, on account of the amortization or loss of useful value of machinery alleged to have been acquired for the purpose of producing articles contributing to the prosecution of the war. FINDINGS OF FACT. The taxpayer is a corporation organized under the laws of West Virginia, having its principal office at Marlinton. It was organized in April, 1918, and took over the business of the Buena Vista Hardwood Co., which was a partnership and had operated the business for some years. At the time of2633 its organization it issued stock of the par value of $5,000 for mill and machinery of the former business. The corporation from the date of its organization was engaged in the business of manufacturing tree nails and had contracts with the United States Shipping Board Emergency Fleet Corporation for its entire output. These nails were used in the construction of wooden ships. After the signing of the Armistice in 1918, the contracts for the manufacture of the tree nails were canceled, except for 10 carloads of tree nails, which were manufactured under the terms of the cancellation. The Emergency Fleet Corporation had no further use for tree nails, as no further wooden vessels were being built. In the fall of 1918, the corporation ceased to manufacture tree nails and permanently abandoned the mill and machinery as war facilities. For a few months after the cancellation of the contracts, the taxpayer continued to operate and saw lumber for other purposes, but made no tree nails, and only a portion of the mill and machinery was operated. Efforts were made to sell the machinery and mill without success. The buildings were subsequently torn down and destroyed, as they could not2634 be sold, and approximately $250 was received from the sale of the tin roof of one of the buildings, some wood which was cut from lumber in another building, and a small amount of frame lumber. The boilers and engines, sawmill and machinery could have been used for an ordinary sawmill business, but they were located in a section where the timber had been previously removed, and there was no sale for such material in that section. These were abandoned. The machinery and equipment, which was acquired for the issuance of stock of the amount of $5,000 par value, had an actual cash value at the time acquired of at least that amount. The above property had a residual value not greater than $3,000, the amount claimed by the taxpayer. 505 DECISION. The deficrency should be computed in accordance with the following opinion. Final determination will be settled on 10 days' notice, under Rule 50. OPINION. TRAMMELL: A loss of useful value is not involved in this appeal. The deduction allowable, if any, is on account of the statutory amortization of war facilities. If the taxpayer is entitled to such a deduction, the question then arises as to the taxable year or years2635 in which the deduction should be allowed. The taxpayer acquired the facilities after April 6, 1917, for the purpose of manufacturing tree nails. These were used in filling contracts with the Emergency Fleet Corporation for the construction of vessels. While the taxpayer did not construct or acquire vessels for the transportation of articles or men contributing to the prosecution of the war, the articles were used in the construction of such vessels. We have found as a fact that the facilities cost at least $5,000, and that their residual value was not more than $3,000. The facilities upon which amortization is claimed were both acquired and abandoned for war purposes within the taxable year in question, and amortization of $2,000 is a proper and reasonable deduction in that year.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623281/	KANSAS, OKLAHOMA AND GULF RAILWAY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kansas, O. & G. R. Co. v. CommissionerDocket Nos. 93526, 93527.United States Board of Tax Appeals42 B.T.A. 1128; 1940 BTA LEXIS 897; November 1, 1940, Promulgated 897 AFFILIATION - WHAT STOCK IS INCLUDED IN 100 PERCENT FROM WHICH 95 PERCENT IS MEASURED UNDER SEC. 141(d) OF REVENUE ACTS OF 1932 AND 1934. - The 100 percent includes a small number of shares for which stock trust receipts issued in 1919 were never presented in exchange for stock certificates after the trust was terminated in 1931. William R. Spofford, Esq., Charles S. Jacobs, Esq., and Robert S. Ingersoll, Jr., Esq., for the petitioner. Brooks Fullerton, Esq., for the respondent. MURDOCK 1128 The Commissioner determined deficiencies in the petitioner's income taxes as follows: Calendar yearAmount1932$34,074.70193339,529.46193429,288.90193517,751.89The only issue for decision by the Board is whether a block of about 1,100 shares unclaimed by, but held for, the owners of stock trust receipts was "stock" of the petitioner within the meaning of section 141(d) of the Revenue Acts of 1932 and 1934 for the purpose of determining whether or not the Muskogee Co. owned at least 95 percent of the stock of the petitioner and was entitled to include the 1129 petitioner in its consolidated returns898 for the taxable years. The parties have settled by agreement the other issues raised by the pleadings. FINDINGS OF FACT. The stipulation of the parties is hereby adopted as a part hereof. C. Jared Ingersoll was appointed a voting trustee under the "Hook Plan" in 1926 and continued as such until the termination of the trust of 1931. He was assistant to the president of the petitioner prior to June 1932, when he was elected chairman of the board and became its chief executive officer. He has held that position ever since. He was elected president of the Muskogee Co. in the latter part of June 1932, prior to which time he was assistant to the president. He has been president and chief executive officer of the Muskogee Co. since June 1932. The Muskogee Co. became the owner of a majority of the stock of the petitioner in 1925 and 1926. A large number of holders of stock trust receipts under the "Hook Plan" were Europeans. The decision to issue a certificate for 1,180 shares of the preferred stock of the petitioner in the name of "C. Jared Ingersoll, Agent", on December 28, 1931, was reached by the petitioner and by the two surviving voting trustees, under the "Hook899 Plan," C. Jared Ingersoll, and his father. C. Jared Ingersoll believed that he was acting as agent for the petitioner in holding that certificate. He became convinced during 1932 that there was little likelihood of any additional voting trust certificates being presented and that the certificate in the name of "C. Jared Ingersoll, Agent", was not entirely proper, so he surrendered the certificate to the petitioner. Thereafter, those shares were carried on the books as "Stock liability for conversion of preferred stock" and were so shown in reports to the I.C.C. and to stockholders and in income tax returns. No one challenged Ingersoll's right to vote the 1,180 shares at the meeting of June 18, 1932. The voting of those shares was not necessary to insure any action taken at that meeting. Ingersoll voted the stock at that meeting without thinking whether or not it was proper to vote it. Thereafter, the unclaimed shares were never voted and the company did not consider that those shares were entitled to any vote. C. Jared Ingersoll was ready, at all times while he held as agent a certificate for the unclaimed shares, to surrender shares for which stock trust receipts might900 be presented, and he thinks that thereafter the petitioner at all times stood ready to make a similar surrender. The shares represented by undeposited stock trust receipts were authorized and issued stock of the petitioner and that stock has never been retired. 1130 OPINION. MURDOCK: The petitioner was organized under the laws of Oklahoma in 1919, to take over certain railroad properties pursuant to a plan of reorganization known as the "Hook Plan." All of the preferred and common stock of the petitioner was placed in trust pursuant to that plan and stock trust receipts were issued to the persons entitled to the stock. Those receipts were issued in bearer form. The properties of the petitioner were placed in receivership in 1924. A further plan for readjusting the capital structure of the petitioner was agreed upon in order to avoid foreclosure. The plan was put into effect in 1926. The Muskogee Co., hereinafter called Muskogee, had in the meanwhile acquired most of the series A, B, and C, bonds of the petitioner, most of the stock trust receipts, and all of the common stock of the petitioner. The common stock was eliminated from the capital structure of the901 petitioner and most of the preferred stock held by Muskogee through stock trust receipts was also surrendered and canceled pursuant to the plan. Most of the bonds of the petitioner were exchanged pursuant to this plan for series A, B, and C preferred stock. Thus, at the conclusion of the 1926 readjustment, the only stock of the petitioner outstanding was divided into four different classes, namely, series A, series B, series C, and preferred stock, all of which had the same par value and all of which had the same voting privileges. Muskogee owned most of that stock. The stock trust created under the "Hook Plan," which held only the nonseries preferred stock after the 1926 readjustment, was terminated on July 8, 1931. The surviving stock trustees sent a circular letter to all of the holders of the stock trust receipts in so far as their names and addresses were known to the trustees. The letter notified them of the termination of the trust and requested that the stock trust receipts be presented at once for exchange into certificates of preferred stock. Stock trust receipts were surrendered and certificates for 25,820 shares of preferred stock were issued prior to the close902 of 1931. Outstanding stock trust receipts for the remaining 1,180 shares of preferred stock were not surrendered by that time and a certificate for those 1,180 shares of preferred stock was issued to and registered in the name of "C. Jared Ingersoll, Agent" on December 28, 1931. The following table shows the amount of each kind of stock owned by Muskogee on January 1, 1932, and the total amount of that stock issued and outstanding on January 1, 1932: Owned by MuskogeeTotal stock issuedSeries A preferred stock$2,476,987.57$2,830,800Series B preferred stock234,257.84280,400Series C preferred stock5,622,532.135,728,900Preferred stock2,561,400.001 2,700,0001131 Stock trust receipts for 43 additional shares were presented during 1932 and the early part of 1933, so that the unclaimed shares were reduced to 1,137. There was no material change in stock ownership during the taxable years. Ingersoll voted the stock in his name as agent on February 2, 1932. He gave no particular thought to the wisdom of voting the stock. The vote903 was not challenged and was not necessary to any of the business transacted at the meeting. The unclaimed shares were never voted thereafter. All of the nonseries preferred stock, including unclaimed shares, was carried on the books of the petitioner as preferred stock until about March 10, 1933. The petitioner and Ingersoll decided at that time that it was improper for him to have a certificate for the unclaimed shares and he surrendered the certificate. Entries were made upon the books of the petitioner at that time, but as of December 31, 1932, reducing the preferred stock account by the amount of the par value of the unclaimed shares and crediting that amount to an account entitled "Stock liability for conversion - preferred stock." Muskogee, which owns stock of a number of corporations engaged as common carriers by railroad, filed a consolidated return for itself and a number of those companies, including the petitioner, for each of the taxable years. The Commissioner, in determining the deficiencies, has eliminated the petitioner from that affiliated group and has computed its tax separately. He determined that Muskogee owned less than 95 per cent of the stock of the904 petitioner during the taxable years by including as stock, within the meaning of section 141(d) of the Revenue Acts of 1932 and 1934, 1 not only the shares of preferred stock issued to persons who deposited their stock trust receipts and received certificates for preferred stock, but also the shares of preferred stock for which the holders of stock trust receipts had not as yet deposited those receipts. The Muskogee Co., by that method of computation, owned less than 95 percent of the stock of the petitioner during each of the taxable years. The petitioner contends that its stock, for the purpose of section 141(d), includes only the shares of preferred stock issued to persons who had deposited their certificates of preferred stock, and does not include the shares of preferred stock to which the 1132 holders of stock trust receipts who had not yet deposited them were entitled. Muskogee, by that method of computation, owned more than 95 percent of the petitioner's stock during each of the taxable years. Thus, the sole question for decision by the Board is whether or not the stock of the petitioner for the purpose of section 141(d) includes the preferred shares belonging905 to persons who had not deposited their stock trust receipts. The decision of this question is important because the petitioner had a substantial amount of income for each year, whereas the affiliated group, exclusive of the petitioner, had a substantial net loss in each year. There is no definition of the word stock in the Revenue Acts of 1932 and 1934 which is particularly helpful. Cf. section 1111 of the Revenue Act of 1932, section 801 of the Revenue Act of 1934, and the statement in section 141(d) that "the term 'stock' does not include nonvoting906 stock which is limited and preferred as to dividends." There are a number of decided cases in which stock has been defined for the purpose of the question there involved, but their authority here is limited. The arbitrary amount of 95 percent in the definition of an affiliated group appeared for the first time in section 240(c) of the Revenue Act of 1924. Congress used it to eliminate, as far as possible, the uncertainty which had existed under the "indefinite and vague language of existing law." Report of the Ways and Means Committee, 68th Cong., 1st Sess., H. Rept. 179; Report of the Senate Finance Committee, 68th Cong., 1st sess., S. Rept. 398. The House bill contained the words "85 per centum", the Senate amended by increasing the percentage to 95, and the House receded. It was suggested in the discussion of this percentage in the Senate that it ought to be even higher than 95 percent. See Congressional Record, vol. 65, p. 7130. However, the percentage was fixed at 95 and has remained at that amount ever since, although the privilege of filing consolidated returns has been limited to railroads under the 1934 Act. 907 The parties are in dispute only as to what stock is to be included in the 100 percent from which the 95 percent is to be measured. It may be conceded for present purposes that stock owned by the issuing corporation itself, such as, for example, treasury stock, would not have to be included in the 100 percent. Cf. ; Fletcher Cyclopedia of Corporations, vol. 11, §§ 5083, 5088. But all stock owned by others than the issuing corporation would certainly have to be included in the 100 percent (excepting, of course, the nonvoting limited and preferred dividends stock mentioned in section 141(d), which will be disregarded for the present discussion). Muskogee owned most of each of the four classes of preferred stock of the petitioner during the taxable years. Others owned and 1133 held certificates for a portion of each class of that stock. The parties are in agreement as to all such stock. They differ as to whether there should be included in the 100 percent the shares of preferred stock, somewhat in excess of 1,100, for which stock trust receipts had been issued to persons, not otherwise identified in this908 record, who had never surrendered those stock trust receipts for certificates of preferred stock of the petitioner. Those persons were entitled to receive certificates for shares of the preferred stock of the petitioner upon surrender of their stock trust receipts. Furthermore, a certificate is only paper evidence of the ownership of a share of stock and those persons were the real and beneficial owners of that portion of the petitioner corporation measured by the eleven hundred and some shares of stock, even though they had failed to exchange their stock trust receipts for certificates. ; ; Fletcher Cyclopedia of Corporations, vol. 11, § 5092; ; ; ; ; affd., ; . "A share of stock in a corporation consists of a set of rights and duties between the corporation and the owner of the share." 909 ; . Those rights and duties existed as to the shares here in question. The owners of those shares were the owners of that proportionate interest in the petitioner just the same as Muskogee and the other holders of certificates were the owners of the proportionate share in the petitioner represented by the number of shares belonging to them. All of this particular class of preferred stock of the petitioner was included in the trust under the "Hook Plan" and, obviously, all of that stock was outstanding as stock of the petitioner until the termination of the "Hook Plan" in 1931. If at some time thereafter it ceased to be stock of the petitioner, as the petitioner contends, just when did that occur? Surely some proceeding aside from the mere bookkeeping entries made by the petitioner in March 1933 would be necessary to retire and cancel it. The petitioner had some reason to believe that the owners of the small interest here involved might never appear and claim their property. Perhaps their interests might have been forfeited and canceled by a court proceeding, but they never have been. Those interests910 during the taxable years belonged to and were owned by someone other than the petitioner, and that proportionate ownership in the petitioner can not be ignored for the purposes of section 141(d). Therefore, we conclude that the petitioner was not affiliated with Muskogee. Decision will be entered under Rule 50.Footnotes1. This figure includes the 1,180 shares standing in the name of "C. Jared Ingersoll, Agent." ↩1. (d) DEFINITION OF "AFFILIATED GROUP". - As used in this section an "affiliated group" means one or more chains of corporations connected through stock ownership with a common parent corporation if - (1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations; * * * As used in this subsection the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623282/	JAMES F. KENDRICK and DELORES KENDRICK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKendrick v. CommissionerDocket No. 12246-78.United States Tax CourtT.C. Memo 1980-270; 1980 Tax Ct. Memo LEXIS 315; 40 T.C.M. (CCH) 741; T.C.M. (RIA) 80270; July 24, 1980, Filed 315 Petitioner operated a business as a sole proprietor. He systematically understated his business gross receipts by approximately 12 percent for each of the three taxable years before us. This resulted in an understatement of his adjusted gross income by 100 percent. Held: On the record before us we conclude that petitioner's systematic understatement of income was the product of mala fides exclusion of amounts from gross receipts with the purpose of evading income taxes he knew to be due. Held further: fraud penalty properly imposed. Wlliam J. Cooney, for the petitioners. Albert L. Sandlin, Jr., for the respondent. STERRETTMEMORANDUM316 FINDINGS OF FACT AND OPINION STERRETT, Judge: * By a letter dated August 17, 1978 respondent determined deficiencies and additions to tax due from petitioners as follows: Sec. 6653(b)Taxable Year EndedDeficiencyAdditions to TaxDecember 31, 1971$1,932.00$11,503.00December 31, 1972$2,516.96$13,082.11December 31, 1973$5,151.67$16,061.83After concessions the only issue for our decision is whether respondent is entitled to his claimed fraud penalty. Our conclusion on this point will decide the question whether the statute of limitations for the taxable years before us had run prior to the time respondent mailed his notice of deficiency. Respondent has conceded that petitioner Delores Kendrick is not liable for the additions to tax. Petitioners have conceded the deficiency amounts shown above. FINDINGS OF FACT Some of the facts were stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Petitioners James F. and Delores317 Kendrick, husband and wife, resided in North Augusta, South Carolina, at the time they filed their petition herein. Petitioners timely filed joint Federal income tax returns on the cash basis for their taxable years ended December 31, 1971, December 31, 1972, and December 31, 1973, with the Internal Revenue Service Center at Chamblee, Georgia. Petitioners filed amended returns of income for these taxable years in 1975 and paid the increased tax shown thereon. As Mrs. Kendrick is a party hereto solely by virtue of having filed jointly with her husband, "petitioner" as used herein shall refer only to Mr. Kendrick. Petitioner has been engaged in the automobile paint and body repair business since approximately 1951. During the taxable years before us petitioner operated by way of a sole proprietorship doing business as Kendrick's Paint and Body Shop. During the years before us petitioner derived his income from this body shop, as well as other sources, such as sales of junk automobiles and interest. Petitioner's wife had no source of income except interest on bank accounts in her name. When Mr. Kendrick first opened his business in 1951 he had little or no experience or knowledge318 with respect to bookkeeping and accounting. He, therefore, arranged for a friend, with experience as a bookkeeper, to teach him the rudiments of keeping a so-called "DOME" journal, which is in essence a single entry method of accounting. This friend came periodically during the first months that petitioner was operating to oversee his books. Petitioner utilized this single entry method of accounting from 1951 through the taxable years before us.Petitioner accounted for his gross receipts generally as follows: Petitioner's business was repairing the bodies of and painting automobiles. When a car came in petitioner would make out a work order showing the work to be done. As work was performed and parts used the cost thereof would be posted to the work order. When the work was complete, the charges on the work order would be totaled. When the work order was paid in full petitioner would mark it paid. At the end of the week petitioner would total the amounts of all work orders paid in full during that week on an adding machine tape and enter the total in the DOME book as gross receipts. He would then tie the work orders themselves together and put them in a drawer. If a work order319 was only partially paid, the partial payment would not be entered in the DOME book. However, the entire work order amount would be entered in the DOME book when the work order was fully paid. Periodically, petitioner would deposit his gross receipts in a business bank account. Throughout the years before us petitioner's tax returns were prepared by various CPA's. For each of the taxable years before us petitioner provided only his DOME book for that taxable year to the CPA return preparer who then made up petitioner's return solely from the information disclosed therein. For each of the taxable years before us, petitioner failed to enter in the DOME book for that year approximately 12 percent of his gross receipts. As a result of this understatement, petitioner's adjusted gross income was continuously understated by approximately 100 percent per taxable year. At no time did petitioner's return preparers ask for petitioner's banking records which would have, as a general matter, more accurately disclosed petitioner's actual income. Petitioner personally kept the DOME journal, prepared all business records and work orders, totaled his work orders, and deposited his receipts320 in his business bank account. Indeed, petitioner controlled all aspects of his business except the actual preparation of his income tax returns. Petitioner never reconciled the DOME journal to his bank deposits. As found, petitioner filed timely returns of income, Forms 1040, for each of his taxable years 1971, 1972 and 1973. Also as found, in 1975, after respondent's investigation of petitioner's returns had begun, petitioner filed amended U.S. individual income tax return Forms 1040X for each of these taxable years. The original and amended returns revealed the following: 1971Orig.1040XGross Receipts$293,491.00Gross Business Profit50,300.00Net Business Profit29,932.00Adjusted Gross IncomeGross Business Profits29,932.00Interest+12,258.00$42,190.0084,690.00Taxable Income36,686.00Tax Paid11,217.0032,290.351972Orig.1040XGross Receipts$345,476.35Gross Business Profit65,963.68Net Business Profit31,838.73Adjusted Gross IncomeGross Business Profits31,838.73Interest+13,951.82$45,790.5592,885.17Taxable Income41,540.55Tax Paid12,730.3336,377.581973Orig.1040XGross Receipts$444,261.54Gross Business Profit82,770.82Net Business Profit39,208.28Adjusted Gross IncomeGross Business Profits39,208.28Interest+18,206.4057,414.68112,401.88Taxable Income53,164.68Tax Paid19,163.9546,135.94321 Petitioner deposited all of his business receipts in a business bank account, Account No. 001-846-2, he maintained at the Georgia Railroad Bank in Augusta, Georgia. The amounts actually deposited, which in general represented petitioner's true business gross receipts, the gross receipts reported by petitioner on his original return, and the December 31 balance of petitioner's business checking account, less outstanding checks, for each of the taxable years 1970, 1971, 1972 and 1973 are as follows: Business Bank AccountGross Receipts PerActual GrossOriginal ReturnReceipts% ChangeEnding Balance1970$ $ $102,065.521971293,491.00336,496.0512.78%91,690.321972345,476.35388,381.5111.04%110,196.411973444,261.54527,622.9115.79%102,439.85The percent increase in petitioner's adjusted gross income between his original and amended returns and his percent understatement of adjusted gross income are as follows: 197119721973Increase50.18%50.70%48.92%Understatement100.7%102.84%95.77%As part of his business of body repairing and painting, petitioner would occasionally322 take possession of cars later abandoned by their owners. In such a case, petitioner would hold the car for a reasonable length of time and then sell it to a disposal company for salvage in order to recoup all or part of its storage and other costs. During the years before us, petitioner received the following amounts from the following sources with respect to the sale of junk autos: Salvage Disposal Co.Gibbs Auto Parts1971$1,741.50$1,398.7019721,510.003,566.6519732,942.002,712.00None of these amounts were included in petitioner's income except $459.15 paid by Gibbs Auto Parts in 1972. Petitioner had undeposited cash on hand on December 31 of each of the years 1970, 1971, 1972, and 1973 never exceeding the sum of $3,000. Mrs. Kendrick did not have any undeposited cash on hand as of said dates. Petitioner acquired a variety of certificates of deposit as seen below: Not HeldCost BasisAs ofIssuerSerial No.Acq. DateAs of$25,00012/31/70Georgia RailroadT 708032/20/7012/31/72Bank &Trust Co.26,20012/31/70Trust Co.T 708042/20/7012/31/72100,00012/31/73Trust Co.T 708052/20/7025,00012/31/73Trust Co.353077/21/7125,00012/31/73Trust Co.353087/21/7125,00012/31/73Trust Co.353097/21/71100,00012/31/73Trust Co.A-54117/27/73*323 All these certificates of deposit were purchased and held by petitioner in the names of "James F. Kendrick or Delores S. Kendrick." Throughout the years 1970 through 1973 inclusive, petitioner had a variety of checking accounts. The bank in which the account was held, the account number, the account name and type, and the deposit in each account as of December 31 (less outstanding checks) was as follows: BankAcct. No.Name/TypeBalance/Dec. 31, 191. Georgia Railroad106-245-0Mr. & Mrs. James$ 1,187.19/70Bank & Trust Co.F. Kendrick/911.13/71Personal1,133.60/72999.76/732. Georgia Railroad011-846-2Kendrick Paint102,065.52/70Bank & Trust Co.& Body Shop/91,690.32/71Business110,196.41/72102,439,85/73Petitioner and/or his wife held savings accounts as follows: 1. Bankers Trust of10-2822-Mr. J. F.16,870.94/70South Carolina0762Kendrick17,552.53/71- 0 - /72- 0 - /732. Palmetto Federal101864-4Mrs. James F.12,192.30/70Savings & LoanKendrick12,813.42/71Assoc. of Aiken13,466.17/7214,152.19/733. First Federal43316James F.14,289.06/70Savings & LoanKendrick15,017.01/71Assoc. of Augusta15,782.03/7216,586.02/734. Assoc. of Augusta49540Delores6,205.61/70Kendrick6,521.75/716,853.99/727,203.13/735. Georgia Railroad521-269-1James35,641.20/70Bank & Trust Co.Kendrick37,302.22/714,650.68/724,864.72/726. Bank & Trust Co.521-989-4Mr. James15,059.84/70Kendrick15,761.71/71- 0 - /72- 0 - /73324 On May 20, 1970 petitioner purchased a 1970 Buick automobile for $4,350. Petitioner owned this car throughout each of the taxable years ended December 31, 1970 through December 31, 1973. In 1972 petitioner purchased a new building in which to operate his business. Petitioner paid the full purchase price thereof, $126,000 by cashier's check. Petitioner owned various depreciable assets including business buildings and equipment on the dates shown below. 12/31/7012/31/7112/31/7212/31/73Assets (perReturns)$33,428.45$33,428.45$188,845.72$185,265.10Less Land6,000.006,000.0046,000.0046,000.00DepreciableAssets$27,428.45$27,428.45$142,845.72139,265.10Throughout the years before us petitioner owned a parcel of land and the house thereon located in North Augusta, South Carolina. Petitioner had acquired the land in 1955 for $2,250. He built the house in 1956 for a total cost of $19,553.42. Throughout the years before us petitioner owned a parcel of real estate located in Augusta, Georgia. Petitioner purchased this lot in 1961 for $6,000. On October 2, 1972 petitioner purchased the real estate at 1333 Broad Street, 325 Augusta, Georgia, for $40,000. During the years 1971, 1972 and 1973 petitioner expended for personal living expenses and other purposes, for which no deduction is allowable, the following amounts: Items of ExpendituresExpenditures During the Year197119721973(1) Federal incometaxes paid$4,617.00$15,205.00$13,819.33(2) State of SouthCarolina incometaxes paid152.50292.50571.73(3) State of Georgiaincome taxes paid474.001,711.001,536.62(4) Personal livingexpenses as computedbelow:Computation of Personal Living Expenses197119721973Balances in Personalchecking account as ofJanuary 1:$ 1,187.19$ 911.13$ 1,133.60Deposits10,147.8011,051.679,833.78Available$11,334,99$11,962.80$10,967.38Balance as ofDecember 31:911.131,133.60999.76Expenditures10,423.8610,829.209,967.62Add: Expenditures fromBusiness: Murphy & SonsDrug Store232.1784.18119.65Delores Kendrick1,421.66Life & CasualtyInsurance Company155.00155.00155.00Equitable LifeAssurance Society1,635.481,635.481,635.48Total PersonalExpenses$12,446.51$12,703.86$13,299.41326 During the years before us, petitioner and Mrs. Kendrick each owned assets, the ownership of which has been specified above, having a total cost basis of $414,393.63, $483,451.96, $542,182.02 and $632,761.19 as of December 31 of each of the years 1970, 1971, 1972 and 1973, respectively. Petitioner and his wife had no liabilities during these taxable years. All assets purchased were paid for in full. Petitioner, as of December 31 of each of the years 1970 through 1973, had accumulated depreciation on his business assets as follows: 12/31/7012/31/7112/31/7212/31/73Depreciation(per returns)$19,728.51$21,764.51$16,654.60$23,753.42Petitioner did not receive any amounts of nontaxable or excludable receipts for which an adjustment should be made in the computation of their correct taxable income for the years at issue.The net worth of petitioner and his wife at the end of each of the years 1970 through 1973 and the increase in their net worth during each of such years was as follows: Net WorthIncrease in NetYearAt December 31Worth During the Year1970$394,665.02$01971461,687.4567,022.431972525,527.4263,839.971973609,007.7783,480.35327 During the years 1971 through 1973, inclusive, petitioners did not borrow or receive from nontaxable sources any funds or assets not properly taken into account by respondent which would account for the above noted increases in net worth. OPINION Petitioner understated his taxable income by approximately 100 percent for each of the three taxable years before us. 1 Indee, petitioner indicated at trial that it is probable that a similar percent of his taxable income was not reported for each of his taxable years since 1951. Petitioner argues that this pattern of unreported income was a product of his lack of accounting sophistication and minimal formal education, combined with a built-in 12 percent error in reporting business gross receipts peculiar to petitioner's DOME single entry accounting method. Respondent claims that the underreporting was fraudulent. The propriety of respondent's claimed fraud penalty is the only issue before us. If any part of the underpayment of tax conceded by petitioner for any particular year was due to fraud with an intent to evade328 tax believed to be owing, then respondent's section 6653(b), I.R.C. 1954, claim must be sustained. 2 The burden is upon respondent to show, by clear and convincing evidence, that some part of the conceded understatement for each of the years at issue was due to fraud within the meaning of section 6653(b). Section 7454(a); Rule 142(b), Tax Court Rules of Practice and Procedure; Cefalu v. Commissioner, 276 F.2d 122">276 F.2d 122, 128 (5th Cir. 1960). The question is one of fact. Mensik v. Commissioner, 328 F.2d 147">328 F.2d 147, 150 (7th Cir. 1964), affg. 37 T.C. 703">37 T.C. 703 (1962); Stratton v. Commissioner, 54 T.C. 255">54 T.C. 255, 284 (1970). To prove fraud the Commissioner must show that the taxpayer intended to evade taxes, which he knew or believed he owed, by conduct intended to conceal, 329 mislead or otherwise prevent the collection of such taxes. Stoltzfus v. Commissioner, 398 F.2d 1002">398 F.2d 1002, 1004 (3rd Cir. 1968); Webb v. Commissioner, 394 F.2d 366">394 F.2d 366, 377 (5th Cir. 1968); Marcus v. Commissioner, 70 T.C. 562">70 T.C. 562, 577 (1978). Fraud has been defined to be: * * actual intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing. Fraud implies bad faith, intentional wrongdoing, and a sinister motive. It is never imputed or presumed and the courts will not sustain findings of fraud upon circumstances which at the most create only suspicion. [Citation omitted] [Ross Glove Company v. Commissioner, 60 T.C. 569">60 T.C. 569, 608 (1973). Quoting Mertens, Law of Federal Income Taxation, Sec. 55.10, p. 46 (1970 Rev.); Footnotes omitted.] The required proof may be supplied by circumstantial evidence. Plunkett v. Commissioner, 465 F.2d 299">465 F.2d 299, 303 (7th Cir. 1972); Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 224 (1971); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 105-106 (1969). Although the mere understatement of income alone is not sufficient330 to prove fraud, the consistent and substantial understatement of income is, of itself, strong evidence of fraud. Marcus v. Commissioner, supra at 577; Holland v. United States, 348 U.S. 121">348 U.S. 121, 139 (1954); Adler v. Commissioner, 422 F.2d 63">422 F.2d 63, 66 (6th Cir. 1970), affg. a Memorandum Opinion of this Court. Yet we are mindful of the fact that fraud must be affirmatively shown to exist. Estate of Beck v. Commissioner,56 T.C. 297">56 T.C. 297, 363 ( 1971). Thus while we hold for respondent on this issue, we do so not only upon the basis of petitioner's continuous and substantial understatements of income, but upon the other objective facts in the record which indicate fraud. We admit that this case is somewhat unusual. The trial judge resigned after hearing the case and was, therefore, not available for reference. Notice of Reassignment was served upon the parties on March 7, 1980. At that time the Court cautioned the parties that: "If any motions are contemplated in connection with this case, they should be filed on or before March 31, 1980." No such motions were made. While we have not had a first-hand view of petitioner331 on the stand, we have studied the transcript carefully. Further, we find that sufficient objective facts are present in the record to render a decision possible without recourse to witness demeanor. The core of petitioner's case is his claim that some undetectable built-in peculiarity of his DOME bookkeeping method caused him, an untutored autombile painter, to understate continuously and unwittingly his gross receipts by 12 percent with the consequence of an understatement of his adjusted gross income of over 100 percent. We cannot accept this contention. The fact remains that the understatements before us could have occurred in only one way: petitioner consistently and systematically failed to report approximately 12 percent of his gross receipts.He did this by the systematic, and we believe intentional, expediency of simply not adding into his week's gross receipts, work orders representing approximately 12 percent of his gross receipts. It does not require any accounting sophistication to realize that, if you account for your gross receipts by way of work orders and if you throw away or otherwise exclude a work order from your addition, the amount of that work order will332 not appear in gross receipts and, therefore, will not appear in income. These acts of omission were compounded by petitioner's failure to reconcile his bank statements to his income. Further, petitioner's work orders were in so much disarray that no one could trace his deliberate exclusions by way of a review of his work orders alone. Failure to keep adequate records is another indicia of fraud. Marcus, supra at 578; Powell v. Granquist, 252 F.2d 56">252 F.2d 56, 59, 60 (9th Cir. 1958), see Plunkett v. Commissioner, supra at 303. An occasional error or omission is one thing, and accordingly we note, but do not over-emphasize petitioner's total failure to include his receipts from Salvage Disposal Company and Gibbs Auto Parts. However a continual, perhaps even decades long, pattern of omission of a fixed 10 to 12 percent of his gross receipts cannot qualify as a good faith or even negligent error. The numbers themselves make it difficult to come to any conclusion other than that of fraud. Petitioner has admitted the omission of some $154,000 in taxable income in the 3 years before us, an amount that represents approximately one-half333 his true taxable income. His net worth went from $395,000 as of December 31, 1970 to $609,000 as of December 31, 1973. It would be difficult to be unaware of an increase in net worth in 3 years of over $200,000 or 50 percent. Petitioner may not have had much formal education but he was shrewd enough to operate a business whose gross receipts rose from $337,000 in 1971 to $528,000 in 1973. Further, he was sophisticated enough to invest his excess funds, some $175,000 in certificates of deposit in 1971 and 1973. Still further he knew enough about bookkeeping not to understimate his expenses. The pattern of fraud is inescapable. On the record before us we are comfortable with our conclusion that respondent has carried his burden, by clear and convincing evidence, that petitioner filed his returns for the years at issue with mala fides, with a conscious intent to evade the taxes that he knew to be due. Decision will be entered for the respondent. Footnotes. This case was reassigned from Judge William H. Quealy to Judge Samuel B. Sterrett↩ by Order of the Chief Judge dated May 21, 1980.. Held throughout the taxable years before us.↩1. The average understatement of the petitioner's income for the years before the Court was 99.77 percent.↩2. SEC. 6653(b)↩.FRAUD.--If any part of any underpayment (as defined in subsection(c)) of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. In the case of income taxes and gift taxes, this amount shall be in lieu of any amount de-determined under subsection (a). [negligence penalty]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623283/	ERNEST P. FLINT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. OTTO A. BJORNSTAD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. J. J. CAIRNS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Flint v. CommissionerDocket Nos. 17945, 18115, 18143.United States Board of Tax Appeals12 B.T.A. 20; 1928 BTA LEXIS 3621; May 18, 1928, Promulgated 3621 1. Value of certain second mortgages on farms sold by a partnership of which the petitioners were members determined. 2. Depreciation on farm improvements determined by the Commissioner approved. R. M. Cornwall, Esq., for the petitioners. Arthur H. Murray, Esq., for the respondent. LANSDON 20 The respondent asserts deficiencies in income taxes for the year 1920 as to Ernest P. Flint, Otto A. Bjornstad, and J. J. Cairns in the respective amounts of $145.33, $1,471.60, and $1,245.11. Two issues are involved, viz, (1) the gain realized from the sale of certain parcels of real estate in the taxable year, and (2) the correct rate of depreciation on certain farm improvements as a factor in the determination of the profit resulting from the sale thereof as a part of a certain farm property sold in the taxable year. By agreement of counsel the three proceedings were consolidated for hearing and decision. FINDINGS OF FACT. The petitioners, Flint, Bjornstad, and Cairns, in the taxable year were members of a copartnership known as the Iowa Securities Co. which was engaged in real estate operations at Spencer, Iowa, and 21 owned interests3622 therein in the respective proportions of 50/510, 55/510, and 100/510. In 1919 the partnership sold 282.25 acres of land, known as the Erfmeyer Farm, for a recited consideration of $63,528.75, to which the Commissioner in computing the taxable gain realized from the transacion has added $591.27 as depreciation accrued on the improvements. The cost of such farm and of completing the sale thereof was $50,084.48. The consideration received consisted of $12,128.75 cash in the taxable year, the assumption by the purchasers of a first mortgage in the amount of $35,000, and a second mortgage in the amount of $16,000, due March 1, 1925, and bearing interest at the rate of 6 per cent, which was taken back by the seller. The fair market value of such second mortgage at date of sale was $4,000. In 1920 the partnership sold 160 acres of land known as the Brown Farm, for a recited consideration of $39,125, to which the Commissioner, in computing the taxable gain realized from the transaction, has added $604.13 as depreciation accrued on the improvements. The consideration received consisted of $14,125 cash, a first mortgage assumed by the purchasers in the amount of $20,000, and a second3623 mortgage in the amount of $5,000, due March 1, 1925, with interest at the rate of 6 per cent, which was taken back by the seller. The second mortgage had no market value at the date it was received by the partnership. In 1920 the partnership sold 233.41 acres of land known as the Newton Farm, for a recited consideration of $52,515, to which the Commissioner, in computing the gain realized from the transaction, has added $518.93 as depreciation accrued on improvements. The consideration received consisted of $15,401.44 cash, a first mortgage assumed by the purchaser in the amount of $22,500, and two notes, one for $9,613.86 due March 1, 1925, with interest at 6 per cent, and the other for $5,000 due March 1, 1922, with interest at 8 per cent. The two notes were secured by a second mortgage on the farm, taken back by the seller. At the date of the sale the notes secured by the second mortgage had a fair market value of $6,000. The petitioner, Bjornstad, sold a one-half interest in a farm of 316 acres located in Cottonwood County, Minnesota, in the year 1920. In computing the gain realized from such sale the Commissioner added accrued depreciation on improvements in an amount3624 not disclosed by the record, but at annual rates of 4 per cent on farm buildings and drain tile and 10 per cent on farm fences. In 1920 the petitioner Cairns sold his one-half interest in a farm located in Minnesota to Tom Mangan. The consideration received consisted of $3,750 cash, a first mortgage assumed by the purchaser in the amount of $7,000, and two notes, the first for $1,700 and the second for $3,550. The two notes were secured by a second mortgage 22 on the farm taken back by the seller. At the date of the sale the two notes secured by the second mortgage had a fair market value of $1,700. The record does not disclose the amount of profits reported by the partnership in its income-tax return for 1920, resulting from the sale of the Erfmeyer, Brown and Newton farms, bu upon audit of such return the Commissioner held that the second mortgages taken back by the partnership were worth their face value when received and determined the deficiencies here in question. OPINION. LANSDON: The parties agree on the cost of the farms sold by the partnership and on the recited consideration received therefor, and in connection with this point ask that the Board shall3625 only determine the actual value of the second mortgages at the date they were received by the partnership. We have given careful consideration to the evidence introduced by the petitioners. All the witnesses were dealers in first and second farm mortgages in the vicinity of the lands in question. All know the lands and improvements sold and were familiar with land values in the neighborhood of the farms in 1920. Based upon the evidence we have found that at the dates received by the partnership the second mortgages in question had the value which we have set forth in our findings of fact. The question of depreciation is raised only by the petitioner Bjornstad and by him only as to the improvements on the 316-acre farm in Minnesota. The evidence on this point is not sufficient for us to find that the Commissioner was in error in his computation of the accrued depreciation on the improvements on such farm at the date of sale. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623284/	GEORGE COLOPY AND ELSIE COLOPY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentColopy v. CommissionerDocket No. 6279-80.United States Tax CourtT.C. Memo 1984-71; 1984 Tax Ct. Memo LEXIS 604; 47 T.C.M. (CCH) 1087; T.C.M. (RIA) 84071; February 13, 1984. A. J. Schmitt III, for the petitioners. Linda K. West, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: Respondent determined deficiencies in petitioners' joint Federal income tax and asserted additions to tax against petitioner George Colopy under section 6653(b) 1 as follows: addition to TaxSec. 6653(b),YearDeficiencyI.R.C. 19541970$ 291.60$ 882.401971$34,475.17$18,007.741972$31,885.21$16,833.511973$20,104.11$10,848.02The issues for decision are: 1. Whether respondent correctly reconstructed the taxable income from petitioner George Colopy's sheetrock hanging and finishing business during the years before the Court; and 2. Whether any part of any underpayment for the years in question was due to fraud on the part of petitioner George Colopy within the meaning of section 6653(b). FINDINGS OF FACT Petitioners filed delinquent joint Federal income tax returns for each of the years in606 question with the Internal Revenue Service Center, Austin, Texas. At the time their petition in this case was filed, they resided in Metairie, Louisiana. During each of the years in issue, petitioner George Colopy (petitioner) was self-employed as a subcontrator in the sheetrock hanging and finishing business. His principal place of business was Metairie, Louisiana. The time which petitioner spent on his business was devoted almost entirely to bidding on jobs, hiring crews to perform work on the jobs that he received, and inspecting the work done to make sure that it was satisfactory. Except for some touch-up work on practically completed jobs, he did not perform the actual labor himself. The work was performed by crews, usually composed of six to ten men. Petitioner had no permanent employees but instead hired two new crews for each job; one to hang the sheetrock and the other to do the finishing. Petitioner bid on jobs by the square foot of sheetrock to be hung. During the years in question, most of petitioner's bids were about 7 to 8 cents a square foot. Petitioner would then pay 2 to 2-1/2 cents per square foot to the crew that hung the sheetrock and another 2 to607 2-1/2 cents per square foot to the crew that did the finishing. The sheetrock was furnished by the contractors, but on most jobs petitioner was required to furnish all other materials, including nails, brushes, rollers, joint compound ("mud"), tape, and corner beads. During the years in issue, petitioner kept no records of his business receipts and expenses. He maintained no checking or savings account. He paid substantially all of his business and personal expenses in cash. Petitioners failed to file timely Federal income tax returns for the years 1966 through 1973. Petitioner testified that he did not file for the years 1966 through 1969 because he was working "very little" at that time. Petitioner was aware that he was required to file for the years here in question, 1970 through 1973, but explained that he did not do so because "I failed to file and I got scared. I didn't know what to do really." On December 21, 1976, an information was returned in the United States District Court for the Eastern District of Louisiana charging petitioner with four counts of willfully and knowingly failing to file income tax returns, in violation of section 7203. The four counts concerned608 the years 1970 through 1973, respectively. Petitioner pled guilty to counts 2 and 3, concerning the years 1971 and 1972. 2 On June 8, 1977, he was fined $2,500 and sentenced to prison for one year for each count. The prison sentences were suspended. Respondent reconstructed petitioner's gross income for the years in question by the specific items method. He consulted the records of the contractors for whom petitioner worked, and determined that petitioner had received the following amounts of gross income: 1970$ 90,851.831971$187,183.571972$202,149.831973$159,857.29Petitioner has stipulated to the correctness of these amounts. Respondent condeces that this income was partially offset by the following deductions: 1970197119721973Rent$ 600.00$ 600.00$ 600.00$ 600.00Telephone95.92107.14113.08123.82Truck1,361.001,496.001,454.001,738.00Legal fees200.00500.00Officesupplies120.00120.00120.00120.00Depreciation724.33724.331,866.22622.08Interest157.06$157.05Taxes &licenses131.50Insurance123.11123.10Labor58,320.0060,700.0073,102.0062,115.00Materials18,470.8234,956.8238,986.8830,777.97Total$79,692.07$98,704.29$116,853.85$96,877.02609 Respondent also developed these expense figures by means of the specific items method. Respondent interviewed as many of petitioner's suppliers and crew members as could be found and allowed deductions based on their records and recollections of what petitioner had paid them. Subtracting the conceded expenses from the stipulated gross receipts yields the following net profits and profit margins (net profits as a percentage of gross receipts): 1970197119721973Grossreceipts$90,851.83$187,183.57$202,149.83$159,857.29Expenses79,692.0798,704.29116,853.8596,877.02Netprofit$11,159.76$88,479.28$85,295.98$62,980.27Profitmargin12 percent47 percent42 percent39 percentPetitioner filed delinquent returns for the years in question, 1970 through 1973, in March 1977, after the commencement of the criminal action described above. The returns were prepared by Terry Meyer, a professional accountant. Meyer did not sign the returns as preparer, however. As he testified, "it was just based on information that I wasn't sure whether was right." The results of petitioner's sheetrock business were reported in the610 returns simply by the entry of the following net profit figures, with no breakdown into gross receipts and expenses: 1970$ 9,612.521971$10,505.521972$12,131.921973$10,121.87Meyer also prepared petitioner's returns for the years 1974 through 1980, signing these returns as preparer. In these returns, the results of petitioner's business were reported in detail on Schedules C. Reported gross receipts for these years averaged $448,522, ranging from a low of $188,390 in 1974 to a high of $639,006 in 1978. The reported expenses for materials, labor, and other items, and the net profit, varied little when measured as percentages of gross receipts. Materials expense averaged 12 percent of gross receipts, with a low of 11 percent and a high of 16 percent. Labor expense averaged 78 percent of gross receipts, varying from a low of 76 percent to a high of 79 percent. Other expenses ranged from 2 percent to 5 percent of gross receipts, averaging about 4 percent. Net profit averaged 6 percent of gross receipts, varying from a low of 5 percent to a high of 8 percent. So far as the record informs us, respondent has not challenged the accuracy of petitioner's611 returns for the years 1974 through 1980. Petitioner is of the opinion that the profit margin of his business was about the same in those years as it was during the years in question. OPINION 1. DeficiencyA taxpayer is required to maintain such records as will enable him to file a correct return. Sec. 1.446-1(a)(4), Income Tax Regs.; sec. 1.6001-1(a), Income Tax Regs. In the absence of such records, taxable income may be reconstructed by the Commissioner using any method which, in his opinion, clearly reflects income. Sec. 1.446-1(b)(1), Income Tax Regs.; Schellenbarg v. Commissioner,31 T.C. 1269">31 T.C. 1269 (1959), affd. in part and revd. in part on another issue 283 F.2d 871">283 F.2d 871 (6th Cir. 1960). In the present case, respondent has chosen to use the specific items method of income reconstruction, based on the records and memories of third parties with whom petitioner dealt. This method has been approved by this Court. 3 Petitioner argues that respondent should have reconstructed his income by multiplying the stipulated gross receipts for the years in question by profit margins approximating those shown in his returns for subsequent years. This method, 612 too, has been approved by this Court. Tunningley v. Commissioner,22 T.C. 1108">22 T.C. 1108, 1117 (1954). It is clear that, when the inadequacy of a taxpayer's records forces respondent to reconstruct his incom by some indirect method, the choice of that method rests with respondent. Schellenbarg v. Commissioner,supra, at 1277. We are convinced, however, that petitioner's profit margins during the years in question were nearer to the 5 to 8 percent range that he achieved during the subsequent years 1974 through 1980 than to the large margins resulting from respondent's computations, particularly the 47 percent, 42 percent, and 39 percent margins resulting from respondent's determinations for the years 1971 through 1973. The discrepancy, we conclude, is largely due to respondent's failure to take into account all of the expenses, most significantly those of labor and materials, which petitioner actually incurred. 4613 In stating this conclusion, we do not inply that respondent was required to reconstruct petitioner's income by the method petitioner advocates. We merely recognize that all methods of reconstruction are imprecise 5 and find, based on the documented results of subsequent years and the record as a whole, that respondent, while properly exercising his discretion in selecting the method of reconstruction, has overstated petitioner's net income from his sheetrock business for the years in question. Using our best judgment on the basis of the record before us, we find that petitioner realized net income from his sheetrock business in the following amounts: 1970$10,0001971$22,5001972$25,0001973$20,000Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d Cir. 1930). 2. Addition to TaxSection 6653(b) provides that, if any part of any underpayment is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. 614 Fraud, within the meaning of section 6653(b), is an intentional wrongdoing with the specific intent of evading a tax believed to be owed. Powell v. Granquist,252 F.2d 56">252 F.2d 56, 60 (9th Cir. 1958); Mitchell v. Commissioner,118 F.2d 308">118 F.2d 308, 310 (5th Cir. 1941). Whether fraud exists with respect to an underpayment of tax is a question of fact, and the burden is on respondent to show the existence of such fraud by clear and convincing evidence. Sec. 7454(a); Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 220 (1971); Rule 142(b). The answer to this question must be determined by an examination of the entire record. Stratton v. Commissioner,54 T.C. 255">54 T.C. 255, 284 (1970). The required intent may be shown by circumstantial evidence and reasonable inferences drawn from the facts. Stone v. Commissioner,supra at 224; Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 200 (1976), affd. per order (8th Cir. May 2, 1978). We hold that respondent has carried his burden of proving that part of the underpayment for each of the years in issue was due to fraud on the part of petitioner George Colopy. Due to his criminal615 convictions under section 7203, petitioner is collaterally estopped to deny that he willfully failed to file for 1971 and 1972, Gemma v. Commissioner,46 T.C. 821">46 T.C. 821, 834 (1966), i.e., that he voluntarily and intentionally violated a known legal duty. United States v. Pomponio,429 U.S. 10">429 U.S. 10 (1976). The willfulness of his failure to file for 1970 and 1973, the remaining years in issue, is established by his own testimony that he knew he was required to file but was scared to do so because of his previous pattern of nonfiling. This willful failure to file is not, by itself, sufficient to establish that petitioner acted with fraudulent intent, but it may be taken into account as persuasive evidence of fraud, particularly where such failure has persisted over a period of years. Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002, 1005 (3d Cir. 1968); Powell v. Granquist,supra at 60-61. 6 As this Court stated in Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1, 19 (1980): An extended pattern of nonfiling plus some "convincing affirmative indication" of the requisite specific intent to defraud warrants imposition of616 the addition to tax for fraud. Stoltzfus v. United States,398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968). The years in question were the fifth, sixth, seventh, and eighth years in succession that petitioner filed to file a timely Federal income tax return. While petitioner testified that he did not file for the years 1966 through 1969 because he worked "very little" at that time, he does not argue that his earnings for those earlier years were so low that no return was required under section 6012(a). Indeed, the fact that petitioner was scared by his failure to file for those years leads to the inference that he believed that some tax was owed with respect to them. Also, his continuing failure to file returns in those circumstances supports the conclusion that he hoped thereby to conceal his liability and ultimately to evade and defeat its collection. An additional indication of fraud is petitioner's failure to maintain any records. Grosshandler v. Commissioner,supra at 20; Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 109 (1969). The inference of fraud617 arising from these facts is not rebutted by petitioner's unconvincing testimony that he did not intend to keep the money that he owed to the Government. There is no evidence that he was setting aside funds with which to pay his annually increasing tax liability. Considering petitioner's 8-year pattern of nonfiling together with his failure to maintain any records from which his taxable income could be computed, we conclude that part of the underpayment for each of the years in question was due to an attempt fraudulently to evade the income tax. Accordingly, we sustain respondent's imposition of additions to tax under section 6653(b). Petitioner argues that the fines totaling $5,000 that he paid as a result of his convictions under section 7203 should be credited against the addition to tax here imposed under section 6653(b). We do not agree.While the Internal Revenue Code provides that certain sanctions shall be mutually exclusive, 7 no such relationship exists between fines under section 7203 and additions to tax under section 6653(b). Under the statutory scheme, therefore, it is clearly contemplated that both sanctions may be imposed in the same case. The addition to tax*618 under section 6653(b) is not a criminal penalty, but instead is a civil measure which is "provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud." Helvering v. Mitchell,303 U.S. 391">303 U.S. 391, 401 (1938). Its imposition in conjunction with a criminal penalty does not violate the double jeopardy clause of the Fifth Amendment. Helvering v. Mitchell,supra at 398-399. Accordingly, the addition to tax for fraud is not abated by the fines paid in connection with petitioner's criminal convictions. Petitioner argues in the alternative that the criminal fines should be credited against his income tax deficiency.This argument is without merit. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise noted.↩2. The record does not reveal the disposition of counts 1 and 4 concerning 1970 and 1973.↩3. See, for example, Ballard v. Commissioner,T.C. Memo. 1982-466, on appeal (8th Cir. May 31, 1983); Bolton v. Commissioner,T.C. Memo. 1975-373↩.4. For example, according to respondent's determinations, in 1970 petitioner incurred labor costs of $58,320 in generating gross income of $90,851.83. In 1971, respondent determined that petitioner incurred labor costs of $60,700 in generating gross receipts of $187,183.57. In other words respondent maintains that petitioner's labor costs increased only slightly while his gross income more than doubled. Respondent's determinations for 1972 and 1973 are also based on labor costs much lower in relation to gross receipts than those incurred in 1970. Respondent's determinations regarding petitioner's labor expenses, particularly those of the years 1971-1973, are sharply at variance with our finding that it cost petitioner 4-5 cents of labor expense to earn 7-8 cents of gross income. We conclude that respondent understated petitioner's labor costs. It is relevant, we think, that the gross receipts figures developed by respondent from interviews with contractors reflect expenses deductible by them. Petitioners' deductions for labor and materials, on the other hand, reflect income items in the hands of the workers and suppliers. This is a problem inherent in the method chosen to reconstruct petitioners' income.↩5. This, of course, includes our own reconstructions of income and expenses under the rule of Cohan v. Commissioner,39 F.2d 540">39 F.2d 540↩ (2d Cir. 1930), to which we have frequently resorted.6. See also Estate of Ming v. Commissioner,T.C. Memo. 1976-115↩.7. For example, the additions to tax for negligence and fraud under sec. 6653(a) and (b), respectively, may not be simultaneously imposed. Sec. 6653(b)(3).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623285/	Longue Vue Foundation, Transferee of the Assets of the Estate of Edith R. Stern, Deceased; Estate of Edith R. Stern, Deceased, Edgar B. Stern, Jr., Executor, Petitioners v. Commissioner of Internal Revenue, RespondentLongue Vue Foundation v. CommissionerDocket No. 4440-85United States Tax Court90 T.C. 150; 1988 U.S. Tax Ct. LEXIS 12; 90 T.C. No. 12; January 26, 1988January 26, 1988, Filed 12 A testamentary charitable bequest was voidable by the exercise of statutory rights of forced heirs under Louisiana law. Held, under the facts of this case and because the forced heirs did not exercise their statutory rights, a charitable estate tax deduction under sec. 2055, I.R.C. 1954, as amended, is allowed for the charitable bequest. Thomas B. Lemann and Raymond J. Brandt, for the petitioners.Linda K. West, for the respondent. Swift, Judge. SWIFT151 This matter is before the Court on petitioners' motions for summary judgment and for partial summary judgment filed under Rule 121. 1 Respondent objects to petitioners' motion for summary judgment on the merits of the issue raised therein, and respondent objects to petitioners' motion for partial summary judgment on the grounds that the issue raised therein is not ripe for summary judgment.13 In a statutory notice of deficiency dated December 4, 1984, respondent determined a deficiency in the amount of $ 9,244,917 in the Federal estate tax liability of the Estate of Edith R. Stern. In a statutory notice of transferee liability dated December 4, 1984, respondent determined that petitioner Longue Vue Foundation was liable as a transferee for the full $ 9,244,917 Federal estate tax deficiency determined against the Estate of Edith R. Stern.Petitioners' motion for summary judgment raises the following issue: Whether a charitable estate tax deduction is allowable under section 2055 for a testamentary bequest to charity where the charitable bequest is voidable by the exercise of a forced heir's legitime 2 interest under Louisiana law. Petitioners' motion for partial summary judgment raises an issue concerning the retroactivity of a particular Louisiana statute. In light of our decision on petitioners' motion for summary judgment, it is not necessary to address petitioners' motion for partial summary judgment and that motion will be denied as moot.14 152 FINDINGS OF FACTMany of the facts have been stipulated and are found accordingly.Decedent Edith R. Stern died on September 11, 1980. On the date of death, she was a resident of Louisiana. Decedent was the mother of three children: Edgar B. Stern, Jr. (the executor of decedent's estate and one of the petitioners in this case), Philip Stern, and Audrey Stern. Audrey Stern died prior to decedent's death but was survived by children.During her lifetime, decedent made large gifts to her children. The parties have agreed on the value of the inter vivos gifts made to decedent's children as of the date of the various gifts and as of the date of decedent's death, as follows:Date-of-gift valuesDate-of-death valuesEdgar B. Stern, Jr.$ 4,290,639$ 13,926,002Philip Stern5,469,52915,968,259Audrey Stern4,696,84013,919,764Total14,457,00843,814,025Also during her lifetime, decedent, whose father was Julius Rosenwald (one of the founders of Sears, Roebuck & Co.), expressed her desire to leave her large home and garden in New Orleans to charity for use as a public museum.On October 4, 1980, decedent's will was probated. Under the terms15 of the will, decedent devised her home and garden to Longue Vue Foundation, a charitable organization. Decedent also bequeathed $ 5 million in cash to Longue Vue Foundation as an endowment to maintain the home and garden. At the time of decedent's death, the approximate total value of the devise and bequest to Longue Vue Foundation was $ 12,437,257.The residue of decedent's estate passed by will to her two surviving children, Edgar and Philip Stern, and to a Thomas B. Hess. The record does not disclose the identity of Thomas B. Hess. Other than the residue of her estate, decedent made no specific bequests to her children or grandchildren in her will.Under Louisiana law, decedent's two surviving children and the children of Audrey Stern were considered forced heirs. Upon her death, decedent's two children and the 153 children of Audrey Stern therefore were entitled to two-thirds of the estate. 316 On May 30, 1981, within 9 months of decedent's death, Edgar B. Stern, Jr., executed a disclaimer of his right to his legitime interest in decedent's estate, as well as to his share of the residue of decedent's estate. The effect of Edgar Stern's disclaimer was to increase the size of the legitime interest to which the remaining forced heirs were entitled. La. Civ. Code Ann. art. 1498 (West 1987).The Federal estate tax return for decedent's estate was filed on December 15, 1981. The value of decedent's estate as reported on the return was $ 14,466,067. The $ 12,437,257 devise and bequest to Longue Vue Foundation was claimed as a charitable deduction under section 2055.In 1983, three years after decedent's death, the remaining forced heirs (namely, Philip Stern and the children of Audrey Stern) waived their rights to claim their legitime interests in decedent's estate. The waivers, dated September 30, 1983, were included in the joint petition that was filed by the estate, by Philip Stern, and by the children of Audrey Stern in the Louisiana State Civil District Court for the Parish of Orleans to permit the Longue Vue Foundation to take possession of decedent's home and garden, 17 and the $ 5 million cash bequest. The judgment authorizing Longue Vue Foundation to take possession of the property was dated September 30, 1983.In calculating the amount of the forced heir's legitime interests under Louisiana law, respondent determined that the total cumulative value of decedent's estate was $ 93,498,593. This figure included inter vivos gifts made by decedent and the value of the property includable in decedent's estate on the date of death. Respondent calculated the total cumulative value of the estate as follows:ValueEstate at death (per return)$ 14,466,067 Plus inter vivos gifts79,435,209 Less amounts owed by the estate(402,683)Total cumulative value of estate93,498,593 154 Respondent further calculated that the legitime interests of the forced heirs was two-thirds of the total estate, or $ 62,332,394. The portion of decedent's estate that respondent determined was not subject to the legitime interests of the forced heirs was the remaining one-third of the value of the estate, or $ 31,166,199.Because the forced heirs received $ 43,814,025 in gifts from decedent (based on the date-of-death values therefor), respondent determined18 that the forced heirs would be entitled to claim an additional $ 18,518,369 from the estate. 4 Respondent, therefore, determined that no deduction was allowable under section 2055 for the charitable bequest to Longue Vue Foundation because the bequest was voidable through the exercise of the forced heirs' legitime interests.Petitioner concedes that if we disallow the charitable deduction to decedent's estate, petitioner Longue Vue Foundation will be liable as a transferee under section 6901(a) for the deficiency in estate taxes due from the estate.OPINIONA decision on a motion for summary judgment may be rendered if there is no genuine issue as to any material fact. Rule 121(b). Either party may move for summary judgment in his favor on all or any part of the legal issues in controversy. Rule 121(a). Respondent has not alleged any specific facts that would necessitate a trial on the issue raised in petitioners' motion for summary judgment. See Gauntt v. Commissioner, 82 T.C. 96">82 T.C. 96, 101 (1984).19 Section 2055 allows a Federal estate tax deduction for charitable devises and bequests to qualified donee organizations. Where a charitable devise or bequest is contingent upon the happening of a precedent event or condition, or upon the happening of a subsequent event or condition, a charitable deduction will not be allowed unless the possibility of the occurrence of the event or condition is so remote as to be negligible. Sec. 20.2055-2(b)(1), Estate Tax Regs. 520 155 Respondent argues that the possibility that decedent's forced heirs would exercise their legitime interests was not so remote as to be negligible. Respondent also argues that in order for the charitable devise and bequest to be deductible, the forced heirs would have had to file disclaimers of their legitime interests as provided under section 2518.Petitioners argue that the cases that have considered the effect on charitable deductions of State statutes that protect forced heirs have allowed charitable estate tax deductions where the charitable bequest was explicit in the will, where under State law, the bequest to charity was merely voidable, and where the charitable donee actually received the full amount of the bequest with respect to which the charitable deduction was claimed. Petitioners also argue that there is no factual matter in dispute relevant to this issue and that this issue can be decided as a matter of law. For the reasons set forth below, we agree with petitioners.Under Louisiana law, a testamentary disposition that impinges on a forced heir's legitime interest is not void. It is merely voidable. Article 1502 of the Louisiana Civil Code Annotated 21 (West 1987) provides as follows:Art. 1502. Reduction of excessive donationsAny disposal of property, whether inter vivos or mortis causa, exceeding the quantum of which a person may legally dispose to the prejudice of the forced heirs, is not null, but only reducible to that quantum.The testamentary transfer is effective immediately upon death of the testator, and the testamentary donee lawfully holds ownership and possession of his interest even if the 156 testamentary transfer impinges on a legitime interest of a forced heir. Only if and when the forced heir demands a reduction of the testamentary transfer will any reduction thereof occur. Ramsey v. Ramsey, 385 So. 2d 919">385 So. 2d 919, 924 (La. App. 1980); Cox v. Von Ahlefeldt, 105 La. 543">105 La. 543, 30 So. 175">30 So. 175, 214 (1900).A forced heir, under Louisiana law, is seized of a right but is not seized in fact and has no legal interest in the property subject to the testamentary transfer until he asserts his right to the succession and takes possession of his interest according to law. Succession of Marten, 234 La. 566">234 La. 566, 100 So. 2d 509">100 So. 2d 509, 512-513 (1958);22 Sun Oil Co. v. Tarver, 219 La. 103">219 La. 103, 52 So. 2d 437">52 So. 2d 437, 443-444 (1951). See also Baten v. Taylor, 386 So. 2d 333">386 So. 2d 333, 340 (La. 1979).Accordingly, under Louisiana law, decedent's testamentary transfer to Longue Vue Foundation was effective to transfer ownership of the property and the cash endowment to Longue Vue Foundation immediately upon decedent's death. Longue Vue Foundation received its ownership interest from decedent under the will, not from the forced heirs and not as a result of their failure to assert their legitime interests.In Varick v. Commissioner, 10 T.C. 318 (1948) (Court-reviewed), we examined the deductibility for Federal estate tax purposes of a charitable bequest that was voidable by the exercise of a forced heir's statutory share under California law. The facts were similar to those involved herein. One forced heir disclaimed his interest in the charitable bequest made by the decedent. The other forced heir did not disclaim her interest. Distinguishing under California law between void and voidable charitable bequests, we found that the estate tax charitable23 deduction was allowable even though a disclaimer was not made by both forced heirs, where the charitable bequest was merely voidable and where the forced heirs did nothing to assert their statutory rights. The Court stated as follows:The charitable bequests of decedent in excess of one-third of her estate were voidable by her heirs. No steps were taken by them to render the bequests invalid, but, on the contrary, they gave explicit or tacit consent to the distribution of decedent's estate pursuant to the terms of her will. Therefore, the full amount of the interests bequeathed by decedent to the 157 three charities here involved passed to them from decedent under her will and is deductible from her gross estate. * * [Varick v. Commissioner, supra at 322.]See also Estate of Butler v. Commissioner, 18 T.C. 914">18 T.C. 914, 921-922 (1952).In Humphrey v. Millard, 79 F.2d 107">79 F.2d 107 (2d Cir. 1935), a New York statute provided that charitable bequests could not be made of more than one-half of an estate. The Second Circuit noted New York court decisions that described charitable bequests in violation24 of the New York statute as voidable, not void. The Second Circuit concluded that the charitable bequests were not too remote, uncertain, or indefinite to be disallowed for Federal estate tax purposes. In that regard, the Second Circuit emphasized that the uncertainties affecting the charitable bequests were not found in the will but arose only by virtue of State law, as follows:But here no uncertainty existed at the time [decedent] died which was inherent in the language of his will. But for the New York statute above quoted, the provisions of the will disposing of the residuary estate were definite enough. Until and unless the widow exercised her statutory right to defeat partially the tax-exempt testamentary disposition of the residuary estate which her husband had made, his will was effective as to all of it. * * While it cannot be said that there was no uncertainty as to the amount of the charitable bequests at the time the testator died, however unreal subsequent events have proved that uncertainty to have been, that related only to the validity of the will as an instrument for the transfer of one-half of the residuary estate. When the will was proved and allowed in 25 the Surrogate's Court, it was for the first time judicially determined to be the effective will of the testator in all respects as written. This was not only a decision binding upon the defendants that the will was valid, but that it disposed of the residuary estate as of the date of the death of the testator in a manner exempt from federal estate taxation under section 403(a)(3) of the Revenue Act 1921. It may be said that more or less uncertainty exists as to the validity of any will until it is proved and allowed. * * [Humphrey v. Millard, supra at 108. Citations omitted.]In Commissioner v. First National Bank of Atlanta, 102 F.2d 129">102 F.2d 129 (5th Cir. 1939), affg. 36 B.T.A. 491">36 B.T.A. 491 (1937), a Georgia statute provided that charitable bequests made under a will executed within 90 days of a testator's death shall be void. The Fifth Circuit held that the charitable bequests were effective and that the bequests were sufficiently 158 definite and certain to be allowed for Federal estate tax purposes. The Fifth Circuit explained that --the definiteness and certainty of bequests, required by the26 Federal statutes, is as to the intent of the testator as manifested by the terms of his will. It is not affected by the possibility of contest and defeat of the will, or of any provision in it. If read according to its terms, the bequests are definite, certain, unequivocal and final from the standpoint of the testator's desire and will, and unobjected to, they stand as valid as against those having right to contest or object to them, they stand also as valid and definite for the purposes of taxation. [Commissioner v. First National Bank of Atlanta, supra at 131. Citations omitted.]See also Dimock v. Corwin, 99 F.2d 799">99 F.2d 799, 802 (2d Cir. 1938).The regulations under section 2055 contain an example that supports our analysis. In example (6) of section 20.2055-2(e)(1)(i), Estate Tax Regs., a testator devised real property to charity. The charitable devise could have been defeated by the exercise of the surviving spouse's statutory dower rights. The example concludes that the surviving spouse's unexercised dower rights are to be ignored, and the charitable deduction is to be allowed.A provision of the recently promulgated27 regulations under section 2518 also is relevant to our analysis. 6 Section 25.2518-1(c)(2), Gift Tax Regs., distinguishes between disclaimers that are void or voided, on the one hand, and those that are merely voidable, on the other. It states that disclaimers that are void, as well as disclaimers that are voidable but that, at some point in time, are voided, will not be treated as valid disclaimers. Disclaimers that are merely voidable, however, and that, in fact, are not ever voided by whoever holds that power are to be recognized as qualifying disclaimers. 7 It is the latter situation that is analogous to the voidable charitable devise and bequest before us.28 If the voidability of a disclaimer is to be ignored for Federal gift and estate tax purposes where the right to void the disclaimer is not exercised, we discern no reason why the voidability of a charitable gift cannot be ignored where the charitable gift is not voided, where the charitable gift otherwise is effective as of the date of death, and where the 159 testator's intent to make the charitable gift is clearly set forth in the will. In both of these situations, as of the date of death or as of the date of the disclaimer, some indefiniteness and uncertainty exists as to what eventually will happen to the devise or bequest in question. As explained, however, the cases and respondent's regulations look beyond the voidable character of the gifts or disclaimers, and treat the gifts or disclaimers as effective and final, at least in those situations where the gifts or disclaimers in question are never voided. In other words, the mere voidability of a gift or disclaimer in these situations is not regarded as creating a contingency that fails the "so remote as to be negligible" test of the regulations under section 2055.Respondent contends that if petitioners prevail herein, 29 respondent's agents constantly will have to monitor charitable gifts that are voidable by forced heirs in order to ascertain whether the charitable gifts are ever voided. Petitioners respond that even where formal disclaimers are required under section 2518, respondent's agents constantly must determine whether the disclaimers are valid. Petitioners emphasize that under any decision we reach, as part of the audit examination process, respondent's agents will have to verify various post-death events.It would appear that respondent's agents can adequately protect the revenue where voidable charitable gifts are involved, as they did in the instant case, by keeping the examination of the estate open until after the transfer to the charity has occurred. Typically, State probate authorities will not allow actual transfers of the property to occur until after all forced heirs have waived their statutory rights to void the charitable gifts. In further regard to respondent's argument on this point, we agree with the following statement of the Ninth Circuit in rejecting a similar argument:it is not necessary to police this matter preemptively by denying or limiting the charitable deduction30 on the basis of an artificial procedure that estimates the probability of such a settlement at the moment of death. * * If we were to invalidate the charitable deduction in such cases * * * we would largely undermine Congress's purpose in allowing charitable deductions -- to encourage testators to make charitable 160 bequests. * * [Ahmanson Foundation v. United States, 674 F.2d 761">674 F.2d 761, 771 (9th Cir. 1981).]Respondent argues further that in order for the charitable devise and bequest to the Longue Vue Foundation to be deductible, each of the forced heirs must file disclaimers that qualify under section 2518. 8 Paragraph 4 of section 2518(b) makes it clear, however, that the disclaimer provisions apply only where the interest in property being disclaimed will be transferred to the decedent's spouse or to a person other than the person making the disclaimer as a result of the disclaimer. As we have explained, under Louisiana law, the devise and bequest in question herein passed to the Longue Vue Foundation under the will, immediately upon the death of decedent. The transfer of ownership to Longue Vue Foundation occurred as a testamentary31 gift from the decedent, not as a result of disclaimers executed by the forced heirs. See also Estate of Dancy v. Commissioner, 89 T.C. 550">89 T.C. 550, 557 (1987).32 Respondent relies on Bel v. United States, 310 F. Supp. 1189">310 F. Supp. 1189 (W.D. La. 1970), affd. in part and remanded in part 452 F.2d 683">452 F.2d 683 (5th Cir. 1971), which involved rights of forced heirs under Louisiana law in the context of the marital deduction under section 2056. The District Court, in effect, held that because of the anti-disclaimer provision of section 2056, as applicable to decedents dying in 1961, 9 a transfer 161 contrary to the rights of forced heirs in Louisiana, for marital deduction purposes, was to be treated as void, regardless of its void or voidable nature under Louisiana law. Therefore, any such interest that the surviving spouse actually received was treated as passing not from the decedent to the surviving spouse, but from the decedent to the forced heirs and then to the surviving spouse. Accordingly, the District Court held that such an interest was not eligible for the marital deduction.33 The District Court's decision in Bel on the marital deduction issue was remanded by the Fifth Circuit for an analysis of that issue under the provisions of section 20.2056(e)-2(d)(2), Estate Tax Regs. Bel v. United States, 452 F.2d 683">452 F.2d 683, 694 (5th Cir. 1971). Those provisions do not apply in this case. Respondent, however, cites the District Court opinion in Bel as controlling our resolution of this case. We find the District Court's opinion in Bel to be inapplicable. The charitable deduction provisions of section 2055 that apply in this case contain no provision comparable or even analogous to the anti-disclaimer provision of section 2056 that applied to the year at issue in Bel. That opinion is completely distinguishable from the facts and law of the instant case and provides no support for respondent's position herein.For the reasons stated, we conclude that the charitable deduction in question is allowable under section 2055. Petitioners' motion for summary judgment will be granted.An appropriate order will be entered. Footnotes1. All Rule references are to the Tax Court Rules of Practice and Procedure, and, unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect as of the date of decedent's death.↩2. "Legitime" has been defined as follows:"In the civil law, that portion of a parent's estate of which he cannot disinherit his children without a legal cause. That interest in a succession of which forced heirs may not be deprived. * * * [Black's Law Dictionary 811 (5th ed. 1979).]"↩3. As described more fully below, under Louisiana law, forced heirs are legal heirs of the testator and have the right, if they so elect, to claim as their legitime interest a specified portion of the testator's property. Testamentary dispositions that would deprive forced heirs of their legitime interest are voidable but are not void. La. Civ. Code Ann. arts. 1493, 1495, and 1502↩ (West 1987), and the provisions thereof in effect in 1980.4. $ 62,332,394 minus $ 43,814,025 equals $ 18,518,369.↩5. Sec. 20.2055-2(b)(1), Estate Tax Regs., provides as follows:(b) Transfers subject to a condition or a power↩. (1) If, as of the date of a decedent's death, a transfer for charitable purposes is dependent upon the performance of some act or the happening of a precedent event in order that it might become effective, no deduction is allowable unless the possibility that the charitable transfer will not become effective is so remote as to be negligible. If an estate or interest has passed to, or is vested in, charity at the time of a decedent's death and the estate or interest would be defeated by the subsequent performance of some act or the happening of some event, the possibility of occurrence of which appeared at the time of the decedent's death to be so remote as to be negligible, the deduction is allowable. If the legatee, devisee, donee, or trustee is empowered to divert the property or fund, in whole or in part, to a use or purpose which would have rendered it, to the extent that it is subject to such power, not deductible had it been directly so bequeathed, devised, or given by the decedent, the deduction will be limited to that portion, if any, of the property or fund which is exempt from an exercise of the power.6. The regulations under sec. 2518↩ were promulgated on Aug. 6, 1986.7. Sec. 25.2518-1(c)(2), Gift Tax Regs., provides as follows:(2) Creditor's claims↩. The fact that a disclaimer is voidable by the disclaimant's creditors has no effect on the determination of whether such disclaimer constitutes a qualified disclaimer. However, a disclaimer that is wholly void or that is voided by the disclaimant's creditors cannot be a qualified disclaimer.8. Sec. 2518, in relevant part, provides as follows:SEC. 2518(a). General Rule. -- For purposes of this subtitle, if a person makes a qualified disclaimer with respect to any interest in property, this subtitle shall apply with respect to such interest as if the interest had never been transferred to such person.(b) Qualified Disclaimer Defined. -- For purposes of subsection (a), the term "qualified disclaimer" means an irrevocable and unqualified refusal by a person to accept an interest in property but only if -- (1) such refusal is in writing.(2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of -- (A) the date on which the transfer creating the interest in such person is made, or(B) the day on which such person attains age 21,(3) such person has not accepted the interest or any of its benefits, and(4) as a result of such refusal, the interest passes without any direction on the part of the person and passes either -- (A) to the spouse of the decedent, or(B) to a person other than the person making the disclaimer.↩9. Sec. 2056, in relevant part, as applicable in 1961, provided as follows:SEC. 2056(d). Disclaimers. (2) By any other person. -- If under this section an interest would, in the absence of a disclaimer by any person other than the surviving spouse, be considered as passing from the decedent to such person, and if a disclaimer of such interest is made by such person and as a result of such disclaimer the surviving spouse is entitled to receive such interest, then such interest shall, for purposes of this section, be considered as passing, not to the surviving spouse, but to the person who made the disclaimer, in the same manner as if the disclaimer had not been made.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623286/	Louisiana Delta Hardwood Lumber Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentLouisiana Delta Hardwood Lumber Co. v. CommissionerDocket No. 8006United States Tax Court7 T.C. 994; 1946 U.S. Tax Ct. LEXIS 53; October 21, 1946, Promulgated 53 Decision will be entered under Rule 50. 1. Petitioner had a net operating loss in 1940. For 1941 petitioner took a deduction for percentage depletion. Since there was no allowable cost depletion, the percentage depletion so taken was in its entirety in excess of any allowable cost depletion. Held, in converting the net operating loss carry-over from 1940 into a net operating loss deduction for 1941, under section 122 (c) of the Internal Revenue Code, the carry-over from 1940 must be reduced by an amount equivalent to the deduction taken by petitioner in 1941 for percentage depletion.2. Held, under the facts, that petitioner can deduct for the calendar year 1941 only the capital stock tax which accrued July 1, 1941, and can not for deduction purposes treat the capital stock tax on a monthly accrual basis. Walter E. Barton, Esq54 ., for the petitioner.D. Louis Bergeron, Esq., and Roland K. Jones, Esq., for the respondent. Hill, Judge. HILL995 Respondent determined a deficiency in petitioner's income tax liability for the taxable year ended December 31, 1941, in the amount of $ 11,788.69. An issue involving depreciation has been settled by stipulation which will require a recomputation under Rule 50. The remaining questions are (1) whether respondent properly reduced the amount of petitioner's claimed net operating loss deduction and (2) whether respondent properly reduced the amount claimed by petitioner as a deduction for its accrued capital stock tax liability. Petitioner filed its income tax return on an accrual and calendar year basis with the collector of internal revenue for the district of Louisiana, at New Orleans. The case was submitted on oral testimony, exhibits, and stipulations of fact. The facts as stipulated are so found.FINDINGS OF FACT.Petitioner was incorporated under the laws of Louisiana, with its principal place of business in Shreveport. Petitioner is engaged in the lumber business.Net operation loss deduction issue. -- On its 1940 income tax return petitioner55 reported a net operating loss of $ 40,616.99. The parties are now agreed that the correct net operating loss for 1940 was $ 41,484.09. On its 1941 income tax return petitioner deducted as a net operating loss the amount of $ 40,616.99. During the taxable year 1941 petitioner received rentals, bonus, and royalties from oil leases in the amount of $ 135,786.84, on account of which petitioner took percentage depletion at the rate of 27 1/2 per cent, amounting to a deduction of $ 37,341.38. During 1942 and 1943 some of the oil leases expired, as a result of which petitioner was required to restore to income portions of the amount taken as percentage depletion in 1941.In his deficiency determination respondent, to arrive at the net operating loss deduction for 1941, reduced the amount of the corrected net operating loss carry-over from 1940 of $ 41,484.09 by the amount of the 1941 percentage depletion, or $ 37,341.38, and accordingly allowed as a net operating loss deduction for 1941 the difference of $ 4,142.71. There was no allowable cost depletion available to petitioner with respect to the oil leases and consequently the entire amount of percentage depletion taken by petitioner56 was in excess of what would have been allowable if computed without reference to discovery value or percentage depletion.Capital stock tax issue. -- For the capital stock tax years ended June 30, 1940, 1941, and 1942, petitioner paid capital stock taxes in the 996 amounts of $ 548.90 in the calendar year 1940, $ 5,000 in the calendar year 1941, and $ 750 in the calendar year 1942. On its income tax returns, which were filed on a calendar year basis, petitioner deducted these capital stock taxes as follows: $ 548.90 was deducted in 1940, $ 5,000 in 1941, and $ 750 in 1942. In other words, petitioner deducted the capital stock taxes in the calendar years during which they were paid.Respondent allowed as a deduction in 1941 on account of capital stock tax the amount of $ 750, representing the capital stock tax for the capital stock tax year which commenced July 1, 1941, and ended June 30, 1942. Respondent accordingly disallowed as a deduction in 1941 the amount of $ 5,000 claimed by petitioner as representing the capital stock tax paid in the calendar year 1941 for the capital stock tax year ended June 30, 1941.Petitioner now claims that the proper deduction in 1941 57 on account of capital stock tax is $ 2,875, representing one-half of the $ 5,000 capital stock tax for the capital stock tax year ended June 30, 1941, and one-half of the $ 750 capital stock tax for the capital stock tax year ended June 30, 1942.OPINION.Net operating loss deduction issue. -- Respondent, in arriving at the net operating loss deduction for 1941, reduced petitioner's net operating loss carry-over of $ 41,484.09 by $ 37,341.38, which latter figure represents the excess of 1941 percentage depletion over cost depletion. Since there was no allowable cost depletion, all of the percentage depletion constitutes such excess. Respondent argues that this reduction was made in accordance with section 122 of the Internal Revenue Code, as interpreted by the regulations. Petitioner contends that this reduction is improper and not warranted by the statute. We think respondent must be sustained.Section 122 (c) provides:SEC. 122. NET OPERATING LOSS DEDUCTION. * * (c) Amount of Net Operating Loss Deduction. -- The amount of the net operating loss deduction shall be the aggregate of the net operating loss carry-overs and of the net operating loss carry-backs to the taxable58 year reduced by the amount, if any, by which the net income (computed with the exceptions and limitations provided in subsection (d) (1), (2), (3), and (4)) exceeds, in the case of a taxpayer other than a corporation, the net income (computed without such deduction), or, in the case of a corporation, the normal-tax net income (computed without such deduction).Section 122 (d) (1) and (3) provides that:The exceptions and limitations referred to in subsections (a), (b), and (c) shall be as follows:997 (1) The deduction for depletion shall not exceed the amount which would be allowable if computed without reference to discovery value or to percentage depletion under section 114 (b) (2), (3), or (4); * * (3) No net operating loss deduction shall be allowed.In our opinion the above quoted provisions, as applied to the instant case, clearly require, for purposes of arriving at the amount of petitioner's net operating loss deduction for 1941, that petitioner's net operating loss carry-over be reduced by the difference between petitioner's 1941 net income increased by the 1941 percentage depletion and petitioner's 1941 normal tax net income. The difference in this case is the59 amount of the percentage depletion taken as a deduction in 1941 and this is the amount by which respondent reduced the net operating loss carry-over for the purposes of determining the amount of the net operating loss deduction.Petitioner, on brief, states:* * * There is no specific language in Section 122 from beginning to end stating that the adjustments referred to in Section 122 (d) are required to be made in respect of the taxable year. * * This statements either overlooks section 122 (c) or misconstrues its proper meaning. Petitioner's confusion is, we think, partly due to a failure to recognize that the 122 (d) adjustments to 1941 income under section 122 (c) are made only for the purpose of determining the net operating loss deduction. Except for this purpose, section 122 (d) does not affect the 1941 income nor otherwise exclude the percentage depletion deduction.Petitioner further states that certain of the oil leases expired in 1942 and 1943 and that as a result portions of the percentage depletion taken in 1941 had to be restored to income in those later years. From this petitioner argues that it is a tax hardship on it to reduce its net operating loss deduction60 by percentage depletion which in later years may be restored to income. If there were merit in this contention, it would seem to us to be a fault which only Congress could properly correct.We hold that the respondent's determination in reducing petitioner's net operating loss deduction was correct.Capital stock tax issue. -- Petitioner, on its 1941 return, deducted $ 5,000 representing capital stock tax for the capital stock tax year ended June 30, 1941, which was paid during the calendar year 1941. Petitioner now claims that the proper deduction in 1941 on account of capital stock tax should be $ 2,875, or an amount based on monthly accruals during the calendar year 1941 of the capital stock tax for the last half of the capital stock tax year ended June 30, 1941, and the first half of the capital stock tax year which commenced July 1, 998 1941. Respondent contends that, for the capital stock tax year ended June 30, 1942, petitioner can deduct only the amount of $ 750 representing the capital stock tax which accrued July 1, 1941.The issue, therefore, is whether petitioner may treat its capital stock tax liability as accruing month by month during the calendar year, 61 as petitioner contends, or whether the capital stock tax must be treated as accruing entirely on the first day of the capital stock tax year, as respondent contends. Treating capital stock tax liability on a monthly accrual basis has been approved where such treatment has been consistently followed by the taxpayer and no distortion of income is involved. Atlantic Coast Line Railroad Co., 4 T. C. 140; G. C. M. 24461, 1945 C. B. 111. Such treatment is in the nature of an exception to the generally accepted concepts of accrual accounting. The authorities cited above countenanced the exception, but emphasized that "The dominant characteristic of this situation is that petitioner has consistently followed the method of accounting it now seeks to have approved." We think the approval of monthly accruals of capital stock taxes should be limited to situations wherein such treatment has been consistently followed by the taxpayer and should not extend to permit innovations. Since in the instant case petitioner has not consistently followed a method of monthly accruals, we do not think it is desirable or proper to permit*62 the initiation of such treatment now. We therefore hold that petitioner is entitled to deduct in the calendar year 1941 only the capital stock tax which accrued on July 1, 1941, for the capital stock tax year ended July 30, 1942, or the amount of $ 750.The petition raised an issue concerning the proper amount allowable as a deduction on account of accrued state income taxes. Since petitioner did not at the hearing or on brief mention or discuss this question, we consider it abandoned, and respondent's determination in this respect is therefore sustained.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623287/	SHARON L. & JOSE L. GOMEZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGomez v. CommissionerDocket No. 4957-79.United States Tax CourtT.C. Memo 1980-565; 1980 Tax Ct. Memo LEXIS 18; 41 T.C.M. (CCH) 585; T.C.M. (RIA) 80565; December 18, 1980Sharon L. Gomez and Jose L. Gomez, pro se. Robert J. Alter, for the respondent. TANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined a deficiency of $ 702.88 in petitioners' income tax for the calendar year 1976. The sole issue is the extent to which petitioners are entitled to a deduction, under section 280A, 1 for home-office expenses paid by Sharon L. Gomez in connection with her business activities. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. 19 Petitioners resided in New York, N.Y., at the time they filed their petition herein. During 1976, Sharon L. Gomez (Mrs. Gomez) was employed full time by Revlon, Inc. (Revlon) as a Sales Account Manager. She sole merchandise to, and serviced existing accounts of, Revlon customers and developed new accounts in an assigned sales territory. Revlon did not furnish Mrs. Gomez with any office. She used her home as her office, where she kept her business records and from which she maintained, by telephone, contact with her customers and stayed in touch with Revlon. From January 1, 1976, to July 31, 1976, petitioners lived in a three-room (one bedroom) apartment with a total square footage of 535 square feet. Mrs. Gomez used a portion of her living room as an office to perform work related to her job but such portion was not a specific portion thereof. The furniture and furnishings which she used in this fashion were located at different places in the room, which also contained furniture which was used for personal purposes. Petitioners paid $ 2,292 in rent for this apartment plus $ 70 in repairs and maintenance and $ 231 in electricity. From August 1, 1976, through December 31, 1976, petitioners20 lived in a two-bedroom apartment with a total square footage of 747 square feet. Mrs. Gomez used one bedroom exclusively as an office to perform work related to her job. Petitioners paid $ 2,800 in rent for this apartment and $ 125 in electricity. During 1976, Mrs. Gomez did not meet with any clients or customers in either of the apartments. OPINION On brief, respondent concedes that the apartments constituted Mrs. Gomez' principal place of business and it is clear from the record herein that such use was on a regular basis and for the convenience of Revlon. Thus, the only question before us is whether "a portion of the dwelling unit [the apartment]" was so used. 2 Section 280A(c)(1). The burden of proof is on the petitioners. Rule 142(a), Tax Court Rules of Practice and Procedure.As to the apartment occupied from January 1, 1976, to July 31, 1976, we hold that petitioners have failed to carry their burden. The phrase "a portion" contained in section 280A(c)(1) is explained in the legislative history as follows: Exclusive use of a portion of a taxpayer's dwelling unit means that21 the taxpayer must use a specific part of a dwelling unit solely for the purpose of carrying on his trade or business. The use of a portion of a dwelling unit for both personal purposes and for the carrying on of a trade or business does not meet the exclusive use test. Thus, for example, a taxpayer who uses a den in his dwelling unit to write legal briefs, prepare tax returns, or engage in similar activities as well for personal purposes, will be denied a deduction for the expenses paid or incurred in connection with the use of the residence which are allocable to these activities. [Emphasis added.] S. Rept. No. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 186; H. Rpt. No. 94-658 (1975), 1976-3 (Vol. 2) 695, 853; Joint Committee Explanation, 1976-3 C.B. (Vol. 2) 1, 152. 3Such legislative history disposes of petitioners' argument that the phrase "a portion" can be interpreted to refer to various segmented parts of a single room where furniture utilized for business is physically located, assuming arguendo that such phrase does not require a space that is physically22 separated by a wall, partition, etc., from space used for personal purposes. As to the apartment occupied from August 1, 1976, to December 31, 1976, we hold that petitioners have carried their burden of proof. While the record herein is technically incomplete as to the square footage of the bedroom used for business purposes, we are satisfied that the 250-square-feet figure, used by petitioners for purposes of a limited stipulation by respondent, is within the bounds of reason and should be accepted. Consequently, petitioners are entitled to a deduction of 250/747 of $ 2,925 ($ 2,800 rent plus $ 125 in electricity). Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year at issue.↩2. No issue as to substantiation of the amounts expended is involved herein.↩3. See also Weiner v. Commissioner,T.C. Memo. 1980-317↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623289/	TERMINAL RAILROAD ASSOCIATION OF ST. LOUIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Terminal R.R. Ass'n. v. CommissionerDocket Nos. 49832, 53429, 63699.United States Board of Tax Appeals33 B.T.A. 906; 1936 BTA LEXIS 807; January 14, 1936, Promulgated 807 The Commissioner raises an affirmative issue and claims an increased deficiency on the ground that the petitioner was not entitled to deductions for depreciation which were allowed in determining the deficiency. The petitioner was a lessee and was not entitled to the deductions. However, the deductions were claimed on a consolidated return. There was affiliation between the petitioner, the lessee, and the lessors through complete stock ownership. Since it does not appear that the lessors were not entitled to the deductions, the Commissioner has failed to show that the deficiencies should be increased. J. T. Haslam, Esq., for the respondent. MURDOCK 906 OPINION. MURDOCK: The Commissioner determined the following deficiencies in the petitioner's income tax: Docket no.YearDeficiency498321926$31,803.8549832192736,430.80534291928$33,467.3763699192948,880.13All of the issues raised in the pleadings relating to the above deficiencies have been settled by a stipulation of the parties. The only matter now in controversy is an issue in each proceeding, raised by the respondent, whereby he claims that808 the amounts which he allowed as deductions for depreciation for each year were erroneously allowed. The facts of record bearing upon this issue have been presented by a stipulation. The stipulation may be summarized for present purposes as follows: The petitioner is a corporation organized under the laws of Missouri. Its principal office is at St. Louis, Missouri. It kept its books on an accrual basis and in accordance with the classification of accounts prescribed by the Interstate state Commerce Commission. The petitioner owned all of the outstanding capital stock of St. Louis Merchants Bridge Terminal Railway Company and of Wiggins Ferry Company. Wiggins Ferry Company owned all of the outstanding capital stock of St. Louis Transfer Railway Company and of the East St. Louis Connecting railway Company. The petitioner, for itself and affiliated companies, filed consolidated income tax returns for all of the years here involved. Those returns included the income and deductions of the companies above mentioned. The returns were filed on an accrual basis. The petitioner, as lessee, leased the properties of St. Louis Merchants Bridge Terminal Railway Company, of East St. 809 Louis Connecting Railway Company and of the St. 907 Louis Transfer Railway Company for a period of 99 years beginning January 1, 1926. These leases were approved by the Interstate Commerce Commission in 1925. The properties leased consisted of railways, bridges, structures, depots, shops, locomotives, cars and all other properties owned comprising the entire railroad systems of the lessors. The rental which the petitioner was required to pay under the leases consisted of taxes, assessments and other like charges imposed upon the lessor companies and interest on bonds of one of the companies. Each lease contains the following provision: The Lessee Company shall and will maintain and keep the premises hereby delivered, and every part thereof, in good condition, and make all necessary repairs and renewals of the same, and operate and use the same for the purposes for which the Lessor Company holds the same, and shall and will indemnify and save harmless the Lessor Company from any and all claims for damages arising out of such operation and use. The petitioner operated the properties during the taxable years in accordance with the terms of the leases. The properties810 leased were constructed with funds of the lessor companies or their predecessor companies. The various expenditures to be made by the petitioner in the payment of interest, taxes, assessments, repairs, renewals, maintenance, etc., were made as required by the terms of the leases and the amounts thereof were deducted from the gross income of the petitioner as expenses. Those deductions have been allowed by the Commissioner in determining the deficiencies. The petitioner, in the consolidated returns, claimed the following amounts for depreciation of the properties, and the deductions were allowed by the Commissioner in determining the deficiencies: For 1926$30,871.48For 192730,404.80For 192830,488.65For 192929,054.06The notice of deficiency for the years 1926 and 1927 contains the following statement: In accordance with the agreement for the allocation of tax executed under date of April 16, 1929, the deficiencies for the years 1926 and 1927 are assessable against your company. The following statement appears in the notice of deficiency for the year 1928: The entire tax is allocated to your company, in accordance with agreement signed under811 date of September 3, 1930, by you and the subsidiary companies listed above. The following statement is from the deficiency notice for 1929: In accordance with article 16(a) of Regulations 75, the deficiency will be assessed severally against each corporation named above. The Commissioner is the moving party on the single issue left for decision by the Board. He is asking that his action in determining the deficiencies be changed so as to disallow deductions which he says he erroneously allowed. If, under such circumstances, he fails to establish by a preponderance of the evidence that his determination of the deficiencies was erroneous, he must lose the point. He 908 contends that the petitioner has no capital investment in the properties, and, therefore, has nothing to recover by way of depreciation. He further states that the petitioner has been allowed all deductions to which it is entitled, including all expenses of repairing and maintaining the property in good condition and all costs of renewals. He further states that the lessors will not suffer loss from depreciation on their properties and are not entitled to deductions for depreciation. His argument812 in support of this statement is that the loss from depreciation can not fall upon the lessors since the petitioner, as lessee, is required to maintain every part of the properties in good condition and make all necessary repairs and renewals of the same. Therefore he concludes that, since neither the petitioner nor the lessors are entitled to depreciation, he erred in allowing any depreciation in determining the deficiency. Section 214(a)(8) of the Revenue Act of 1926 and section 23(k) of the Revenue Act of 1928 authorize the deduction of "a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." This provision in the latter act is captioned "Depreciation." The basis for computing the deduction, as provided in these statutes, is the same as the basis for gain or loss upon the sale or other disposition of the property. Sec. 204, Revenue Act of 1926; secs. 23(m) and 114(a), Revenue Act of 1928. That basis is cost, if the property was acquired by the taxpayer after March 1, 1913, or cost or value on March 1, 1913, whichever is greater, in case the property was acquired by the taxpayer before813 March 1, 1913. Sec. 204, Revenue Act of 1926; sec. 113, Revenue Act of 1928. The petitioner is not entitled to any deduction for depreciation on the properties under these statutes. . It does not own the properties and they have no basis for gain or loss and, consequently, no basis for depreciation in its hands. The lessors are the owners and, if any one is entitled to depreciation on the properties, it is the lessors and not the petitioner. ; affd., ; ; affd., ; certiorari denied, ; ; certiorari denied, . However, it appears that the lessors joined with the petitioner in a consolidated return for each of the years and the petitioner is liable for the total tax including the deficiencies. The Commissioner may not succeed in having the deficiencies increased unless the evidence shows that the lessors are not entitled to deductions for814 depreciation of the properties, that is, if the Commissioner's only mistake was to allow the deductions for depreciation to the petitioner instead of to its subsidiaries, then that mistake is not a sound reason 909 for increasing the deficiencies computed on a consolidated return basis. If the situation were reversed, that is, if the Commissioner, in the determination of the deficiency, had added an item to income as shown on the consolidated return, the petitioner could not have the deficiency reduced by merely showing that it had had no such item of income, particularly if the evidence left a possible inference that the item might have been income to the subsidiary companies included in the same consolidated return. The Commissioner, the moving party here, in under no less a burden to show that the deficiency should be increased. The evidence does not go so far as to show that the lessors were not entitled to some deduction for depreciation. The petitioner, as lessee, was required to maintain and keep the premises and every part thereof in good condition and to make all necessary repairs. But such a requirement, even if fulfilled, would not completely offset the gradual815 wearing out of the properties. . The petitioner was also required to make all necessary renewals of the leased premises. The meaning of this term "renewals", as used in the lease, is not entirely clear. It may have been intended by the parties to refer to ordinary renewals of a more or less minor character which clearly would not completely offset depreciation. The Commissioner allowed deductions as ordinary and necessary expenses for the actual expenditures made by the lessee, which would indicate that the renewals were of a minor character. One of the properties involved was a bridge over the Mississippi River. It seems at least doubtful whether the use of the word "renewals" in the lease would require the petitioner to replace the present bridge. The Commissioner has not shown that the lessors were not entitled to deductions for wear and tear. But, however that may be, there is no provision in the lease which would obviously completely compensate the lessors for the loss growing out of the obsolescence of their properties. There is nothing in the evidence to show that the deductions in question were not in proper816 amounts. Neither the cost nor the probable useful life of any property has been shown. The evidence does not show that in the consolidated returns the deductions for depreciation were improper. Consequently, the evidence does not show that the deficiencies were too small on this account. Reviewed by the Board. Decision will be entered under Rule 50.ARUNDELLARUNDELL, dissenting: The petitioner herein is the lessee of property of another railroad, all of whose stock it owns and with whom it has joined in the filing of a consolidated return. The petitioner 910 deducted in its returns depreciation on the leased property and originally the Commissioner allowed the deduction. In these proceedings the Commissioner has raised as an affirmative issue the validity of this deduction. The majority opinion, while conceding the correctness of the Commissioner's position that the petitioner as the lessee of property is not entitled to a deduction for depreciation thereon (Weiss v. Wiener,279 U.S. 333">279 U.S. 333), nevertheless refuses to allow the resulting deficiency because, as it is stated, the Commissioner does not carry his burden further and817 establish that the lessor likewise is not entitled to depreciation. The petitioner did not contend originally and does not contend in these proceedings that the lessor is entitled to depreciation and in view of the decisions in Georgia Railway & Electric Co. v. Commissioner, 77 Fed.(2d) 897, and Commissioner v. Terre Haute Electric Co., 67 Fed.(2d) 697, it would seem at least doubtful whether the lessor would be entitled to deductions for depreciation. At any rate, there is no showing that the deductions, if allowable, would be in the same amounts as claimed by the lessee. The respondent has met his burden of proof when he shows that the petitioner is not entitled to the deductions claimed and allowed, and the majority opinion carries the burden too far. The Commissioner should prevail. LEECH, TURNER, and TYSON agree with this dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623291/	APPEAL OF THE WARREN CO.Warren Co. v. CommissionerDocket No. 4588.United States Board of Tax Appeals3 B.T.A. 1154; 1926 BTA LEXIS 2456; April 3, 1926, Decided Submitted December 15, 1925. 2456 The determination of the Commissioner disallowing, as a deduction for compensation for services rendered, additional amounts credited to officers of a corporation in December of the taxable year, the officers owning all of the stock and such additional credits being in substantial accord with their stockholdings, approved in the absence of proof that such additional credits, together with the other compensation paid during the taxable year, constituted reasonable compensation for services rendered. Deduction Allowed corporation, under such circumstances, in the case of one officer, upon proof that the amount credited to him did not exceed a reasonable compensation. Morris D. Kopple, Esq., for the taxpayer. George G. Witter, Esq., for the Commissioner. PHILLIPS1154 Before GRAUPNER, TRAMMELL, and PHILLIPS. Taxpayer appeals from the determination by the Commissioner of a deficiency of $2,239.81 in income and profits taxes, alleging that the taxes in controversy are income and profits taxes for the calendar years 1920 and 1921. The deficiency letter asserts a deficiency for 1920 of $2,239.81 and no deficiency for 1921. Taxpayer2457 alleges that the Commissioner committed error in refusing to allow a deduction from gross income in the years 1920 and 1921 of $11,700, claimed by the taxpayer to be a part of the salary paid to its officers. FINDINGS OF FACT. The taxpayer is a Texas corporation with its principal office in Houston. During 1920 and 1921 it was engaged in the plumbing business in Houston and had an established reputation, having completed contracts for the plumbing work upon some of the larger and most recently built office buildings in that city. It had the following officers and directors: B. W. Warren, president and general manager; C. L. Warren, treasurer, construction superintendent, and assistant manager; and J. W. Phillips, vice president, secretary, and assistant general manager. All of these officers had several years' experience in the business prior to the organization of the taxpayer by them in 1914. 1155 B. W. Warren was in charge of securing business, having good business connections and being well known among architects and builders. He also did the buying for most of the large contracts. C. L. Warren supervised all construction work and did all of the estimating. 2458 Phillips was in charge of the office, secured estimates and prices upon materials, attended to some of the buying, and assisted in the management of the business. Each of the three devoted their entire time and long hours to the business. When the corporation was organized there was an understanding, which continued to the years here in question, that salaries of the officers would be based on what the company was able to pay. In 1919 the salaries paid the several officers were as follows: B. W. Warren, $6,000; C. L. Warren, $3,300; and Phillips, $3,000. During that year the corporation paid a cash dividend. On March 1, 1920, the directors, consisting of the three officers, passed a resolution "to raise all salaries beginning with January 1, 1920." No amount was fixed in the resolution. Salaries were credited on the books monthly during 1920 as follows: B. W. Warren, $800; C. L. Warren, $350; and Phillips, $300. In December, 1920, there were credited to their respective accounts the following additional amounts: B. W. Warren, $9,000; C. L. Warren, $1,200; and Phillips, $1,500. At that time C. L. Warren and Phillips had each overdrawn their accounts to approximately the amounts2459 so credited to them. Beginning on January 1, 1921, the officers were credited monthly with salaries as follows: B. W. Warren, $1,550; C. L. Warren, $450; and Phillips, $425. Upon its tax returns the taxpayer claimed the full amount of such credits to its officers as proper deductions for salaries. The Commissioner refused to allow as a deduction for 1920 the amount of $11,700, credited in December, 1920, and also reduced the amount claimed in 1921 by a like amount. During 1920 and 1921, 80 per cent of the stock of taxpayer was owned by B. W. Warren; 10 per cent by C. L. Warren; and 10 per cent by Phillips. The gross business of the taxpayer in 1920 was $208,549.06, which was more than double that of 1919, and in 1921 it was $198,634.52. The net income for 1919 was $6,320.25; for 1920, $35,582.89; and for 1921, $641.63, before the deduction of any part of the amounts in dispute in this appeal. In 1921 a stock dividend was declared, increasing the stock from a par value of $20,000 to $50,000. In 1922 salaries were reduced below the amounts credited in 1920 and 1921, and C. L. Warren left the employ of the taxpayer for a more lucrative position. Five thousand four hundred2460 dollars was reasonable compensation for the services rendered to the corporation by C. L. Warren during 1920 and 1921. 1156 The return filed by the taxpayer for 1921 showed a loss of over $19,000 and no tax due. In the deficiency letter from which the appeal is taken the Commissioner determined the 1921 net income to be $641.63 and no tax to be due. OPINION. PHILLIPS: For the year 1921 the taxpayer has paid no tax and the Commissioner has found no tax to be due and has asserted no deficiency. The deficiency for 1920 is not affected by the determination of the net income for 1921, and in these circumstances there is nothing before the Board for its determination with reference to 1921. The appeal, so far as it relates to that year, must be dismissed. During 1919 the taxpayer paid its officers salaries of $12,300. In 1920 it increased the monthly credits for salaries, and in this manner, during the year, credited its officers with $17,400 as salaries, which amount has been allowed as a deduction by the Commissioner. In December, 1920, it credited the accounts of its officers with the additional sum of $11,700, claimed by it to be additional salaries This amount*2461 was disallowed as a deduction by the Commissioner. It was divided between the officers substantially upon the basis of their stock ownership. No dividend was declared in 1920, although the taxpayer's business was much more successful in that year than in 1919 when dividends had been declared. In such circumstances we are not inclined to disturb the determination of the Commissioner without some convincing proof that the payments were reasonable compensation for the services rendered. No such proof has been furnished, except with respect to C. L. Warren. We are satisfied that the additional $1,200 credited to him in December, 1920, together with his other compensation, was reasonable compensation for the services he performed, and the net income for 1920, as computed by the Commissioner, should be reduced by $1,200. Order dismissing the appeal as to the year 1921 and redetermining tax for 1920 will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623292/	DR. PEPPER BOTTLING COMPANY OF MEMPHIS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dr. Pepper Bottling Co. v. CommissionerDocket No. 101626.United States Board of Tax Appeals45 B.T.A. 540; 1941 BTA LEXIS 1108; October 31, 1941, Promulgated 1108 Taxpayer was required to set aside and apply two-thirds of its cash on hand over and above $7,500 on its indebtedness under the terms of a written contract executed by it prior to May 1, 1936, which prohibited the payment of any dividends until the indebtedness was paid in full. On July 31, 1937, during the taxable year, the indebtedness was paid in full out of 1937 earnings and profits. Held, taxpayer is not entitled to a credit under either section 26(c)(1) or section 26(c)(2) of the Revenue Act of 1936 in the amount of $29,924.38 paid on the indebtedness. Sylvanus W. Polk, Esq., for the petitioner. Frank M. Thompson, Esq., for the respondent. DISNEY540 OPINION. DISNEY: The Commissioner determined a deficiency in petitioner's income tax liability for 1934 in the amount of $6,428.62. The only question involved is whether the petitioner is entitled to a credit of $29,924.38 under section 26(c)(1) and (2) of the Revenue Act of 1936, relating to contracts restricting dividends. The facts were stipulated and are found as stipulated. We set forth herein only such facts as are pertinent. The petitioner is a Tennessee corporation, 1109 with its principal office and place of business at Memphis, Tennessee, and the return was filed with the collector for the district of Tennessee. On June 27, 1933, the petitioner entered into a written agreement with the National Bank of Commerce at Houston, Texas, acting as trustee for a group of creditors. The agreement was in the form of a deed of trust to the bank as trustee acknowledging and securing the payment of debts in the aggregate amount of $37,086.30, evidenced by a series of 59 notes. The agreement contained, inter alia, the following provisions: The Corporation covenants and agrees as follows: Section 1. That it will perform all obligations which, either expressly or by reasonable implication, are imposed on it by this Indenture, and will permit no default hereunder to occur. * * Section 3. In the event the corporation's cash on hand shall exceed the sum of $7,500 at any time while this indenture is in force and effect the Corporation shall, * * * set aside and apply two-thirds of the excess over and above $7,500.00, and may, in its sole discretion, set aside and apply any further part or all of such excess for whichever of the following purposes1110 the Corporation shall deem preferable, to-wit: 541 (a) The purchase for the purpose of cancelling the same of any note or notes or of one or more installments of any note or notes issued hereunder, at the lowest price obtainable by tenders from the holders of same, provided such price is below the face value of principal and interest then accrued thereon. (b) A payment on the principal of each note secured hereby plus the interest accrued to date of payment upon the part of said principal so paid, such principal payments to be made on each of said notes ratably in proportion to the unpaid principal of each of said notes. Section 4. It will not declare and/or pay any dividends to its stockholders until all said notes are fully paid and discharged. On June 30, 1937, the petitioner sold for $51,000 in cash its franchise for distribution of Seven-Up in this territory to an independent corporation in which petitioner had no interest. The franchise was originally acquired by petitioner without cost and the entire proceeds from its sale represented earnings and profits. The unpaid balance of the notes secured by the above mentioned deed of trust at the time of the1111 sale of the franchise amounted to $29,924.38. The petitioner immediately upon the sale of the franchise deposited in the National Bank of Commerce at Houston a part of the proceeds from the sale sufficient to satisfy the unpaid balance on the notes. On July 31, 1937, the notes were paid in full out of the funds so deposited with the bank. The net income of the petitioner for 1937, before deducting excess profits taxes, was $50,409.67. The money applied to the payment of the notes secured by the trust deed was a part of such net income, earnings, and profits of petitioner for 1937. Under the terms of the deed of trust, the holders of the notes had a right to require the application of $29,924.38 of the proceeds from the sale of the franchise to the payment of their notes. The deed of trust remained in full force and effect until such payment was made. The Commissioner recognized the above mentioned deed of trust as one entitling the petitioner to a credit under section 26(c) of the Revenue Act of 1936 in determining its tax liability for 1936. The adjusted net income of petitioner for 1937 was $40,597.11. The balance sheet of petitioner as of January 1, 1937, discloses1112 an operating deficit of $98,812.27 and its balance sheet as of December 31, 1937, discloses an operating deficit of $63,182.72. The petitioner, in computing undistributed profits surtax in his return, claimed credit for $29,924.38 on account of contracts restricting dividend payments. The credit claimed was disallowed, the deficiency notice making reference to section 26(c)(2) of the Revenue Act of 1936, the result being computation of a deficiency in income tax in the above stated amount of $6,428.62. In the petition and upon brief the petitioner contends for the allowance of the credit under both 542 subsection (c)(1) and subsection (c)(2) of section 26, Revenue Act of 1936. 11113 We first consider the application of subsection (c)(2) for the reason that we think it can be very briefly disposed of. In our opinion, though the contract was written and executed prior to May 1, 1936, section 26(c)(2) does not apply for the simple reason that the contractual provision relied upon does not expressly deal with the disposition of earnings and profits of the taxable year, nor expressly require them to be paid or set aside within the taxable year in discharge of debt. The provision merely provides that, in the event the corporation's cash on hand shall exceed $7,500, two-thirds of the excess shall be applied upon the debt. It is obvious that "cash on hand" is not the equivalent of "earnings and profits of the taxable year", for cash on hand might have a source entirely unrelated to earnings or profits, e.g., capital contributed, and earnings and profits might not be cash on hand. The company might have far more earnings and profits than cash on hand, yet the contractual provision requires the application only of "cash on hand", to the designated extent, upon the debt. We hold that section 26(c)(2) does not entitle the petitioner to the credit sought. 1114 . Nor do we think that section 26(c)(1) covers the situation placed before us or entitles petitioner to the credit desired. Though the contract, as above seen, was written, was executed prior to May 1, 1936, and expressly deals with the payment of dividends, nevertheless we think that no contractual provision prevented distribution of the amount involved as a dividend "within the taxable year." The contract nowhere provides that dividends shall not be distributed within the taxable year here involved or any other year, but merely provides 543 against such payment of dividends until the indebtedness involved is paid and discharged. This might have been done upon the first day of the year, leaving the corporation free to pay dividends the entire year, save the one day; or, as above seen, the debt might have been paid from a capital contribution or other source not constituting earnings or profits. It is clear that the intent of the statute is to allow the credit, where an express contract is violated by distribution of adjusted net income as dividends, in a manner corresponding to a credit where the dividend1115 is actually paid. The contract here did not forbid distribution of income as dividends during the year, nor provide that the debt be paid from income. The petitioner could have distributed within the taxable year all of its adjusted net income, undiminished by the $29,924.38 paid on its debts, without violating any provision of any written contract, for the contract could have been satisfied with funds other than income, and thus not be violated by distribution of income. Thus it appears that it is not the contract, but the manner in which the petitioner transacted the matter of its discharge by the use of income, that prevents the distribution of dividends to the extent of the $29,924.38 here involved only because it was in fact paid from the petitioner's only income. In , we held that section 26(c)(1) did not confer credit where a contract provided against payment of dividends after a loan was obtained, the loan was obtained on August 28 of the taxable year, and it was not shown that the net profits of $33,833.06 for the taxable year had not been earned prior to August 28. We conclude and hold that the Commissioner did1116 not err in denying the credit claimed. Reviewed by the Board. Decision will be entered for the respondent.ARNOLD ARNOLD, dissenting: It seems to me that the majority have decided the issue on the basis of matters purely speculative. I see no reason under the facts peculiar to this case to venture into the realm of speculation. This taxpayer derived a profit of $51,000 cash from the sale. By the terms of its contract a specified portion thereof was required to be paid to its creditors. The petitioner recognized that it was contractually bound to pay its creditors out of such moneys and forthwith complied with the terms of its contract. Petitioner started the year with an operating deficit; it closed the year with net income less than the gain realized on the sale. It is beside the point to say that payment might have been made from other sources and the gain from the sale distributed as dividends. The parties have stipulated that the debts were paid from "net income, earnings and profits" of the taxable year. To the extent that this 544 cash was used to satisfy its debts, petitioner was deprived of earnings and profits otherwise available1117 for distribution as dividends. To say that the debts could have been paid the first of the year or at any other time prior to sale of the franchise does not square with the facts. Petitioner would have had no taxable income for the year but for the sale. The situation in , now on appeal to the Fifth Circuit, is different. There, the petitioner failed to show that it had no earnings prior to August 28, 1936, the effective date of the contract. The opinion states, p. 644: * * * Had it been shown that on August 28, 1936, petitioner had no earnings from which dividends could have been declared, it would be clear that any 1936 dividends would have to have been declared out of earnings of the petitioner acquired after the date of the loan. A distribution of these earnings was strictly forbidden by the contract here in evidence. * * * It seems to me that this petitioner has shown that before July 31, 1936, it was contractually prohibited from distributing dividends, and that after July 31, 1936, it had only $6,172.73 of undistributed profits subject to surtax. The $29,924.38 used by petitioner on July 31, 1937, to discharge1118 the indebtedness was not available for payment of dividends at any time during the taxable year. Prior to that date it could not be distributed as dividends because of contract restrictions; thereafter, it was not in petitioner's control for any purpose. Petitioner's adjusted net income of $40,597.11 less the $29,924.38 leaves $10,672.73 which could be distributed. Petitioner distributed $4,500 of this amount, which respondent allowed as a dividends paid credit, leaving $6,172.73 as the only amount subject to tax. In my opinion the credit should be allowed. LEECH, TURNER, and TYSON agree with this dissent. Footnotes1. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS - (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. (2) DISPOSITION OF PROFITS OF TAXABLE YEAR. - An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word "debt" does not include a debt incurred after April 30, 1936. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623294/	TOLERTON AND WARFIELD COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Tolerton & Warfield Co. v. CommissionerDocket No. 45320.United States Board of Tax Appeals23 B.T.A. 892; 1931 BTA LEXIS 1801; June 29, 1931, Promulgated 1801 1. Periods of less than a year for which returns are required held, under the Revenue Act of 1924, to be taxable years for purpose of computation of net loss. 2. Net losses sustained prior to affiliation may be used in computing consolidated net income. Ben Ginsburg Co.,19 B.T.A. 81">19 B.T.A. 81, followed. Allen G. Gartner, Esq., for the petitioner. Eugene Meacham, Esq., for the respondent. ARUNDELL892 Proceeding for the redetermination of deficiencies of $10,070.63 and $1,339.82 in income taxes for the period April 26, 1924, to December 31, 1924, and the calendar year 1925, respectively. The issue is whether net losses sustained during the fiscal year ended January 31, 1924, and the period from February 1, 1924, to April 26, 1924, by two affiliated corporations with which petitioner was affiliated 893 after April 26, 1924, may be allowed as deductions in computing net income of the affiliated group during the taxable periods. The facts were stipulated. FINDINGS OF FACT. For the fiscal year ended January 31, 1924, the William Tackaberry Company, hereinafter called the Tackaberry Company, and the Tackaberry Allen1802 Realty Company, hereinafter called the Realty Company, the former being the owner of all of the capital stock of the latter, filed separate returns. The respective returns showed statutory net losses of $29,025.60 and $679.75. For the period from February 1, 1924, to April 26, 1924, they filed a consolidated return in which the Tackaberry Company showed a net loss of $45,792.28 and the Realty Company net income of $2,447.33, resulting in a consolidated net loss of $43,344.95. No part of the net losses sustained by the two corporations during the fiscal year ended January 31, 1924, was used in computing the consolidated net loss of $43,344.95. The petitioner acquired all of the capital stock of the Tackaberry Company on April 25, 1924, and thereafter the three corporations were affiliated. This affiliated group filed consolidated returns for the calendar years 1924 and 1925. The return filed for 1924 reported petitioner's income for the entire year and that of the two remaining corporations for the period from April 26, 1924, to December 31, 1924. Of the net losses sustained in the year ending January 31, 1924, and the period February 1 to April 26, 1924, amounting to $73,050.30, 1803 the affiliated group deducted $65,031.65 in computing their consolidated net income for 1924, resulting in a return of no net income. The balance of the net loss, amounting to $8,018.67, was deducted by the group in computing consolidated net income for 1925. The Tackaberry Company surrendered its charter in November, 1925. The three corporations had separate accounting systems prior to April 26, 1924. Subsequent to that date they were consolidated. The respondent determined that the petitioner sustained a net loss of $17,906.60 for the period from January 1, 1924, to April 26, 1924, and that thereafter in 1924, the three corporations had net taxable income of $80,565.02. In computing the consolidated net income of the three corporations for the period from April 26, 1924, to December 31, 1924, he disallowed this net loss as a deduction. In determining the proposed deficiencies the respondent disallowed the net losses sustained by the Tackaberry Company and the Realty Company prior to April 26, 1924, as deductions, on the ground that they were sustained prior to the affiliation of the three corporations. 894 OPINION. ARUNDELL: Although the Tackaberry Company1804 owned 100 per cent of the stock of the Realty Company, each filed separate returns for the fiscal year ended January 31, 1924. For the period from February 1 to April 26, 1924, these two companies filed consolidated returns and while this action is not explained it is not contested. On April 26, 1924, the petitioner acquired 100 per cent of the stock of the Tackaberry Company, thus making possible the filing of consolidated returns by all three companies. The petitioner in a consolidated return reported its income for the calendar year 1924, together with the income of the Tackaberry and Realty Companies for the period from April 26 to December 31, 1924. The respondent refused to accept the returns so filed and insisted that the petitioner file a separate return for the period from January 1 to April 26, 1924, and that the consolidated return for all three companies cover only the period from April 26, 1924, to December 31, 1924. We agree with the respondent's action. ; 1805 ; . The Tackaberry and Realty Companies had net losses of $29,025.60 and $695.75, respectively, for the fiscal year ended January 31, 1924. For the short period from February 1, 1924, to April 26, 1924, the Tackaberry Company had a net loss of $45,762.28 and the Realty Company had net income of $2,447.33, more than enough to absorb the net loss of the Realty Company for the period ended January 31, 1924. As a result of respondent's action in requiring a separate return for petitioner covering the period from January 1, 1924, to April 26, 1924, petitioner is shown to have sustained a net loss of $17,906.60, the amount of which is not in dispute if respondent's requirement is in accordance with the law. Section 200 of the Revenue Act of 1924 defines a taxable year as including any fractional part of a year for which a return is made under the law or under regulations prescribed by the Commissioner. As above pointed out, we have construed the law as requiring a return to be made for the short period, February 1 to April 26, 1924, with respect to the Tackaberry1806 and Realty Companies, and for the period January 1 to April 26, 1924, as to the petitioner. These short periods therefore constitute taxable years and are to be treated as such in the allowance of net losses. Under our decisions in ; ; , and other cases cited in the latter opinion, the net losses sustained by the constituent corporations prior to affiliation are allowable deductions in computing consolidated net income. 895 Accordingly, in this case the net loss of the Tackaberry Company for the year ended January 31, 1924, and for the period February 1 to April 26, 1924, may be carried forward and used in computing consolidated net income for the period April 26 to December 31, 1924. Likewise, petitioner's net loss for the period January 1 to April 26, 1924, may be used in computing consolidated net income for the period April 26 to December 31, 1924. Any unabsorbed net loss for the periods ended April 26 and December 31, 1924, may be carried forward and used in computing consolidated net income for*1807 the year 1925. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623295/	ALBERT N. CURRY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCurry v. CommissionerDocket No. 35601-87United States Tax CourtT.C. Memo 1991-102; 1991 Tax Ct. Memo LEXIS 121; 61 T.C.M. (CCH) 2093; T.C.M. (RIA) 91102; March 6, 1991, Filed 121 Decision will be entered under Rule 155. Albert N. Curry, pro se. John W. Sheffield III, for the respondent. PARKER, Judge. PARKER MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in, and additions to, petitioner's Federal income tax as follows: Addition to TaxYearDeficiencySec. 6653(b) 1978$ 138.33$ 1,569.17 19791,872.882,186.4419805,695.476,597.74Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for the years before the Court, and all rule references are to the Tax Court Rules of Practice and Procedure. After concessions by both parties, 1 the issues remaining for decision are: (1) Whether petitioner had unreported taxable income in each of the years 1978, 1979, and 1980 and, if so, the amount of such unreported taxable income each year; and (2) Whether petitioner is liable for the fraud addition for each of those years.122 FINDINGS OF FACT Most of the facts have been stipulated and are so found. The parties' stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. At the time the petition was filed, petitioner resided in Augusta, Georgia. Petitioner filed his Federal income tax returns for the years 1978 through 1980 with the Internal Revenue Service at Atlanta, Georgia. During the years before the Court, petitioner owned and operated, as a sole proprietorship, a hardware store called "Curry's Hardware Store" and a rental business called "Curry's Cornor" in Augusta, Georgia. In his hardware store business, petitioner maintained sales journals to which he posted daily sales directly from the totals shown on his cash register tapes. The amounts reflected in the sales journals were consistent with the amounts shown on the cash register tapes. In the course of his business, petitioner used a single bank account with the Georgia Railroad Bank in which to deposit his business receipts from his hardware business and from his rental business. He also had a personal account at the Citizens and Southern National Bank (C & S). The total deposits to petitioner's123 business account at the Georgia Railroad Bank and the total sales journal entries for petitioner's hardware business for the years 1978, 1979, and 1980 are accurately shown on the adding machine tapes stipulated by the parties. The total sales or business receipts reflected in the sales journals (i.e., the figures taken from the daily cash register tapes) were deposited into the Georgia Railroad Bank business account. The sales journal entries did not reflect the rental income, but petitioner's rental income was also deposited into that business account. Rental income in the amounts of $ 19,650, $ 17,100, and $ 17,100, for the years 1978, 1979, and 1980, respectively, were deposited into that business account. However, the total deposits into that Georgia Railroad Bank business account for those years were substantially greater than the amount of gross receipts reported from petitioner's hardware store business and rental business. For the taxable years 1978, 1979, and 1980, petitioner gave his sales journals to his tax return preparer as representing all sales from his hardware business for the respective years. His sales journals were used by the tax return preparer as the124 exclusive source of information regarding sales by petitioner's hardware store. Petitioner did not give the tax return preparer any bank statements, checkbooks, deposit slips, or other records from which gross receipts could be determined. Petitioner knew that if any sales receipts were not rung up on the cash register tapes and posted from those tapes to the sales journals, such amounts would not be reported on the Schedule C to his tax return as part of the gross receipts of the hardware business. During the years 1978, 1979, and 1980, petitioner's total deposits into his bank accounts 2 were as follows: Deposits 197819791980Ga RailroadBank$ 157,166.89$ 133,736.52$ 147,309.66C & S Bank2,729.523,104.592,554.93Totals:$ 159,896.41$ 136,841.11$ 149,864.59125 These deposits included transfers between the accounts or other non-income items, as follows: 197819791980Transfers$ 0.00$ 0.00$ 7,193.00Other non-incomeitems4,652.804,939.141,466.46Totals:$ 4,652.80$ 4,939.14$ 8,659.46During the years before the Court, petitioner made certain cash expenditures from non-deposited receipts: 197819791980Business expenses$ 12,705.15$ 8,949.45$ 14,418.09Personal livingexpenses5,416.205,818.73 7,675.00Certificate of depositbought with cash7/13/79 not includedin the foregoingbank deposits4,019.69Loan paid1,560.80Capital item - tools1,073.58Totals:$ 18,121.35$ 21,422.25$ 22,093.09During the years 1978, 1979, and 1980, petitioner had the following business expenses and deductions for his hardware business and his rental business: 197819791980Inventory boughtduring year$ 79,168.38$ 64,756.99$ 85,034.85 Reduction ininventory9,118.096,500.22-- Increase ininventory(23,125.70)Cost of goodssold$ 88,286.47$ 71,257.213 $ 61,909.15 Schedule C expensesexcept rentPaid in cash$ 12,137.08$ 9,112.88$ 13,665.25 Other deductions6,243.954,004.704,799.85 Paid by check10,040.9510,473.999,770.14 Totals:$ 28,421.98$ 23,591.57$ 28,235.24 Rental expenses: Depreciation4,045.963,721.963,797.91 Paid in cash-- 324.00114.32 Paid by check17,022.1416,864.9515,039.79 $ 21,068.10$ 20,910.91$ 18,952.02 Rental expenses plusSchedule C expensesplus cost of goodssoldTotals:$ 137,776.55$ 115,759.69$ 109,096.41 126 The only other business expenses petitioner had in those years were the following deductions, which were not claimed on his tax returns: Sales Tax$ 4,942.13$ 4,111.13$ 4,286.22PenningtonSeed491.00925.60WestinghouseCredit2,845.00Bank Charges127.23502.65178.13Storm windowrefund732.10Totals:* $ 8,406.04* $ 6,700.24* $ 5,365.58In 1978 petitioner received some air conditioners on consignment from Westinghouse. He sold some of the air conditioners127 to his hardware store customers that year. Petitioner did not report either the sales or any expenses connected with such sales on his 1978 tax return. These air conditioner sales were not rung up on the cash register, were not included in the cash register tapes and sales journals, and thus were omitted from the gross receipts or sales reported on his Schedule C for the hardware business for that year. 4Some of petitioner's credit card sales were not rung up on the cash register, were not included in the cash register tapes and sales journals, 128 and thus were omitted from the gross receipts or sales reported on petitioner's Schedule C's for the hardware business. Payments on some credit sales (store charge account sales) were not rung up on the cash register, were not included in the cash register tapes and sales journals, and thus were omitted from the gross receipts or sales reported on petitioner's Schedule C's for the hardware business. In 1980 petitioner expanded his hardware business to include sales and installation of storm windows and screen repair work. Some of the sales from storm windows and screen repairs were not rung up on the cash register, were not included in the cash register tapes and sales journals, and thus were omitted from the gross receipts or sales reported on petitioner's Schedule C for the hardware business. Petitioner did not receive any gifts, inheritances, legacies, or devises during the years 1978, 1979, and 1980. Petitioner's net taxable income pursuant to the bank deposits method of reconstruction, and based on the figures stipulated by the parties, was as follows: 197819791980Total bankdeposits * $ 159,896.41 * $ 136,841.11 * $ 149,864.59 Plus cash expenditurespaid from receiptsnot deposited * 18,121.35 * 21,422.25 * 22,093.09 Subtotals:$ 178,017.76 $ 158,263.36 $ 171,957.68 Less non-incomeitems * (4,652.80) * (4,939.14) * (8,659.46)Subtotals:$ 173,364.96 $ 153,324.22 $ 163,298.22 Less cost of goodssold, business andrental expense * (137,776.55) * (115,759.69) * (109,096.41)Totals:$ 35,588.41 $ 37,564.53 $ 54,201.81 Less deductionsallowed but notclaimed on returns * (8,406.04) * (6,700.24) * (5,365.58)Totals:$ 27,182.37 $ 30,864.29 $ 48,836.23 129 All of the figures above bearing an asterisk are figures stipulated by the parties and found as facts by the Court. On his tax returns for the years 1978, 1979, and 1980, petitioner reported taxable income of only $ 15,468.75, $ 20,051.26, and $ 19,327.08, respectively. Petitioner understated and underreported his taxable income each year by the following amounts: 1978$ 11,713.62197910,813.03198029,509.15Accordingly, petitioner underpaid his taxes for each of the years before the Court. A portion of the underpayment of tax for 1980 was caused by an error made by petitioner's tax return preparer that year. The beginning inventory shown on line 1 of Schedule C-1 was reported as $ 71,257.21, whereas the correct beginning inventory was $ 54,325.16. 5 Due to this error by his tax return preparer, petitioner claimed $ 16,932.05 more than he was entitled to as a deduction for cost of goods sold in 1980. However, taxable income for 1980 was still understated by $ 12,577.10 attributable to omitted income. 130 Petitioner's tax return for the year 1978 was selected for a TCMP (Taxpayer Compliance Measurement Program) audit, which is a thorough audit of everything on the return. The revenue agent determined that petitioner's sales journal bookkeeping method was adequate provided that all receipts were in fact deposited into the cash register, recorded on the cash register tapes, and entered into the sales journals, which the return preparer used to determine gross receipts. The revenue agent found that the amounts entered into the sales journals were the same as the cash register tape amounts and that the amounts reported on Schedule C were the same as the amounts in the sales journal. However, when the revenue agent examined the bank records, he found that the deposits in the business account were substantially greater. He also found that petitioner made substantial cash expenditures, both personal and business, from receipts not deposited in the bank accounts. The audit was extended to the years 1979 and 1980, and thereafter a criminal tax investigation ensued. Ultimately petitioner was indicted for income tax evasion under section 7201 for all three years. However, he entered into131 a written plea agreement to plead guilty to one count under section 7206(1) for the year 1978. 6 Petitioner pleaded guilty to willfully and knowingly filing a false tax return for 1978, a return that "he did not believe to be true and correct as to every material matter in that the said [return] stated on Schedule C, line one, that his gross receipts or sales were $ 120,071.81 whereas, as he then and there well knew and believed, his gross receipts or sales were substantially in excess thereof." 132 The audit resumed after the criminal case was concluded. During the audit petitioner admitted that he had not rung up all of his hardware business receipts in the cash register. In the trial in this Court, petitioner denied his earlier statements and insisted that only the rental business receipts were not rung up on the cash register and entered in the sales journal. The Court did not believe petitioner's denials or his version of what occurred with the revenue agents and assistant district counsel. ULTIMATE FINDINGS OF FACT 1. Petitioner understated his taxable income on his tax return for each of the years 1978, 1979, and 1980, and hence underpaid his tax each year. 2. The underpayment of tax each year was due to fraud on the part of petitioner. OPINION This fraud case involves the normal split burden of proof. Petitioner must prove any error in the deficiency determinations by a preponderance of the evidence, and respondent must prove fraud each year by clear and convincing evidence. , affg. a Memorandum Opinion of this Court, cert. denied ; Sec. 7454(a); Rule 133 142(a) and (b). Petitioner's record keeping system would be adequate provided that all receipts or sales for the hardware store business were rung up in the cash register. The cash register tape figures were entered in the sales journals, and the sales journals were used exclusively for the Schedule C gross receipts for the hardware business. The revenue agents found that petitioner's cash register tapes, sales journals, and Schedule C gross receipts figures were all consistent. However, petitioner did not ring up all receipts or sales of the hardware business in the cash register. Petitioner's bank deposits and cash expenditures from undeposited funds disclosed substantial amounts of unreported income. Respondent used the bank deposits and cash expenditures method to reconstruct petitioner's income. That method is a well recognized method of reconstructing income, and bank deposits are prima facie evidence of income. and footnote 4 (5th Cir. 1967) 7; ; , affd. 134 . Respondent need not prove a likely source of that unreported income, but here there is such a likely source, the hardware business receipts or sales that were not rung up in the cash register. Once deficiencies are determined under the bank deposits and cash expenditures method, the taxpayer has the burden to show that the deposits do not constitute income or that other deductions properly reduce that income. , affg. in part and revg. in part a Memorandum Opinion of this Court. Petitioner has failed to carry his burden of proof as to the deficiency determinations. Indeed, as shown in the Findings of Fact above, petitioner 135 has stipulated to every underlying figure in the computations of petitioner's net taxable income for each year. It is true that in the stipulation, at the trial, and in his post-trial briefs, petitioner argued for various adjustments to these net taxable income figures, but he presented no evidence, testimonial or documentary, in support of his confusing arguments and proposed adjustments. 8 The Court concludes that petitioner did not sustain his burden of proof. 136 Respondent must prove by clear and convincing evidence the two elements of fraud: (1) the existence of an underpayment of tax each year, and (2) that some part of the underpayment is due to fraud. , affg. a Memorandum Opinion of this Court. Fraud is actual, intentional wrongdoing, and the intent is the specific purpose to evade a tax believed to be owing. ; , cert. denied . Respondent must show that the taxpayer intended to evade taxes by conduct calculated to conceal, mislead, or otherwise prevent collection of the tax. , affg. a Memorandum Opinion of this Court. Fraud will never be presumed. . Fraud is a question of fact and is to be determined on the basis of the whole record. , affg. ,137 cert. denied , rehearing denied . Fraud can seldom be, and need not be, established by direct evidence, but can be established by circumstantial evidence, by reasonable inferences drawn from the taxpayer's entire course of conduct. ; , affg. a Memorandum Opinion of this Court; ; . Here there can be little question that petitioner's taxable income was understated for each of the three years, and that those understatements resulted in underpayment of petitioner's tax each year. The real issue is whether those underpayments were due to fraud. There was a pattern of consistent understatement of substantial amounts of petitioner's income for the three years. This is strong evidence of fraud. ; , affg. a Memorandum 138 Opinion of this Court. Petitioner pleaded guilty to filing a false return under section 7206(1) for 1978. While intent to evade tax is not an element of the crime under section 7206(1), petitioner is collaterally estopped to deny that he willfully and knowingly filed a false return that year and that the falsity was that his return stated "on Schedule C, line one, that his gross receipts for sales were $ 120,071.81 whereas, as he then and there well knew and believed, his gross receipts or sales were substantially in excess thereof." ; ; . This 1978 false return and the false returns for the other years cannot be blamed on petitioner's tax return preparer. See . Petitioner gave the tax return preparer his sales journals as the exclusive source of information on his gross receipts or sales in the hardware store business. Petitioner knew that if receipts or sales were not rung up on the cash register and included139 in the cash register tape figures which were entered in the sales journals, that such receipts or sales would not be entered in the sales journals and would not be reported on the Schedule C's for his hardware store business. Petitioner knew that in each year some receipts or sales (air conditioner sales, charge card sales, payments on store charge accounts, sales and installation of storm windows, and screen repairs) were not rung up on the cash register. Failure to maintain complete and accurate books and records is also evidence of fraud. ; . Here, petitioner's record system would have been adequate if all receipts or sales had been rung up on the cash register. He knew, however, that all receipts or sales of the hardware business had not been rung up. Petitioner, on at least two occasions during the audit, admitted to revenue agents and to an assistant district counsel that some of the receipts or sales had not been rung up on the cash register. At the trial in this Court petitioner denied he had ever made those statements, and the Court did not believe140 him. His belated story that the only receipts not rung up on the cash register and not entered in the sales journals were receipts from his rental business was inherently incredible. Also petitioner's total rental business receipts and the hardware store receipts shown in the sales journals simply cannot account for the substantial bank deposits and cash expenditures in this case. Petitioner obviously had to know that the cash expenditures (both business expenses and personal expenses) that he made from receipts not deposited in the bank were not being reported as part of his gross receipts or sales and were not being accounted for on his tax returns in any way. Petitioner's cash expenditures from undeposited receipts amounted to $ 18,121.35, $ 21,422.25, and $ 22,093.09, for the years 1978, 1979, and 1980, respectively. Based on the record as a whole and the Court's opportunity to observe the demeanor of petitioner and the other witnesses and to judge their credibility, the Court is satisfied that respondent has proved by clear and convincing evidence fraud on the part of petitioner for each year. To reflect the concessions and the above holdings, Decision will be entered141 under Rule 155. Footnotes1. Most, if not all, of the figures stipulated by the parties differ from the amounts in the statutory notice of deficiency, hence requiring further proceedings under Rule 155 in this case. The parties have also stipulated, and the Court so finds, that petitioner made the following advance payments after the tax returns were filed but before the statutory notice of deficiency was issued: 1978 Amount of Advance PaymentDate of Advance Payment $ 3,000.0003-08-82499.3105-02-86Total: $ 3,499.311979 $ 2,500.0003-08-822,060.9005-02-86Total: $ 4,560.901980 $ 2,500.0003-08-825,000.0011-08-825,794.2405-02-86Total: $ 13,294.24Generally, these advance payments were taken into account in computing the tax deficiencies in the notice of deficiency, but were properly excluded in computing the amount of the fraud addition each year. However, it is not clear whether the $ 5,794.24 advance payment for 1980 was applied to tax or to interest, or not taken into account at all. However, petitioner's complaints about these various payments and questions as to "where is this money" can be dealt with later in the Rule 155 proceedings.↩2. During the years 1978, 1979, and 1980, petitioner's wife also had bank accounts at the First National Bank and Georgia Federal Bank. During these years, the only deposits to the First National Bank account were small interest deposits of about $ 200 per year, which the parties treat as immaterial for purposes of this case. The total deposits in the text above have been adjusted by the parties to exclude all renewals of certificates of deposit. The only deposit to Georgia Federal during the years in question was $ 60,000 which was a transfer from another account. The parties treat these renewals and transfer as immaterial for purposes of this case and have removed them from the stipulated deposit amounts in the text above to simplify the case. No certificates of deposit were withdrawn that were not renewed or redeposited during the years in question. No funds represented by any of petitioner's certificates of deposit were spent by petitioner or his wife during the years 1978, 1979, and 1980.↩3. See infra↩ note 5.. The underlying figures stipulated by the parties add up to only$ 8,405.36, $ 5,539.38, and $ 5,196.45, for the years 1978, 1979, and 1980, respectively. However, the Court has accepted the parties' stipulated total figures, since those higher totals favor petitioner and appear in other paragraphs of the parties' stipulation.↩4. While petitioner contends that he made no profit on these air conditioner sales, he presented no evidence as to the sales prices or as to any expenses. Thus, the Court cannot determine whether these transactions were merely a wash, as petitioner contends. In any event, his bare assertion that these sales resulted in a wash was not persuasive to the Court. Respondent has allowed petitioner expense deductions of $ 2,845 in connection with the air conditioner sales.↩5. The stipulated cost of goods sold figure of $ 61,909.15 for the year 1980 reflects the correction of the tax return preparer's error. The return preparer had erroneously picked up the cost of goods sold for 1979 ($ 71,257.21) rather than the inventory at the end of 1979 ($ 54,325.16) as the opening inventory for 1980. The corrected cost of goods sold figure for 1980 is as follows: ↩$ 85,034.85Inventory purchases in 1980 asper tax return+ 54,325.16Beginning inventory for 1980 (as stipulated by partiesand as shown on the 1979return as ending inventoryfor 1979)$ 139,360.01- 77,450.86Inventory at end of 1980, asper tax return$ 61,909.15Corrected cost of goods soldfor 19806. Petitioner's attorneys signed that written plea agreement. Petitioner also signed a statement that the plea agreement accurately and correctly stated the representations made to him. The United States District Court Judge considered that plea agreement "in conjunction with the interrogation by the Court of the defendant and his attorney at a hearing on his motion to change his plea and the Court [United States District Court for the Southern District of Georgia], finding that the plea of guilty [was] made freely, voluntarily, and knowingly", accepted the guilty plea and ratified and confirmed the plea agreement. Petitioner's complaints about his guilty plea are baseless. Moreover, petitioner is collaterally estopped to deny the legal effect of his guilty plea.↩7. In (en banc), the Eleventh Circuit (to which any appeal in this case would lie) adopted as precedent all decisions of the former Fifth Circuit Court of Appeals decided prior to October 1, 1981.↩8. Petitioner seeks to reduce his net taxable income by the amounts of certain checks he wrote, checks written for other than business expenses or deductible personal expenses. He advances no factual or legal basis for such reductions. Petitioner continues to belabor certain figures in the statutory notice of deficiency or in the revenue agents' workpapers at an even earlier stage of the audit; in doing so, petitioner completely ignores the fact that he has now stipulated to the correct figures for these various items. Petitioner attempts to adjust certain figures on his tax returns without any factual or legal basis for doing so. He tries to adjust stipulated figures for one year by items from a different tax year. As best the Court can fathom his approach, petitioner seems to be trying to combine some elements of respondent's bank deposits and cash expenditures method with petitioner's own version of some type of net worth method of income reconstruction. In any event, the Court finds his various mathematical exercises rather baffling.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623296/	DELBERT C. AND MAUREEN J. FILES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFiles v. CommissionerDocket No. 1384-71.United States Tax CourtT.C. Memo 1976-43; 1976 Tax Ct. Memo LEXIS 359; 35 T.C.M. (CCH) 186; T.C.M. (RIA) 760043; February 23, 1976, Filed Delbert C. Files, pro se. 1Richard D. Hall, Jr., and Frederick T. Carney, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Chief360 Judge: This case was assigned to and heard by Special Trial Judge Randolph F. Caldwell, Jr., pursuant to Rules 180 and 182, Tax Court Rules of Practice and Procedure. The parties have filed no exceptions of law or fact to Special Trial Judge Caldwell's report. The Court agrees with and adopts his opinion which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE CALDWELL, Special Trial Judge: This case was one of a group of 37 which were consolidated for trial, but not for opinion. At the trial evidence was received which bears upon every case in the group. Such evidence relates to certain contractual arrangements between the husband-petitioners' employers (Lockheed Air Service Company any Dynalectron Corporation) and the United States Air Force, as well as the employment arrangements between field team members (such as the husband-petitioners) and such employers. Respondent determined a deficiency in petitioners' 1969 Federal income taxes in the amount of $364.54. The issue for decision is whether all or any portion of $1,910 of per diem payments received by petitioner Delbert Files (hereinafter, "petitioner") from Lockheed Air Service Company (hereinafter, "Lockheed") 361 should be included in his gross income for 1969 under section 61(a) of the Internal Revenue Code of 19542; and, if so, whether petitioner is entitled to deduct any or all of said amount as away-from-home traveling expenses under section 162(a)(2). FINDINGS OF FACT Petitioners, husband and wife, filed their 1969 return with the Internal Revenue Service Center at Chamblee, Georgia. At the time of filing their petition herein, they resided in Lauderdale County, Mississippi. During 1969, petitioner was employed as a member of two different field teams by Lockheed. That company, as well as Dynalectron Corporation (hereinafter, "Dynalectron") had a contract with the United States Air Force during 1969, to provide field team services for the maintenance and modification of weapons systems (i.e., aircraft) and/or support equipment. These contracts were called "basic contracts" and the Air Force entered into such a contract with each of three different contractors. The contracts were for three years maximum duration, and those involved here were for the three362 fiscal years, July 1, 1967-June 30, 1968; July 1, 1968-June 30, 1969; July 1, 1969-June 30, 1970. The contract was firm for the first of the three years; but the Air Force had the unilateral right to extend the contract for the second and third years of the three-year period. The contracts were so extended by the Air Force insofar as both Lockheed and Dynalectron were concerned. (The record herein does not identify the third contractor who had the basic contract.) The basic contract did not, of itself, award any work to be performed thereunder. It did specify the wage rates which would be paid for services rendered by employees of the contractor, if the contractor got work to be performed under the contract. The contract also contained the following provisions relating to the payment of per diem: (ii) Per Diem, not to exceed the applicable amounts set out below, when actually paid by the Contractor and approved by the Administrative Contracting Officer, shall be reimbursed to the Contractor, without regard to the duration of the assignment; provided, however, that no per diem shall be authorized or paid to any employee whose actual residence is within 50 miles of the work station363 to which the employee is assigned, nor shall any per diem be paid to any employee who actually resides at and commutes from his actual residence during the period of his employment, regardless of the distance between said residence and his assigned work station: (See (ii)(e) below). (a) In the CONUS (No quarters and messing facilities furnished by the Government)-- $11.00-Per day per man for Engineer and Leadman and $9.00-Per day per man for the remainder. * * * * (e) For the purpose of this contract the term "actual residence" is defined as the fixed or permanent domicile of an employee. The employee shall certify to the location of his fixed or permanent domicile and this location, if accepted by the Contractor, shall be deemed, for the purpose of this contract, to be the employee's domicile in so far as per diem authorization against this contract is concerned. However, this does not relieve the Contractor of his responsibility to ascertain that the certification is valid. The opportunity for the contractor to perform under the basic contract arose from the issuance by the Air Force of a work order thereunder. Issuance of a work order was entirely within the discretion364 of the Air Force, and it alone had the discretion to select which one of the three holders of a basic contract that was to perform the work order. Performance under a work order might be at any place in the United States or at any place overseas where the Air Force maintained a base. Under the terms of the basic contract, work orders could only be issued during a given year of a basic contract. However, completion of a work order actually issued during such year might be effected after the end of the year. When the Air Force had determined to issue a work order and had notified a contractor of its selection to perform that order, representatives of the Air Force and of the contractor would get together at a "pre-dock" meeting where the time for completion of the contract and the make-up of the contractor's projected field team complement would be worked out. Determination of the time of performance entailed fixing an input-output schedule -- the schedule which showed the number of units coming into the contractor for its maintenance and modification services per day or week or month, and the number of units to be completed by the contractor per day or week or month. After the projected365 field team complement had been worked out, the contractor would then proceed to get the team together. In assembling the team, the contractor would utilize two sources of manpower: (1) existing employees which it transferred from jobs under other work orders; and (2) new employees which it recruited. Whenever a contractor hired a new employee for field team work, that employee was advised that he was subject to being sent anywhere that the contractor might be called upon to perform a work order, and that if the employee was unwilling to travel where thus directed to go, his only alternative was to resign. The employee was also advised that the contractor only had a basic contract for a year and that it had no way of knowing whether or when it would receive work orders under that contract. It was also made clear to the employee that, while the contractor would endeavor to continue to utilize the services of the employee after completion of the work order in connection with which he was hired, it could not guarantee any such further employment; and if none were available, the employee would be laid off. Neither Lockheed nor Dynalectron maintained any pool or central area where an employee366 who had completed an assignment could be sent pending the contractor getting another work order on which such employee could be used. Both Lockheed and Dynalectron were involved in the performance of work orders at Key Field in Meridian, Mississippi, during the years involved. 3Lockheed had first come to Meridian in 1965 and it remained there until June 30, 1969, at which time (although it did not lose its status as holder of one of the three basic contracts) it was supplanted by Dynalectron. During the fiscal year ended June 30, 1969, Lockheed received two work orders to be performed at Meridian; and during the succeeding fiscal year, Dynalectron likewise received two work orders. While in most instances, the contractor's field teams were sent to the location where the aircraft were located, in the case of the work orders performed at Meridian, the aircraft were brought by the Air Force to that work site from other locations. During the367 performance of a work order, the Air Force always had an on-site representative, monitoring the performance of the contractor. One of the areas of concern was to determine whether the field team was over strength or under strength, as well as the quality of work of the field team members. Instances occurred when the composition of the field team was changed as the result of the recommendation of the Air Force's on-site representative. For this reason, as well as for the reason that the composition of the field team varied according to the nearness in point of time to the beginning or the end of the performance under the work order, the projected field team complement as worked out at the pre-dock meeting might vary as much as 10 to 20 percent during the performance of the contract. When an employee was hired, or rehired, by a contractor, he was required to certify to the contractor his "permanent or domicile" address (in the case of Lockheed) or his "fixed or permanent domicile" (in the case of Dynalectron). If the address so certified was further than 50 miles from the job site where the employee was to work and if the employee did not drive back and forth to work, irrespective368 of the address which he had furnished, he was paid the per diem mentioned and described above. The per diem payments made by the contractors were included in their invoices to the Air Force, solely for the purpose of being reimbursed. There was no element of profit to the contractors in the per diem for which they sought reimbursement. Per diem paid to the field team employees who qualified therefor was at the rate of $11 per day for a leadman and an engineer, and $9 per day for the other members of the field teams. Per diem was paid for seven days per week, although the regular work week for field team members was a 5-day, 40-hour week. Field team members also received per diem during their initial travel to a work site, for days of travel when transferred to different work sites, and for a maximum of three days for return to their homes, in the event they were laid off. They did not receive per diem during vacation periods; but they did receive per diem for three days up to a maximum of six days if they were sick. Neither Lockheed nor Dynalectron withheld Federal income tax from the per diem payments made to their employees. Petitioner adivsed Lockheed that his permanent or369 domicile address was at 1406 Spring Street, Poplar Bluff, Missouri. That is a rented house occupied by petitioner's mother and his sister. During 1969, petitioner did not live at that address. Petitioner had been born and raised in Poplar Bluff. He served in the United States Air Force from September 1959 to September 1963. He was married while in the service, in March 1962. His wife is an English woman; and during 1969, the taxable year here involved, she and petitioner had two children, a six-year-old boy and a two-year-old girl. Petitioner was employed by Lockheed in 1966 or at some time prior thereto. When he was hired, he was living in St. Charles, Missouri, and at that time he took his household effects to a storage warehouse in Poplar Bluff where they remained until the Fall of 1969 when petitioner resigned his position with Lockheed to accept employment with Boeing Aircraft Company in the Seattle, Washington, area. During all of petitioner's assignments with Lockheed, his wife and his child or children accompanied him. During petitioner's 1969 assignment in Meridian, the family occupied a rented trailer. Petitioner paid Missouri income tax for 1969, and he held a Missouri370 driver's permit. He also negotiated a $200 signature loan with a Poplar Bluff bank in August 1969 while enroute from Mississippi to Washington State. During an assignment overseas which petitioner had with an employer prior to Lockheed, his wife rented a furnished apartment down the street from the house where petitioner's mother was living. During 1969, petitioner received $1,910 in per diem payments while he was assigned to Key Field in Meridian, Mississippi. He did not include any portion of such payments in income on his return for that year. In his statutory notice of deficiency, respondent included that amount in petitioner's gross income for 1969. OPINION It must first be determined whether the per diem payments received by petitioner from Lockheed in 1969, in respect of his assignment to Meridian, are includible in his gross income for that year. It is believed that the Meridian-related per diem payments when received by petitioner constituted gross income. In very broad and sweeping language, section 61(a)(1) provides that "gross income means all income from whatever source derived." The Supreme Court has construed this "broad phraseology" to evince a Congressional371 intention "to tax all gains except those specifically exempted." Commissioner v. Glenshaw Glass Co.,348 U.S. 426">348 U.S. 426, 430. The per diem payments were "undeniable accessions to wealth, clearly realized and over which the [petitioner had] complete dominion," ( Commissioner v. Glenshaw Glass Co.,supra, p. 431); and the Code contains no provision exempting per diem payments from taxation. Manifestly, then, the respondent was correct in including in petitioner's income the $1,910 of per diem payments received at Meridian in 1969. Leo C. Cockrell,38 T.C. 470">38 T.C. 470, 477-478, affd. (8th Cir.) 321 F.2d 504">321 F.2d 504; Darrell Spear Courtney,32 T.C. 334">32 T.C. 334, 341. 4The question remains whether petitioner is entitled to deduct any part or all of the per diem payments under section 162(a)(2) as expenses for travel while away from home in pursuit of his trade or business as an employee of Lockheed, Leo C. Cockrell,supra, p. 479. In the Cockrell case, it was pointed out that the Supreme Court, in Commissioner v. Flowers,326 U.S. 465">326 U.S. 465,372 rehearing denied 326 U.S. 812">326 U.S. 812, had laid down three requirements that a taxpayer must meet to be entitled to deduct away-from-home expenses: The expense must be (1) reasonable and necessary traveling expense, (2) incurred by the taxpayer while away from home, and (3) incurred in pursuit of business. In the present case, the parties differ only on the point of whether petitioner was away from home. In the case of Truman C. Tucker,55 T.C. 783">55 T.C. 783, 786, the factors to be considered in determining whether a taxpayer should be treated as away from home for tax purposes were crystallized. It was there said: The purpose of allowing the deduction of living expenses while a taxpayer is "away from home" is "to mitigate the burden of the taxpayer who, because of the exigencies of his trade or business, must maintain two place of abode and thereby incur additional and duplicate living expenses." Ronald D. Kroll,49 T.C. 557">49 T.C. 557, 562 (1968). In furtherance of this purpose, when a taxpayer with a principal place of employment goes elsewhere to take work which is merely temporary, he may deduct the living expenses incurred at the temporary post of duty, 373 because it would not be reasonable to expect him to move his residence under such circumstances. Emil J. Michaels,53 T.C. 269">53 T.C. 269 (1969); Ronald D. Kroll,supra.For this purpose, temporary employment is the type which can be expected to last for only a short period of time. Beatrice H. Albert,13 T.C. 129">13 T.C. 129, 131 (1949). Two points are thus presented: Was petitioner's assignment to Meridian temporary, as opposed to indefinite? And, did he maintain two places of abode and thereby incur additional and duplicate living expenses? Respondent has conceded that petitioner's Meridian assignment was temporary. Thus, there remains only the second point for consideration. The evidence is not persuasive that petitioner maintained two places of abode and thereby incurred those additional and duplicate living expenses, the burden of which the deduction afforded by section 162(a)(2) is designed to mitigate. Mrs. Files and the two children accompanied petitioner to Meridian, and it was in that city that they worked, ate, slept -- in short, made their home and incurred family living expenses. Petitioner incurred no such expenses at Poplar Bluff, 374 Missouri, or at any other locality during his Meridian assignment. Petitioner's ties to Poplar Bluff are just not substantial in nature, so as to qualify that city as his home for tax purposes during his Meridian assignment. Summing it up, petitioner was at, not away from, his home for the purposes of section 162(a)(2), during his 1969 Meridian assignment. It is no doubt true that at some earlier point, Poplar Bluff could have qualified as petitioner's tax home; but, by 1969, and probably long before that year, it had been abandoned and could no longer qualify as such. Accordingly, petitioner should not be entitled to any deduction for away-from-home travel expenses under section 162(a)(2) for 1969. * * * * *In accordance with the foregoing, Decision will be entered for respondent.Footnotes1. DeQuincy V. Sutton was counsel of record for petitioners at the time of trial. Mr. Sutton died in August 1974, shortly after the last brief was filed. There is presently no counsel of record for petitioners.↩2. All section references are to the Internal Revenue Code of 1954, unless otherwise specified.↩3. The petitioner-husband in the present case, as well as all the other husband-petitioners, worked at Key Field in Meridian. It is this work at Meridian that is the common element that prompted the consolidation of the cases for trial.↩4. See also Fred W. Phillips,T.C. Memo. 1973-58↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623297/	ALFRED S. FRANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Frank v. CommissionerDocket No. 27870.United States Board of Tax Appeals16 B.T.A. 771; 1929 BTA LEXIS 2530; May 28, 1929, Promulgated 2530 The principle of law that the Federal Government may not tax the means, agencies or instrumentalities by which a State exercises its governmental functions does not exempt from the Federal income tax the distributive share, or any part thereof, of a member of a partnership who was not himself an employee of the State but whose partner was such an employee and paid his entire salary into the partnership treasury. Alfred S. Frank, Esq., pro se. J. L. Backstrom, Esq., for the respondent. VAN FOSSAN 771 The deficiency in this proceeding of which redetermination is asked is for income taxes for the calendar year 1925 in the amount of $38,76. Two errors are alleged: (1) The holding by the respondent that certain income received by petitioner from a partnership of which he was a member was not exempt from taxation, and (2) the addition to income of $37.29 on account of expense deductions disallowed. Error was conceded by respondent as to the second issue. FINDINGS OF FACT. Petitioner is an attorney at law and a member of a partnership consisting of O. B. Brown and himself, engaged in the practice of law in Dayton, Ohio. During the taxable2531 year 1925 the agreement between the partners provided for an equal division of all fees and other proceeds with the single exception of directors' fees. After the disastrous floods of the Miami River in 1913, which resulted in the loss of several hundred lives and millions of dollars in property, there was passed by the Ohio Legislature a law known as The Conservancy Act of Ohio. (104 Ohio Laws, pp. 13 to 64, inclusive.) The Conservancy Act indicated the procedure to be followed 772 in the creation of Conservancy Districts and granted to a Conservancy District, once established, power to proceed with the erection of such a district and all incidental powers necessary and essential to the carrying out of the general purposes of the act, which were "to prevent floods; to protect cities, villages, farms and highways from inundation and to authorize the organization of drainage and conservancy districts." Among the powers granted were those to borrow money, to assess benefits against property owners, to police said district, to condemn land, and to exercise the right of eminent domain, superior to the general right of eminent domain exercised by railraods, telegraphs and other2532 agencies. Among other things it was provided that "the board may also employ a chief engineer, who may be an individual, copartnership or corporation, an attorney and such other engineers, attorneys and other agents and assistants as may be needful and may provide for their compensation, which, with all other necessary expenditures, shall be taken as a part of the cost of improvement. The employment of the secretary, treasurer, chief engineer and attorney for the district shall be evidenced by agreements in writing, which, so far as possible, shall specify the amounts to be paid for their services." Pursuant to the above legislation, the Miami Conservancy District was established by decree of court, June 28, 1915. On July 7, 1915, the board of directors passed a resolution in the following tenor: "On motion of Mr. Allen, seconded by Mr. Rentschler, Judge O. B. Brown was unanimously chosen attorney for the district at a salary of $600 per month." On July 25, 1915, an agreement was entered into pursuant to the above resolution, in the following form: This agreement entered into by and between the Board of Directors of the Miami Conservancy District, party of the first part, and2533 O. B. Brown, party of the second part, WITNESSETH: That, whereas, on the seventh day of July, 1915, the said Board of Directors appointed the said O. B. Brown attorney for the said district, pursuant to the general code of Ohio, section 6828-11, which is section 11 (eleven) of the law known as the conservancy law of Ohio. Now, therefore, the said party of the second part, in consideration of the agreement herein contained hereby agrees to serve the said party of the first part as attorney for the said in Miami Conservancy District and that he will devote such time to his duties as attorney for the district as said party of the first part may require. In consideration of the above, said party of the first part agrees and promises to pay the said party of the second part a salary of six hundred ( $600) dollars per month, payable semi-monthly. IN WITNESS WHEREOF, the said Board of Directors of the Miami Conservancy District, to-wit: Edward E. Deeds, Henry M. Allen, and Gordon S. Rentschler, has hereto set the name of said district and the individual members thereof have hereunto affixed their signatures, and cause the seal of the district to be here unto attached and unto a2534 duplicate hereof and the said O. B. Brown has hereunto set his hand and unto a duplicate hereof, this 24th day of July, 1915. 773 Thereafter for some years Brown devoted all of his time to the affairs of the Conservancy District. In 1923 or 1924 the work tapered off and he handled some other legal matters.In 1925 he devoted from 75 per cent to 80 per cent of his time to the work of the Conservancy District. Under authority of the board of directors, he employed such legal assistants as were necessary for special litigation and one local counsel in each of the nine counties covered by the District.During the early days of his service Brown had an office in the office building of the Conservancy District, where he spent considerable time. The officers of the firm of which he was a member during all of this period were in a different building. During 1925 Brown engaged in consulations with outside clients in the office of the firm, but participated in no court work or litigation outside of that required by his employment by the District. In 1919 he discontinued his office in the offices of the District and thereafter used only his personal office for his work. Throughout2535 the entire period Brown turned his entire salary, $7,200 each year, into the partnership treasury and it was commingled with other funds coming into the partnership. Brown and the petitioner herein divided the total net funds available for distribution equally between them in each of the years. Petitioner was at no time employed as an attorney for the District. Respondent ruled that Brown was not an employee of the Miami Conservancy District, a political subdivision of the State of Ohio, and, hence, that the salary of $7,200 received by said partnership through him for the year 1925 was not exempt and that petitioner's share thereof was taxable. OPINION. VAN FOSSAN: We do not deem it essential to this decision to decide whether or not Brown was an employee of a political subdivision of the State of Ohio. Brown is not the petitioner. We have before us the partners, Frank, who claims that the mantle of immunity which might shield Brown as to income paid to him also protects the partner in so far as his distributive share of the partnership proceeds represents a division of the salary paid to Brown and turned in by him to the partnership. With this contention we can not2536 agree. Section 1211 of the Revenue Act of 1926 provides: Any taxes imposed by the Revenue Act of 1924 or prior revenue Acts upon any individual in respect of amounts received by him as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded. 774 Though this section deals primarily with refunds, it seems clear that Congress contemplated that the immunity be personal to the person receiving the same "as compensation for personal services as an officer or employee of any State or political subdivision thereof * ." We believe this section to be merely enunciatory of the general rule of law covering the scope of the immunity afforded the employees of one government from taxation by another. Here Brown's salary was paid into the partnership and indiscriminately mixed with funds received from other sources. A decision as to the legal effect of such a commingling as to Brown's income is not pertinent2537 here, but to extend immunity to the share of the partnership income received by petitioner would be stretching the doctrine beyond reason or precedent. Frank was at no time an employee of the District. He received no income therefrom. It would do violence both to the language and spirit of the Act and to the general rule of law to relieve him from the tax in question. Reviewed by the Board. Judgment will be entered under Rule 50.MARQUETTE, SMITH, and GREEN concur in the result.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623299/	CHARLOTTE COXE TEUBER, BY HER ATTORNEY IN FACT, JOHN CADWALADER, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Teuber v. CommissionerDocket Nos. 37112, 41564.United States Board of Tax Appeals25 B.T.A. 1130; 1932 BTA LEXIS 1423; April 13, 1932, Promulgated 1423 Petitioner was a life beneficiary under two different trusts created under the wills of two deceased relatives. She had no interest in the corpus of either trust. held, the entire amounts distributed to her by the trustees were income to her, and she was not entitled to a deduction for depletion of the corpus. John Cadwalader, Jr., Esq., for the petitioner. A. H. Carnduff, Esq., for the respondent. LOVE 1131 These proceedings are for the redetermination of deficiencies in income taxes for the calendar years 1923, 1924 and 1925, in the amounts of $1,149.30, $752.60 and $683.56, respectively. Both proceedings were heard separately, but it was stipulated by the parties that all of the evidence introduced in the first proceeding should also be considered as evidence in the second proceeding. The issues are (1) whether petitioner, who is a life beneficiary under two different trusts created under the wills of two deceased relatives, is entitled to a deduction for depletion on the amounts distributed to her as such beneficiary, and (2) whether an amount of $120.38 was income to petitioner in 1923 or in 1924. The only evidence introduced1424 in connection with the first issue was an "Indenture" executed on June 24, 1904, the wills of Rebecca Coxe and Eckley B. Coxe, Jr., and petitioner's income-tax return for the calendar year 1923. No evidence was offered in connection with the second issue. FINDINGS OF FACT. Petitioner is Charlotte Coxe Teuber, residing at #6 Wattmannsgasse, Vienna, Austria. In her income-tax return for the calendar year 1923 petitioner reported "other income" from fiduciaries as follows: Estate of Rebecca Coxe, deceased$1,842.89Estate of Brinton Coxe, deceased6,437.78Estate of Eckley B. Coxe, Jr., deceased7,965.55Attached to the return for the year 1923 was a rider captioned "Protest," which read as follows: Amounts received from trust funds are included in this return under protest, because such amounts are not taxable income, and all tax assessed thereon is therefore paid under protest. For the year 1923 the respondent increased the "other income" reported by petitioner from the said fiduciaries in the following amounts: Estate of Rebecca Coxe, deceased$1,649.06Estate of Brinton Coxe, deceased120.38Estate of Eckley B. Coxe, Jr., deceased6,439.061425 For the years 1924 and 1925 the respondent increased the income reported by petitioner from the estate of Eckley B. Coxe, Jr., deceased, by the additional amounts of $8,055.92 and $5,929.63, respectively. The reason given by the respondent in his deficiency notice 1132 for such increases in income was that in view of General Counsel's Memorandum No. 1673 (C.B. VI-1, p. 252) "beneficiaries are not entitled to deduct depletion from their proportionate share of income from an estate or trust." On June 24, 1904, Rebecca Coxe, Eckley B. Coxe, Jr., and certain other persons not here material, "hereinafter called the Lessors, of the first part, and Coxe Brothers and Company, Incorporated, a corporation organized under the laws of the State of Pennsylvania, hereinafter called the Lessee, of the second part" executed an instrument called "THIS INDENTURE," which consisted of 52 printed pages. It covered the mining rights in tracts of land in Luzerne, Carbon and Schuylkill Counties, Pennsylvania, by far the larger amount being in Luzerne County. The lessors "demise and let" in certain parts certain lands, reserving surface rights and excepting certain described premises used for1426 churches, lodges, etc., and also in other parts certain veins of coal, and again in still other parts certain surface lots and parcels of land. Further on in the indenture the lessors "demise, let and grant" unto the lessee certain other veins of coal, and "further grant" the right to carry coal from any tract to any colliery then erected on the said lands, and the said lessors do "further demise and let" to the said lessee "all the houses, buildings, structures, improvements, machinery, apparatus and fixtures of every kind and description belonging to said Lessors, whether on or under the surface, which shall be on the hereinbefore mentioned tracts of land at the beginning of the term hereby created excepting the surface of the hereinbefore excepted surface tracts." The habendum clause of the indenture is as follows: TO HAVE AND TO HOLD the premises, rights and privileges hereby demised or granted, subject to the covenants and conditions herein contained to be kept and performed by the said Lessee from the date hereof until the coal in the hereinbefore described tracts or pieces of land shall have been practically exhausted for mining purposes, as to which matter any difference1427 of opinion between the Lessors and the Lessee is to be determined by arbitrators as hereinafter provided. The reddendum clauses of the indenture provide, among other things, for the payment of royalties of certain specified amounts on different sizes of coal on or before the 25th day of each month during the term, for the mining, sending away and paying royalty in each and every year on at least 417,000 tons of coal unless prevented by faults in the veins or other unavoidable causes, such as strikes, floods, accidents in the mines, etc.; and for the payment of all taxes assessed against the fixtures erected by the lessee and certain other taxes. And, in case of default, the indenture provided: * * it shall and may be lawful to and for the said Lessors, their heirs, successors and assigns, into and upon the said demised premises to re-enter, 1133 and the same again to have, repossess, and enjoy as in their first and former estate; and the leasehold estate and rights hereby granted to the said Lessee shall cease and determine and become void, anything herein contained to the contrary notwithstanding. Rebecca Coxe, petitioner's aunt, by will dated February 27, 1906, devised1428 and bequeathed as follows: THIRTIETH, All the rest, residue and remainder of my estate, real, personal and mixed, of whatever kind and description and wherever situated, not herein otherwise disposed of and subject to the annuities and bequests hereinbefore directed to be paid, I give, devise and bequeath as follows: * * * 3rd. I give, devise and bequeath three-ninths thereof unto my executors hereinafter named, and the survivor of them, and the heirs and executors of such survivor in trust nevertheless, to pay to my niece Charlotte Coxe Teuber, Eliza M. Coxe Young and Mary Rebecca Coxe Gerhard, * * * the net income or revenue each a one-ninth thereof, for and during their respective lives, and from and immediately after the death of each of the said tenants for life to pay over the shares so held in trust for each of my said nieces, being the one-ninth thereof, to her children, share and share alike. Eckley B. Coxe, Jr., petitioner's cousin, by will dated November 7, 1910, devised and bequeathed a residuary estate in trust to the Trust Company of North America. On June 12, 1916, he executed a codicil to his last will and testament which codicil provided in part as follows: 1429 I give devise and bequeath all of the rest, residue and remainder of my Estate real and personal whatsoever and wheresoever and whether in possession or expectancy to my Executors Charles Sinkler and John Cadwalader, Junior in Trust to hold the same and to invest and reinvest the principal sums whenever and so often as may be necessary in their judgment and to pay the whole of the net interest and income of my said Estate to my mother in monthly payments as nearly equal as possible during the term of her natural life and from and after the death of my said mother to hold to sum of ten thousand Dollars ($10,000.00) in trust to pay the net interest and income thereof for the maintenance of a nurse to attend to the sick and injured in the town of Eckley Luzerne Co. Pa. so long as mining shall be continued at Eckley. And as to all the rest residue and remainder of my said Estate to hold the same in further Trust to pay the net interest and income thereof in equal shares to my cousins Charlotte Teuber; Eliza Middleton Young; Mary Rebecca Gerhard and Edmund J. b. Coxe in monthly installments during their natural lives for the sole and separate use of Charlotte Eliza and Mary Rebecca1430 and free and clear of all liability for the debts of them and of the said Edmund J. D. Coxe and without any power of anticipation by any of them and upon the deaths of each and all of my said cousins to hold the said respective shares of my said cousins and to pay over to to their respective children taking by representation the share or shares of their respective parents a full and equal share of the principal to each and every such child * * . OPINION. LOVE: Petitioner's principal contention in these proceedings is that she is entitled to a deduction for depletion of the coal mined by 1134 Coxe Brothers and Company under the indenture dated June 24, 1904. She bases this contention upon the ground that she is a life beneficiary under the wills of two of the original lessors of the said indenture. She had no interest in the corpus of either trust created under the wills of Rebecca Coxe and Eckley B. Coxe, Jr. The taxable years in question are all prior to the taxable year 1928. Under such circumstances we have held in a long line of decisions that deductions in the nature here contended for are not allowable. See 1431 Sophia G. Coxe (where the will of Eckley B. Coxe, Jr., was also involved), ; ; Richard Sharpe (a Pennsylvania case), ; ; ; affirmed by the First Circuit at ; and , and cases therein cited. Petitioner cites and relies upon the decision of the Second Circuit in , but this case is to be distinguished from the instant proceedings on the same basis as it was distinguished in But petitioner further contends that while the indenture of June 24, 1904, is in the form of a lease, yet the courts of Pennsylvania. where the coal lands in question were located, hold that where the term is for the exhaustion of the mineral, the agreement between the parties in such cases cases is a sale of the coal in place and not a lease thereof. From this contention petitioner argues that the amounts she received from the two trusts1432 in question "are in fact installments of the purchase price of the coal and relate to capital assets"; that "the mere intervention of a trustee through whom the said royalties are paid does not change their nature"; and that "as the royalties represent shares of capital, the taxpayer receives them as an owner in fee and is entitled to the same deductions to which all owners in fee are entitled." At this point it should be specifically noted that the record made by petitioner is substantially deficient in proof of the amounts of the deductions she is claiming, and that, upon the present record, we would have to sustain the respondent's determination even if we agreed with petitioner on the law. Neither is there any evidence that the indenture of June 24, 1904, was in effect during the taxable years here in question. Assuming, however, that the indenture was in effect during the years 1923, 1924 and 1925; that the two trusts here in question received royalties thereunder; and that petitioner was paid a part of such royalties (all of which petitioner contends is true), we are clearly of the opinion that petitioner is not entitled to reduce the actual amounts which she received1433 from the two trusts by any deduction for depletion or, in the language of petitioner, "deductions to which all owners in fee are entitled," and we discuss 1135 the law issue simply to show that there is no miscarriage of justice, due to petitioner's failure to offer proof as to the amounts of the deductions she is claiming. It is our opinion that as far as these proceedings are concerned it is wholly immaterial whether we regard the indenture of June 24, 1904, as a lease or as a sale of coal in place. The fact remains, based upon the above assumption, that petitioner was paid the amounts in question by the trustees appointed in the two wills and under such wills she had no interest in the corpus of the trusts, but was merely a life beneficiary. In her brief petitioner states that "The contention here is not that no income tax should be charged on the coal royalties but as they partake of the nature of capital a reasonable allowance for depletion should be made as provided by the Act of Congress." We regard the decisions cited above as controlling, and, therefore, find no error in the respondent's determination as to this issue. See also *1434 ; and . Petitioner offered no evidence on the issue as to whether an amount of $120.38 was income to petitioner in 1923 or in 1924. The respondent determined that the amount was income in 1923. We sustain the respondent. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623301/	Hoyt Butler and Virginia W. Butler, Petitioners, v. Commissioner of Internal Revenue, RespondentButler v. CommissionerDocket No. 2759-64United States Tax Court46 T.C. 280; 1966 U.S. Tax Ct. LEXIS 97; May 23, 1966, Filed 97 Decision will be entered for petitioner. The conveyance by one of petitioners of a one-half interest in his accounting practice to another with whom he formed a partnership for the practice of accounting resulted in capital gain to the extent that the amount received exceeds petitioner's basis in the assets sold, the portion of the payment in excess of that allocable to the tangible assets transferred to the partnership being in payment for one-half of the business' goodwill. Joseph B. Alala, Jr., and Charles D. Gray III, for the petitioners.O'Hear W. Fraser, Jr., for the respondent. Scott, Judge. SCOTT 280 Respondent determined deficiencies in petitioners' income tax for the calendar years 1959, 1960, and 1961 in the amounts of $ 361.58, $ 361.57, and $ 216.95, respectively.The issue for decision is whether petitioner Hoyt Butler received the amount of $ 9,641.99 as payment for goodwill of a one-half interest in his accounting practice which he conveyed to J. Edward Stowe pursuant to an oral agreement between the two for the formation of a partnership for the practice of accounting.FINDINGS OF FACTSome of the facts have been stipulated and are found 98 accordingly.Petitioners, husband and wife residing in Gastonia, N.C., filed their joint Federal income tax returns for the calendar years 1959, 1960, 281 and 1961 with the district director of internal revenue, Greensboro, N.C. Petitioners kept their records and reported their income on the cash basis of accounting.Hoyt Butler (hereinafter referred to as petitioner) is a certified public accountant. He received his certificate from the State of North Carolina in 1949 and has been engaged in the practice of accounting as a certified public accountant since that time.Prior to March 31, 1956, petitioner operated his accounting practice as a sole proprietorship. On March 31, 1956, petitioner entered into an oral agreement with J. Edward Stowe (hereinafter referred to as Stowe) to form a partnership as certified public accountants to practice under the name of Butler and Stowe.The oral agreement made on March 31, 1956, between petitioner and Stowe included an understanding (1) that the value of the business owned solely by petitioner prior to the formation of the partnership on March 31, 1956, was $ 40,000, measured by a formula agreed upon by them, (2) that Stowe would receive99 a one-half interest in the business for the payment to petitioner of $ 10,000, and (3) that petitioner and Stowe were to share profits in the newly formed partnership for the year ended March 31, 1957, on the basis of 40 percent to Stowe and 60 percent to petitioner, for the year ended March 31, 1958, on the basis of 43 percent to Stowe and 57 percent to petitioner, for the year ended March 31, 1959, on the basis of 46 percent to Stowe and 54 percent to petitioner, for the year ended March 31, 1960, on the basis of 49 percent to Stowe and 51 percent to petitioner, and for the year ended March 31, 1961, and years subsequent thereto, on the basis of 50 percent to Stowe and 50 percent to petitioner. Under the agreement the assets previously used by petitioner in his business as a certified public accountant were placed into the partnership, except the cash and accounts receivable, which petitioner retained. Petitioner assumed all liabilities existing as of March 31, 1956, and the partnership did not assume any of these liabilities.Petitioner and Stowe also had an understanding that if either partner died, the other would buy from his estate his interest in the partnership. The interest100 was to be valued by the amount of cash, accounts receivable, and fixed assets, plus annual fees based on the amount of such fees for the 12 months immediately preceding the partner's death. In recognition of this understanding, petitioner and Stowe each bought an insurance policy on the other's life in order to have available the funds to discharge the obligation of the purchase of the other partner's interest should the other die.The value of an accounting practice is frequently expressed in terms of 1 year's gross fees. For the calendar year 1955 the gross fees and net profits of petitioner's accounting business were $ 38,124.65 and 282 $ 16,111.95, respectively. The salary of Stowe for the year 1955 was $ 7,255.Approximately one-half of petitioner's fees prior to the formation of the partnership was derived from general accounting services of the nature usually rendered by certified public accountants and the balance of his fees was derived from bookkeeping and posting services, commonly referred to as write-up work.Prior to the formation of the partnership, petitioner, upon acquisition of clients for which he or his employees did bookkeeping or posting services, established101 books and records and procedures for such clients. These records and procedures were used in the conduct of the business of the partnership after its formation.During 1955 petitioner employed in addition to Stowe three other individuals. Stowe and two of petitioner's other employees performed bookkeeping services and the third employee performed both bookkeeping and typing services. Total salaries paid by petitioner to his employees in 1955 were $ 14,759.50.The tangible assets which petitioner transferred to the partnership consisted of office furniture and equipment with a book value and fair market value of $ 716.02.In 1957 petitioner and Stowe engaged a law firm to put their oral agreement into written form. After discussions with petitioner and with Stowe as to the substance of their agreement, the attorneys prepared a draft agreement containing 17 paragraphs. The agreement was never signed by petitioner and Stowe because they were unable to agree as to the wording of the paragraph dealing with the amount which Stowe might withdraw from the partnership prior to petitioner's having been paid the entire $ 10,000, which Stowe agreed to pay him for a one-half interest in the102 business and the paragraphs dealing with disposition of clients' papers upon termination of the partnership, the notice to be given to the other party of either partner's intent to withdraw from the partnership and the payment to be made upon such withdrawal, the interest to be maintained by either partner in the partnership in the event of his disability over an extended period or temporarily absenting himself to engage in other work, and the payment to be made and the time to be allowed therefor by the surviving partner to the executors and administrators of the deceased partner if the partnership were terminated by the death of one of the partners. The other provisions incorporated in the draft were agreed to by each of the partners as being in accordance with their oral contract. The provision in the draft with respect to the $ 10,000 stated:It is further understood and agreed that the said Hoyt Butler does hereby convey to the said J. Edward Stowe a one-half interest in said business for and in consideration of the agreement on the part of the said J. Edward Stowe to pay to the said Hoyt Butler the sum of $ 10,000.00, which said sum is to be payable in accordance with a 103 schedule hereinafter set out. * * *283 The provision as to the division of income of the partnership was also set forth in the proposed draft and was in accordance with the terms as heretofore set forth as being the oral agreement of the parties.Petitioner was desirous of selling Stowe a one-half interest in his accounting business and forming a partnership with Stowe primarily for two reasons. One was that petitioner was suffering from a back ailment which, at the time he formed the partnership with Stowe, he believed to be arthritis. Petitioner's back ailment caused him to experience difficulty in sitting for long periods. The other primary reason for petitioner's desire to form a partnership with Stowe was that petitioner's business had expanded to the point that he felt it necessary to have someone to share the responsibility of the business who had a proprietary interest therein. Petitioner was willing to accept $ 10,000 from Stowe in payment for a one-half interest in the business which the parties considered to be worth $ 20,000 (one-half of the $ 40,000 total value) since he considered Stowe to have a value to the firm due to his approximately 7 years of employment104 therewith greater than a person who might come into the firm without previous contact therewith. Petitioner felt that Stowe's value to the firm should be considered in setting the consideration for the conveyance of a one-half interest in the business to Stowe. Petitioner considered that he should receive more than 50 percent of the profits of the partnership for the first 4 years in recognition of the greater worth of his work to the firm because of his experience as an accountant being over a longer period than Stowe's. Stowe had received his certificate as a certified public accountant from the State of North Carolina early in 1956.During each of the calendar years 1959 and 1960 petitioner received $ 2,500 of the $ 10,000 Stowe had agreed to pay him and during 1961 received $ 1,500 of that amount. On his Federal income tax returns for the years 1959, 1960, and 1961 petitioner reported as long-term capital gain the amounts of $ 2,410.50, $ 2,410.50, and $ 1,446.30, respectively, which were arrived at by reducing the total payments he received under his agreement with Stowe in each of these years by amounts obtained by multiplying such payments by the percentages that one-half105 of the book value of the tangible assets was to $ 10,000. Petitioner included one-half of the amounts of the capital gain reported in his taxable income for each year. The parties agree that the total amounts as reported by petitioner are the correct amounts of the payments under petitioner's agreement with Stowe attributable to something other than the physical assets of petitioner's accounting business.Respondent in his notice of deficiency increased petitioner's reported net income by the one-half of the reported gain on the sale of his 284 accounting business which petitioner had not included in his taxable income, stating that petitioner had not shown that the gain qualified as long-term capital gain as defined in the Internal Revenue Code of 1954.OPINIONRespondent takes the position that when an individual practicing a profession as a sole proprietor forms a partnership with another, transferring to the other an interest in his existing practice, such individual does not make a sale or exchange of goodwill irrespective of the amount of goodwill which he has developed in his practice or the terminology used in the agreement transferring to the other an interest in 106 the practice. 1 Respondent contends that any payment received by such a professional practitioner, except the portion properly allocable to the physical assets used in the practice, is ordinary income.107 Respondent argues that when a person engaged in the practice of a profession takes in a partner any payment he receives in excess of that for an interest in the tangible assets transferred to the partnership is received either for the relinquishment of rights to receive ordinary 285 income in the future, or present payment for future services or for a combination of the two. Respondent contends that to the extent the consideration is not for an interest in tangible assets there is no basis for treating the amount as capital gain. Respondent states that when an individual takes a partner into his professional firm he does not dispose of any part of the goodwill of the business but retains it and that therefore there has been no sale or exchange of goodwill, relying on such cases as Commissioner v. P. G. Lake, Inc., 356 U.S. 260 (1958), and Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46 (1955) holding that the capital gains provision of the revenue laws should be strictly construed.Respondent does not contend that goodwill is not a capital asset or that a professional person does not have salable goodwill108 connected with his practice. He does not contend that there was not goodwill connected with petitioner's business and that this goodwill had not been held by petitioner for a sufficient time to cause any gain on the sale thereof to be long-term capital gain. His entire argument is the contention that a professional person who forms a partnership with another cannot make a sale or exchange of the goodwill since he retains an interest in the partnership. Respondent contends that the case of E. C. O'Rear, 28 B.T.A. 698">28 B.T.A. 698 (1933), affd. 80 F. 2d 473 (C.A. 6, 1935), specifically so holds and that our holding in Malcolm J. Watson, 35 T.C. 203">35 T.C. 203 (1960), and the holding of the District Court in Rees v. United States, 187 F. Supp. 924 (D. Ore. 1960), affirmed per curiam 295 F. 2d 817 (C.A. 9, 1961), are legally erroneous. In Malcolm J. Watson, supra, we held that a certified public accountant who entered into a contract for the sale of his accounting practice to two other persons with whom he formed a partnership109 terminable in 10 years at which time the taxpayer's entire interest would be transferred to the other two persons, sold goodwill and was entitled to treat as capital gain the excess of the amount received under the contract over his basis in the business assets. We distinguished the case of E. C. O'Rear, supra, on a factual basis. 2 We pointed out that in Rodney B. Horton, 13 T.C. 143 (1949), the majority opinion held that a certified public accountant who was operating as a sole proprietor realized capital gain upon the sale of his practice to the extent of the 286 portion of the purchase price attributable to the transfer of the business goodwill, while the dissenting opinion was based on the view of the dissenters that the conclusion of the majority was in conflict with E. C. O'Rear, supra. In Richard S. Wyler, 14 T.C. 1251">14 T.C. 1251 (1950), we held that a payment received by the taxpayer there involved from an accounting firm as the purchase price for his accounting practice was taxable as capital gain, rejecting respondent's argument based on E. C. O'Rear, supra. In so holding we distinguished E. C. 110 O'Rear, stating that in the O'Rear case we had held that the agreements were not contracts for the sale of goodwill.111 Although respondent does not contend that there is any distinction in Malcolm J. Watson, supra, and the instant case, there is a factual difference in the Watson case and the instant case. In the contract in the Watson case there was not only a specific provision for the present sale of a 45-percent interest in the practice, including its goodwill, but also a specific agreement that the taxpayer would sell and the other parties to the contract would purchase the other 55-percent interest after 10 years. 3 The oral agreement in the instant case makes no provision for the transfer of the remaining interest in petitioner's accounting practice. However, we do not consider the factual differences in the Watson case and the instant case to be sufficiently substantial to justify a different legal result. 4 We agree with respondent that in order to hold in accordance with his contentions in the instant case, it would be necessary to overrule our holding in Malcolm J. Watson, supra.In the Watson case the sale was only of a 45-percent interest in the accounting practice. The legal consequences of this sale112 should not be controlled by the fact that the agreement also included a contract to sell the remaining interest at the end of 10 years.113 We do not agree with respondent that a legal distinction should be made between a situation where a professional person transfers his entire interest in a practice to another and a situation where he transfers only a portion of his interest, retaining the other and forming a partnership with the person to whom the transfer is made. Neither do we agree with respondent's contention that as a matter of law an interest in the goodwill of a professional practice may not be sold where the transferor of that interest remains as a partner with the purchaser and thus continues to benefit from the goodwill established 287 prior to the transfer of an interest in the practice. Prior to the transfer the transferor obtained the full benefit derived from the use of the intangible assets such as goodwill just as he did the full benefit derived from the use of the tangible assets.Subsequent to the transfer, the transferor obtained the benefits from use by the business of the intangible asset, goodwill, and the tangible assets only to the extent of his proportionate interest in the partnership. The purchaser pays for the intangible asset, goodwill, just as he does for the tangible assets. 114 Both are to him capital assets which will be used in the business in which he has purchased an interest to produce income of which he will receive the percentage to which he is entitled under the partnership agreement.Since we conclude in the instant case that petitioner did make a sale of an interest in an intangible capital asset, goodwill, to Stowe, we might distinguish the case of E. C. O'Rear, supra, as we have in other cases on the ground that in that case we held no sale had been made of goodwill. However, there is dicta in E. C. O'Rear, 5 which is subject to the interpretation that upon the transfer of an interest in a business under an agreement whereby the transferor forms a partnership with the transferee there can be no sale or exchange of goodwill. We will not follow such an interpretation of the dicta in E. C. O'Rear, supra, but will follow our holding in Malcolm J. Watson, supra, that capital gain may result from the transfer by an individual of an interest in a professional practice including goodwill, even though the transferor simultaneously forms a partnership with the transferee for the continuation of the practice. 115 Whether goodwill does exist as a capital asset of a sole proprietor and if so whether such goodwill was transferred are questions of fact in each case. In the instant case the facts show the existence of goodwill and the transfer of such goodwill to the partnership composed of petitioner and Stowe.116 Decision will be entered for petitioner. Footnotes1. This position is based on Rev. Rul. 64-235, 2 C.B. 18">1964-2 C.B. 18, which states in part as follows:"Further consideration has been given to Revenue Rulings 57-480, C.B. 1957-2, 47, and 60-301, C.B. 1960-2, 15, which set forth the views of the Internal Revenue Service with respect to the existence of salable goodwill in professional firms."Revenue Ruling 57-480, as clarified by Revenue Ruling 60-301, holds that no portion of the sale price of a professional practice, or any other business, which is dependent solely upon the professional skill or other characteristics of the owner may be treated as proceeds from the sale of goodwill. The revenue rulings also hold that, where a business does not depend exclusively on the personal attributes of the owner, salable goodwill may exist, depending upon the facts and circumstances."In disposing of cases involving the sale of an entire professional practice, the extent to which the proceeds of sale can be allocated to goodwill will be determined on the facts rather than by whether the business is, or is not, dependent solely upon the professional skill or other personal characteristics of the owner."In the cases of Denton J. Rees, et ux. v. United States, 187 Fed. Supp. 924 (1960), affirmed per curiam, 295 Fed. (2d) 817 (1961), and Malcolm J. Watson, et ux. v. Commissioner, 35 T.C. 203 (1960), nonacquiescence, page 9, this Bulletin, the issue was whether amounts paid to a professional man upon the admission of partners to his practice were to be taxed as capital gain. In both cases, the incoming partners purchased an interest in the physical assets used in the practice and made certain additional payments which were attributed by the recipient-taxpayers to the sale of goodwill and thus were treated as capital gains. It is the view of the Service that, in upholding this treatment, the Rees and Watson cases are erroneous and inconsistent with the decision of the United States Circuit Court of Appeals, Sixth Circuit, in the case of E. C. O'Rear v. Commissioner, 80 Fed. (2d) 473 (1935), affirming 28 B.T.A. 698">28 B.T.A. 698 (1933). See, in this regard, Revenue Ruling 62-114, C.B. 1962-2, 15."The O'Rear case held that similar payments received by a professional practitioner upon the admission of partners to his practice represented consideration for the relinquishment of his right to part of the future earnings of the practice. Under the anticipatory assignment of income principle, these payments were held taxable as ordinary income. The court noted that the taxpayer would continue to enjoy the benefit of whatever goodwill he had established and thus had not effected a disposition of that asset. * * "The Service will continue to follow the O'Rear case as a precedent in disposing of similar cases. This position is consistent with the statement in Revenue Ruling 57-480↩, that where a professional man merely takes in partners rather than transferring his entire practice, he cannot be regarded as having made a sale of goodwill within the meaning of the Code provisions relating to capital gain or loss."2. Malcolm J. Watson, 35 T.C. 203">35 T.C. 203, 215 (1960):"If the respondent relies upon the O'Rear case as authority for his position, as he appears to do, he is in error. Our conclusion in O'Rear was that the petitioner there did not prove that he had any vendible goodwill since all he had was his own skill and ability which he could not transfer, as property to others, piecemeal or otherwise, and further that the contract did not purport to sell goodwill, if it had in fact existed. We have reached a different factual conclusion, however, in two other cases. Rodney B. Horton and Richard S. Wyler, both supra. Where there exists vendible goodwill, it is an asset, albeit an intangible one, separate and apart from the personal skills and ability of the transferor. Gain realized on the sale of this asset is capital gain, regardless of whether the transferor continues, as a partner, in active practice with the purchasers. Richard S. Wyler, supra↩."3. In the article "The Tax Treatment of a Disposition of Professional Good Will," Weiss, 73 Yale L.J., 1158, 1171 (1964), the situation in Malcolm J. Watson, 35 T.C. 203 (1960), is considered as a "transitional arrangement." The article concludes that the formation of a partnership as such cannot be accompanied by a sale of goodwill (at 1167, 1184) specifically referring to O'Rear v. Commissioner, 80 F. 2d 473↩ (C.A. 6, 1935), at page 1184.4. In Malcolm J. Watson, 35 T.C. 203">35 T.C. 203, 215 (1960), we did refer to the sale of the "whole" of the goodwill stating:"Given this intangible capital asset and a contract to sell the whole of it to purchasers for a present determined consideration and a future determinable consideration, the problem before us is whether gain realized upon the receipt of the present consideration is gain from the sale of a capital asset."↩5. In discussing this contract in E. C. O'Rear, 28 B.T.A. 698">28 B.T.A. 698 (1933), affd. 80 F. 2d 473 (C.A. 6, 1935), we quoted the following provision of the contract (p. 699):"As further differential in division of fees and income of the firm business, due to the conceded excess value of good will and unearned fees of said O'Rear put into the firm, said Fowler agrees to pay said O'Rear Twenty-five ($ 25,000) thousand dollars * *."We stated at pages 700-701:"But the most damaging defect in the petitioner's argument is the fact that the portions of the agreement with which we are concerned do not even purport to be sales contracts. They do not have the effect of sales contracts. If the petitioner had any "good will" theretofore, obviously he disposed of none of it by entering into these contracts. Thus the provisions of the statutes relating to gain or loss upon the sale or disposition of property do not apply. He was not to refrain from practicing; on the contrary, he was to use every talent and every asset which he had for practicing law successfully. The agreement recognized that he would contribute more to the success of the firm than the others and therefore he should be favored in some way in the compensation which he would receive. The desired result might have been accomplished by a provision that he should have more than one third of the annual earnings. Instead he agreed, in consideration of an immediate cash payment, to relinquish his right to a part of future earnings."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623249/	J. A. FOLGER & COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FOLGER ESTATE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.J. A. Folger & Co. v. CommissionerDocket Nos. 22212, 30721, 31200, 35147.United States Board of Tax Appeals27 B.T.A. 1; 1932 BTA LEXIS 1142; November 4, 1932, Promulgated 1142 1. Held, that the petitioners were not affiliated with J. A. Folger & Company, a California corporation, at any time in either of the taxable years. 2. The tax liability of each of the petitioners for the year 1921 was extinguished by the statute of limitations prior to the issue of the notices asserting deficiencies for that year. 3. In the determination of their true deficiencies for the several taxable years the petitioners are entitled to credit for each year in the several amounts which they paid to their parent corporation in discharge of their share of the taxes shown on the consolidated returns for each of such years. 4. Special assessment denied. James S. Y. Ivins, Esq., Joseph H. Brady, Esq., and H. Edwin Nowell, C.P.A., for the petitioners. Eugene Meacham, Esq., for the respondent. LANSDON 1 The respondent asserted deficiencies against J. A. Folger & Company, a Nevada corporation, for the fiscal years ended November 30, 1921, 1922, and 1923, in the respective amounts of $106,474.09, $32,740.79, and $2,145.78, and against the Folger Estate Company for $1,481.10, $1,681.79, and $1,698.72. The several proceedings1143 were consolidated for hearing. The issues pleaded, as summarized in petitioners' brief, are: (1) Whether the respondent erred in ruling that the petitioners were not affiliated during the taxable years with J. A. Folger and Company, a California corporation which is not a party to this proceeding. (2) In the alternative, and only in the event the Board should deny petitioners' claims for affiliation, the Board will have for decision the questions whether the respondent erred: (a) In failing to hold that deficiencies for the fiscal year 1921 were barred by the statute of limitations; 2 (b) In failing to give petitioners proper credit for taxes paid by them through their parent company, J. A. Folger and Company (California) with whom they filed a consolidated return for each of the years under review; (c) In failing to grant special assessment to petitioner J. A. Folger (Nevada) for the fiscal year 1921 and for the month of December, 1921. FINDINGS OF FACT. The petitioner, J. A. Folger & Company, hereinafter sometimes called the Nevada Company, was organized in 1908 to act as a distributing agent for J. A. Folger & Company of San Francisco, California, hereinafter1144 sometimes called the parent corporation. The petitioner, Folger Estate Company, a California corporation, was organized in 1904 by interests closely affiliated with the parent corporation. In the taxable periods the outstanding common stock of these corporations was held as shown in the following table: Shares of common stock heldStockholdersJ. A. Folger & Co. (California)J. A. Folger & Co. (Nevada)Folger Estate Co.C. E. L. Folger5007882,004 1/3Elizabeth M. Folger3907882,004 1/3E. R. Folger91E. B. F. Tibbitts7102,004 1/3Folger Estate Co1,340J. A. Folger & Co. (California)3,080Others132Total2,9504,6606,015Emma F. Platt100265A. K. Munson250R. R. Vail175F. P. Atha900Total3,3006,0006,015In the same periods the parent corporation had outstanding preferred stock, held as follows: Shares of preferred stock heldStockholdersNov. 30, 1921Nov. 30, 1922Nov. 30, 1923Folger Estate Co300300300John M. Cunningham200200200E. B. F. Tibbitts200200200C. E. L. Folger150150150Elizabeth M. Folger150150150In hands of public1,854644None.Total2,8541,6441,0001145 The relationship of these parties is as follows: C. E. L. Folger, sister-in-law of president E. R. Folger; Elizabeth M. Folger, wife of president E. R. Folger; E. B. Tibbitts, sister of president E. R. 3 Folger; Emma F. Platt, widow of a former pensioned employee of the Folger interests; A. K. Munson, employee of the Folger interests from 1880 until death in 1924; R. R. Vail, employee of the Folger interests from 1880 until retired on pension December 31, 1921; E. P. Atha, vice president and general manager of the Nevada Company and employee of the Folger interests since 1899; John M. Cunningham, son of Mrs. C. E. L. Folger, under a prior marriage and employed by the California Company. This preferred stock, under the California laws, had voting powers equal to common stock, but carried no rights of participation in the profits of the corporation in excess of 7 per cent, except in case of liquidation of the corporation, in which event, the holders were preferred to the extent of the par value, plus 2 1/2 per cent. It was all callable by the corporation at 102 1/2 per cent, plus accrued dividends, on any quarterly dividend date upon 30 days notice; and after the date1146 fixed in such notice for such redemption, all rights of the holders, other than to receive the amounts then due, ceased, except in case the corporation defaulted in providing money for redemption. At all times material here the parent corporation was financially able to redeem all of its outstanding preferred stock and to liquidate in cash all of its obligations incident thereto. For the periods involved the parent corporation filed consolidated income tax returns for itself and these petitioners, which attributed income to the latter companies as follows: 192119221923J. A. Folger & Company$280,414.98$232,528.03$220,377.14Folger Estate Company16,810.9715,682.2915,589.79The consolidated return for the fiscal year ended November 30, 1921, was filed February 16, 1922. Thereafter, on October 19, 1925, the parent corporation and the Commissioner of Internal Revenue entered into an agreement in writing which waived the statutory time for making any assessment of income and war profits tax due under any return made on behalf of that taxpayer for 1921 and extended it to December 31, 1926. On March 4, 1926, these petitioners, separately, 1147 executed waivers to the Commissioner of Internal Revenue extending the time for making tax assessments against each of them in respect to the same period until December 31, 1926. On December 14, 1926, new waivers covering this period were executed by all three corporations and the Commissioner of Internal Revenue, which further extended the time for making tax assessments against each taxpayer to December 31, 1927. The deficiency notices for the 4 fiscal year ended November 30, 1921, were mailed to the Folger Estate Company and J. A. Folger & Company on November 12, 1926, and July 20, 1927, respectively. The consolidated return for 1921 disclosed a tax liability of $82,537.67, payable on consolidated net income of $386,328.73 made up as follows: J. A. Folger & Company (California)$89,102.77J. A. Folger & Company (Nevada)280,414.99Folger Estate Company16,810.97The entire amount of tax shown on such return was paid in the year 1922 by the parent corporation and in the same year the petitioner, J. A. Folger & Company (Nevada) paid to such parent corporation the amount of $73,637.67 on account of its proportion of the tax shown on the return. 1148 The consolidated return for 1922 disclosed a tax liability of $31,482.26, payable on a net income of $248,142.80 made up as follows: J. A. Folger & Company (California) (loss)$67.52J. A. Folger & Company (Nevada)232,528.03Folger Estate Company15,682.29The entire amount of tax shown on such return was paid by the parent corporation in 1923. In the same year the petitioner, J. A. Folger & Company (Nevada) and the Folger Estate Company paid to such parent corporation the respective amounts of $30,000 and $1,482.86 on account of their tax liabilities for the fiscal year 1922. The consolidated return for 1923 disclosed a tax liability of $27,100.08 on a consolidated net income of $216,800.66, made up as follows: J. A. Folger & Company (California) (loss)$19,166.27J. A. Folger & Company (Nevada)220,377.14Folger Estate Company15,589.79The entire amount of tax shown on such return was paid by the parent corporation in 1924, except that portion which was satisfied by credit of an overassessment of $3,863.65 which was paid May 21, 1926. In the same year J. A. Folger & Company (Nevada) and the Folger Estate Company paid the parent1149 company the amounts of $27,547.14 and $1,948.72 on account of tax liability for 1923. Each of the petitioners filed Form 1122 for each of the taxable periods here involved, and gave the name and address of the parent company as J. A. Folger and Company, 101 Howard Street, San Francisco, California. In the space provided for question (7) for the statement of, "The amount of income and profits taxes for the taxable period to be assessed against the subsidiary or affiliated corporation 5 making this return," the petitioners in each instance inserted the word "none" after the dollar sign. The deficiency notices at Docket Nos. 22212, 30721 and 35147 do not indicate that the respondent, in computing the deficiencies, gave the petitioners credit for any portion of the consolidated tax which they paid as above set forth. The deficiency notice at Docket 35147, Folger Estate Company, shows that in computing the deficiency of $1,698.72 for 1923 the respondent gave no credit for the amount paid by this company to the parent corporation in 1924 on account of its tax liability for 1923 or any other year. During the periods involved, E. R. Folger was president of these petitioners, 1150 as well as of the parent corporation. In their intercompany dealings, the parent company invoiced its products to the petitioner, J. A. Folger & Company, for sale and distribution in its territory at actual cost, plus 5 per cent, which price was from 7 per cent to 10 per cent below the open market price on like products. In addition to this preference in price, which was worth not less than $20,000 per year to the agent on the goods distributed, the parent company extended to this petitioner an unlimited line of credit which enabled it to realize on its sales before paying for the goods. For a number of years prior to 1919, the parent company had been a regular borrower of money from the Wells-Fargo Nevada National Bank of San Francisco, and in the latter part of that year was indebted to the bank in the sum of $600,000. This company was prosperous and in no way embarrassed by these loans, but its officers considered that it was not good business to have so large an indebtedness subject to call and, therefore, decided to liquidate the same by a preferred stock issue. Accordingly, on October 27 of that year, by proper corporate action, this corporation amended its charter so1151 as to authorize the issuance of 4,000 shares of 7 per cent preferred stock having a par value of $100 each. This stock was issued on November 1 and November 3, following, and 1,000 shares were purchased by members of the Folger family. During the month of January, 1920, the corporation repurchased 50 of the shares of its preferred stock which had been sold to the public and, before the end of that fiscal period, additional lots, amounting to 406 shares in all. Further purchases and retirement of this stock were made by this company, amounting in all to 2,594 shares before the end of the fiscal period of 1922. In 1923 none of this stock was in the hands of the public. During all of these periods, the entire issue of preferred stock was voted at all stockholders' meetings by E. R. Folger, president of the three companies, in virtue of proxies held by him from the owners. 6 OPINION. LANSDON: Each of the petitioners here claims that it was affiliated with the parent corporation for Federal income tax purposes in each of the taxable years. The parent corporation and the Nevada Company had common stock outstanding in the several taxable years in the respective amounts1152 of 3,300 and 6,000 shares. Five persons and corporations which may be regarded as the Folger family interests owned stock in the two corporations in the respective amounts of 2,950 and 4,660 shares or 89 2/3 and 77 2/3 per cent of the entire issues. Four persons not members of the Folger family owned respectively 350 and 1,340 shares of such corporations. Emma F. Platt owned 100 and 265 shares, respectively; A. K. Munson owned 250 shares of the parent corporation and none of the Nevada company; R. R. Vail, and F. P. Atha owned respectively 175 and 900 shares of the Nevada company and none of the parent corporation. The record contains no evidence of any effective legal control of the minority stock by the Folger family interests. Since such interests, even if they were the same within the meaning of the law owned only approximately 90 per cent and 78 per cent, respectively, of the stock of the parent corporation and the Nevada company, they fall short, as now determined by the courts, of ownership of substantially all the stock of those corporations. As they had no legal control over the minority stock holdings, we think it follows that the parent corporation and the Nevada company1153 were not affiliated in any of the taxable years. . The Folger family interests owned all but two of the shares of the Folger Estate Company and all but 351 shares, or slightly under 90 per cent, of the stock of the parent corporation. There is no evidence that the minority holdings in the parent corporation were subject to any effective legal control by the majority, and, as the stock of the parent corporation falls short of substantially all of the ownership, we think it follows, on the authority above cited, that the parent corporation and the Folger Estate Company were not affiliated in the taxable years. Inasmuch as the common stock situation in the taxable years deprived the petitioners of the right to file consolidated returns as subsidiary corporations of the parent corporation it is not necessary to discuss the effect, if any, of the diverse holdings of the preferred stock of that concern. The petitioners also contend that the statute of limitations had run against their deficiencies for 1921, if any, prior to the date of the respective deficiency notices. The consolidated return for the fiscal 7 1154 years ended November 30, 1921, was filed on February 16, 1922. It was a completed return and stated separately the income and invested capital of each corporation. Since the record discloses that consolidated returns filed by the parent corporation had been accepted and tax liability thereunder settled in prior years, it can not be said that such return was unauthorized at the date of its filing. In our opinion it was sufficient to start the statute of limitations running against the tax liability, if any, for each of the petitioners. ; ; ; ; ; ; affd., . The four-year limitation period applicable to the tax liability of the three corporations included in the consolidated return filed on February 16, 1922, expired on February 16, 1926. On March 4, 1926, the petitioners separately executed waivers extending the time for assessing and collecting their1155 1921 taxes to December 31, 1926. On December 14, 1926, new waivers were executed by all three corporations extending the time for making assessments to December 31, 1927. The deficiency notices that are the bases of these proceedings were mailed to the Folger Estate Company and the Nevada Corporation on November 12, 1926, and July 20, 1927, respectively. Since the statute of limitations ran against the petitioners on February 16, 1926, and no waivers were filed prior to the enactment of the Revenue Act of that year on February 26, the agreements entered into on March 6, 1926, could not extend the time for assessment. Section 1106 of the Revenue Act of 1926 extinguished all tax liability against which the statute had run prior to its enactment unless waivers had been executed prior to that date. ; ; . The record discloses that the parent corporation filed a waiver on October 25, 1925, which extended the time for making assessments of 1921 taxes to December 31, 1926, and that it filed similar waivers on April 19, 1926, and1156 December 14, 1926, extending such time to December 31, 1927. In his brief counsel for respondent argues that such waivers were effective to extend the period of limitation as to the petitioners, since the parent corporation had acted as the agent for its subsidiaries in filing the consolidated return and so had authority as such agent to execute waivers binding on the petitioner. A sufficient answer to this argument is that, even if the parent corporation had authority to execute waivers as the agent of its subsidiaries, it never did so. The waivers filed by the parent corporation related only to its own tax liability. They include no mention 8 of the subsidiaries. They were not signed by any officer of either of the petitioner taxpayers here as such and therefore are lacking in all the statutory requirements of binding agreements effective to extend the period of limitations. Nor would this situation have been different had the respondent finally held in favor of the affiliation contended for here. In that event the parent corporation would have been liable for all the taxes due upon the income of its subsidiaries in conformity with the information returns filed and1157 neither of these petitioners would have the standing of a taxpayer within the meaning of the law. In our opinion the respondent was without authority to assess or collect any 1921 taxes as to these petitioners when the notices of deficiencies were issued. The parent corporation filed consolidated returns for itself and the petitioners in each of the years under review and paid all the taxes shown to be due thereon. The information return filed by the petitioners for each of such years stated that none of the tax was to be assessed against either subsidiary corporation. On or about the dates at which the parent corporation paid the several installments of taxes shown on the consolidated returns it was reimbursed by each of the subsidiaries, as set forth in our findings of fact. The petitioners contend that in the computation of the deficiencies here involved the respondent should have credited each of them in each of the taxable years with the amounts it paid in discharge of its liability shown on the consolidated return. This contention is in conformity with decisions of this Board in several proceedings involving similar questions. 1158 Affiliation having been denied, it follows that the true deficiency against each of the separate companies is the difference between its share of the tax shown on the consolidated return and the amount of its tax liability as a separate taxpayer. The deficiencies asserted against the several petitioners should be credited with the amounts which each of them paid to the parent corporation in discharge of its proportion of the tax shown on the respective consolidated returns. ; ; ; ; ; ; . Petitioners also claim the right to have their taxes computed under the provisions of section 328 of the Revenue Act of 1921. The evidence of abnormalities in income and invested capital does not convince us that either petitioner will suffer any hardship, as compared with like corporations1159 in a similar business, if its tax liability for each of the several years under review is determined under the *9 provisions of section 230 of the Revenue Act of 1921. The plea for special assessment is denied. The findings of fact and opinion herein take the place of our findings of fact and opinion in these proceedings promulgated on May 13, 1931, which are hereby vacated. Reviewed by the Board. Decision will be entered under Rule 50.SMITH SMITH, dissenting: I dissent from so much of the opinion of the Board as holds that the tax liability of each of the petitioners for the year ended November 30, 1921, was extinguished by the statute of limitations prior to the issuance of the deficiency notices for that year. The consolidated and information returns filed for that year showed that the parent company was liable for the tax due on the consolidated return. All of the evidence goes to show that the parent company acted as the agent of the subsidiary corporations. MARQUETTE, STERNHAGEN, and GOODRICH agree with this dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623251/	HARRY R. SECOY and MARY V. SECOY, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Secoy v. CommissionerDocket Nos. 5280-85, 7443-85, 7825-85, 13512-85, 13513-85.United States Tax CourtT.C. Memo 1987-286; 1987 Tax Ct. Memo LEXIS 286; 53 T.C.M. (CCH) 1050; T.C.M. (RIA) 87286; June 9, 1987. Laura Lee, for the petitioners. Henry Thomas Schafter, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies and additions to tax as follows: Additions to TaxTaxSectionSectionYearDeficiencies6653(a)(1) 26659Secoy, Docket No. 5280-851980$25,010$1,251$2,561198140,074 * 2,00411,815198244,444 * 2,22213,333Saty, Docket No. 7443-851978$ 1,097$ 55$ 32919792,96114888819804072019819,261 * 4632,77819824,736 * 2371,421Low, Docket No. 7825-851981$ 5,580 * $ 279$1,57219825,048 * 2521,514Weldon, Docket No. 13512-851980$ 811198123,412$4,069198215,0313,977Weldon, Docket No. 13513-851979$ 3,551$1,065289 In amendments to the answers, respondent alleged that petitioners are liable for interest on the underpayments of tax calculated at the higher rate provided in section 6621(c) [formerly section 6621(d)]. 3The issues for decision are (1) whether petitioners are entitled to deductions and credits with respect to certain master sound recordings; (2) whether petitioners are entitled to a theft loss deduction for out-of-pocket payments made with respect to master sound recordings; (3) whether petitioners are liable for additions to tax under section 6659 because of underpayments of tax attributable to valuation overstatements with respect to the290 master sound recordings; and (4) whether petitioners are liable for the increased rate of interest provided in section 6621(c) because the underpayments are attributable to tax-motivated transactions. FINDINGS OF FACT All of petitioners were residents of the State of Washington at the time their respective petitions in the above cases were filed. They filed Federal income tax returns for each of the years in issue. In addition, petitioner Ronald A. Weldon filed a Form 1045, Application for Tentative Refund, seeking to carry back certain items from 1982 to 1979, 1980, and 1981. At all times material hereto, petitioner Harry R. Secoy (Secoy) was in the private practice of ophthalmology; petitioner Ronald A. Weldon (Weldon) was employed by the Snohomish County, Washington, Public Utilities Department, as a journeyman lineman, safety supervisor, or security administrator; and petitioner Patrick M. Low (Low) was employed by the Xerox Corporation as a technical supervisor, dealing with new employees and account problems. Low and petitioner Patrick E. Saty (Saty), along with Douglas Mumaw, were partners in a partnership known as Ridgewood Associates. Ridgewood Associates was formed291 at the suggestion of Percy E. "Ted" Goodwin (Goodwin), Low's father-in-law, and Clifford M. Johnston (C. Johnston) in about October 1981. Weldon was a 2/35 limited partner in a partnership known as Emerald Isle, Ltd. (Emerald Isle), in which the general partners were Richard A. Watts (Watts) and Frederick A. Johnston (F. Johnston). 4Secoy, Emerald Isle, and Ridgewood Associates purportedly acquired master recordings 5 in issue here from Jerden Industries, Inc. (Jerden), a Washington corporation headed by Gerald B. Dennon (Dennon). Petitioners entered into transactions with Jerden through C. Johnston and Goodwin, sales agents for World Decca, the "marketing arm" for Jerden. F. Johnston, brother of C. Johnston, moved to Seattle in 1981 to act as a sales agent for Jerden, specializing in forming and selling limited partnership interests. The master recordings purportedly acquired292 by petitioners or their partnerships were as follows: PetitionerDateTitleStated PriceSecoy6-25-81Toots Thielemans$452,000 Low andSaty/RidgewoodAssociates10-26-81Johnny Horton533,000Weldon/EmeraldIsle6-1-82Buddy Rich533,000Diana Honey533,000Hi-Fi533,000Mark Winkler533,000Lonesome City Kings533,000Ian Matthews533,000Secoy chose the master Toots Thielemans; he had seen Thielemans perform in person and on television. The master purportedly acquired by Ridgewood Associates was selected by Goodwin or Dennon, but Low had general knowledge of the artist, Johnny Horton. The masters purportedly acquired by Emerald Isle were selected by Watts and F. Johnston. Petitioners each received various promotional materials from Goodwin or C. Johnston, although not all petitioners received all of the materials used in promoting Jerden investments. Certain documents, such as appraisals and an opinion letter written by attorney David C. Mitchell of Everett, Washington, were received, if at all, only after petitioners had entered into the transactions in issue. The master recordings offered by293 Jerden sold for only four prices: $351,000, $452,000, $533,000, and $702,000. The purchase price was to be paid with a small down payment payable in cash or in cash and a short-term recourse promissory note. The balance of the purchase price was payable by a long-term recourse promissory note with installments payable from sales of records. The promotional materials represented that an advance loan commitment would be made available by a bank to refinance the long-term recourse note at its maturity. Prior to the transactions in issue, petitioners had participated in master recording tax shelters in which a portion of the consideration purportedly paid for a master recording was represented by nonrecourse promissory notes. Prior to Secoy's transaction here in issue, the Internal Revenue Service (IRS) had commenced an audit of Secoy's tax returns with respect to his earlier master recording transactions, and he was aware of the position of the IRS with respect to fair market value of master recordings and the use of nonrecourse financing generally, as well as Jerden transactions in particular. Low was also aware at the time of the Ridgewood Associates transaction in issue that294 recourse financing had a tax advantage over nonrecourse financing. Low knew of no nontax reason to use recourse financing instead of nonrecourse financing in master recording transactions. The promotional materials emphasized the tax benefits of purchasing a master recording rather than any economic benefits that could be expected. Examples and projections demonstrating the large ratio of the tax benefits available to the cost of a master recording were set forth in tabular form. The promotional materials included no projections of sales or income to be derived from a master recording, but included a 25 page tax opinion by Joseph Wetzel, a Portland, Oregon, attorney. Wetzel had reviewed and revised various master recording documents, sales agency agreements, and loan commitment documents discussed below. Wetzel had no experience in the music recording business. The Jerden promotional materials contained a section entitled "Tax Risks" containing the following language: The seller expects the purchaser to purchase the master for a bona fide business operation and with the intent of the purchaser to make a profit. Nonetheless, there are substantial tax risks associated with295 the purchase of master sound recordings. These risks include, but are not limited to, the possibility that (1) the purchaser will be classified as an associate of a corporation, or as a partner of a partnership, in which event virtually all of the anticipated tax benefits expected to be derived from a purchase of a master sound recording would be unavailable, (2) the Internal Revenue Service (the "Service") may contest the deductibility of certain items, or the tax period in which such items are deductible, anticipated to be claimed as deductions by the purchasers, including the major portion of the depreciation expense and investment tax credit, and (3) a purchaser may be required to recognize taxable income, possibly at unearned income rates at up to 70 percent on income derived from operations, or from the sale or foreclosure of his master sound recording. * * There is substantial risk of audit of the purchaser's tax return by the Internal Revenue Service if losses are experienced. In the event that a purchaser's return is audited there is substantial risk that the Service may disallow all or a part of the losses or credits claimed by the purchaser from participation in this296 offering. The Service may base its attack on any one or more of the grounds outlined below or other grounds: 1. Challenge to Purchase Price. * * 2. Earned Income Challenge. * * * 3. Disallowance of Certain Methods of Depreciation. * * * 4. Recharacterization of Relationship with Distributor. * * * 5. Disallowance of Investment Tax Credit. * * * 6. Challenge of Profit Motive. * * * 7. Phantom Gain on Sale or Foreclosure of an Interest. * * * 8. The Revenue Act of 1978 provides a revised "at risk" rule which would apply to investments (direct and indirect) in all activities except real estate. The amendments made to the at risk rule generally apply to taxable years beginning after December 31, 1978. Accordingly, Purchasers (other than corporations which are not electing small business corporations) will be subject to the "at risk" provisions of sec. 465 and losses in excess of their amounts at risk will not be allowed. 9. Legal Expense. * * * 10. Cash Flow Shortage. * * * Neither the Seller nor the offeror or any advisor or representative of the foregoing assumes any responsibility for the tax consequences297 of this transaction to any Purchaser. Potential Purchasers should be aware that changes in the Internal Revenue Code, or regulations or interpretations thereof, by Congress, the Internal Revenue Service or the courts may reduce or eliminate anticipated advantageous tax consequences to the Purchaser. Even if tax advantages are available, their utility to the Purchaser will depend upon his personal tax position for the year of purchase and subsequent years. It should also be noted that, under certain circumstances, purchase of a Master Sound Recording could result in a net tax disadvantage. The Purchaser should consult his own tax implications of this placement and of ownership of an interest to him. * * Each Purchaser must consult with his tax counsel to analyze the risks involved in this Offering, for federal, state and local taxes. Weldon discussed the Jerden transaction with his accountant, Gilbert Hain. Otherwise none of petitioners consulted tax experts in relation to their transactions with Jerden. They did not seek independent appraisals of the master recordings or seek the advice of anyone with experience in the music or record industry as to the merits of purchasing298 a master recording. They relied solely on the salespersons promoting Jerden with respect to all aspects of the transactions. In relation to their respective transactions, each of the petitioners or his partnership delivered to Jerden the following: NameCash1-Year Note10-Year NoteSecoy$10,500$10,500 $431,000Low/RidgewoodAssociates13,00013,000507,000Weldon/EmeraldIsle78,00078,0003,042,000The above amounts shown for Weldon/Emerald Isle reflect the total consideration purportedly paid for six master recordings; the documentation of the transactions is internally inconsistent, with transaction dates ranging from June 1, 1982, to September 21, 1982. Under the terms of the long-term notes, payments during the first 3 years were to be made solely out of 50 percent of net income from the master recordings. Beginning on the third anniversary of the note, minimal annual payments were required. Petitioners or their partnerships executed purchase agreements with Jerden providing as follows: WHEREAS, [Jerden] owns all rights including all rights in and to the respective artists' contracts hereinafter conveyed to Purchaser299 * * * free and clear of all liens and encumbrances, in and to certain master sound recordings * * * to be used in the manufacture of phonograph record albums and prerecorded tapes * * * for all purposes whatsoever and in perpetuity throughout the whole world; and * * * NOW, THEREFORE, the parties hereto agree as follows: 1. Sale of the Master Sound Recordings. [Jerden] hereby sells, grants, bargains * * * and forever conveys to the Purchaser * * * all of [Jerden's] right, title, privilege, interest, ownership, and claims of any kind and character whatsoever which it now has * * * in the master sound recording. This sale includes without limitation the following rights: (a) The master sound recording and wherever and whenever permitted, the exclusive right to secure copyright registration of the "Sound Recordings" in Purchaser's own name and the right to renew such copyrights * * * with respect to the Master Sound Recording. * * * 2. Seller's Warranties and Representations. [Jerden] hereby warrants, represents, and covenants with respect to each master sound recording and each album as follows: * * * (b) [Jerden] has the sole, full and exclusive right, 300 title, and interest in and to the master sound recording and the unrestricted power to enter into and perform this Agreement. Petitioners also executed security agreements by which they granted Jerden security interests in the respective master recordings. Petitioners also received bills of sale purporting to transfer title to the master recordings. Jerden, however, had at most licenses and did not have clear title to any of the master recordings purportedly conveyed. Simultaneous with the execution of the purchase agreements, petitioners or their partnerships entered into sales agency agreements with First American Records, Inc. (First American). Under these agreements First American agreed to market records produced from petitioners' or their partnerships' master recordings. Petitioners or their partnerships were required to provide the funds necessary for the production of the first 1,000 records; thereafter, First American would advance these costs on behalf of petitioners or their partnerships. First American also agreed to guarantee sales of 2,000 albums per year during the second through the eighth year of the sales agency agreement, regardless of actual sales. Guaranteed301 sales, such as contemplated by the First American agreements, are not common features of distribution agreements in the record industry. According to the promotional materials, these "guaranteed" sales would generate sufficient income to enable petitioners or their partnerships to pay the debt service on the long-term Jerden notes. As compensation for its efforts, First American was to receive 50 percent of total net revenues from the sale of records produced from petitioners' or their partnerships' master recordings. Dennon was active in the music business in the 1950's and the 1960's. His return to the record business was accurately described in a newspaper article dated March 31, 1982 (stipulated to by petitioners) as follows: Making a tough decision to return to the record business, he discovered it was a different world than he had left in the mid-'60s. CBS, Polygram, and W-E-A had all the money. The little guy just didn't have a chance. It was then Dennon discovered that heavyweight investors could be attracted to the record business through tax write-offs on the potential earnings of a tape master. "Here's how one of these shelters works," writes Jonathan Greenberg302 in the April 27, 1981 issue of Forbes. "A promoter produces a number of master recordings of mediocre performers. A master is then resold to an investor as a tax shelter, at a hefty profit to the promoter. The investor pays a certain amount down, and is given a nonrecourse note to inflate the 'fair market value' of the record. With investment credit and depreciation on the leveraged value, the investor gets as much as four times his investment as a write-off on the deal. Nobody really cares what happens to the records. Chartbusters they aren't." "Frankly, I was appalled when I heard that people would make tapes, then put them in the closet," says Dennon. "But then I thought, 'Why not use this as a way to capitalize a legitimate record company?'" Why not indeed? For one thing, it has raised the question in the minds of many local performers, including some on the label, as to whether First American "really cares what happens to the records." Is the company a tax shelter or a record business? First American was a corporation organized under the laws of the State of Washington. Dennon owned all the stock of First American and served as a director and president at the303 time petitioners or their partnerships entered into the transactions with Jerden and the sales agency agreements with First American. First American marketed records under several labels, First American, Music is Medicine, Piccadilly, The Great Northwest Music Company, Stoney Plain, Burdette, and Jazz Man. The First American record catalog consisted primarily of previously released material. For example, the Jazz Man series consisted mainly of re-releases of early recordings of several well known jazz musicians, which generated consistent if not spectacular sales. First American also provided local Seattle artists the opportunity to produce and distribute records made from master records of their music. As promised, on the date petitioners or their partnerships entered into their transactions with Jerden, they received an advance loan commitment from LaSalle Overseas Bank, Ltd. (LOB). The Jerden promotional materials provided that if the purchaser of a Jerden master recording paid the loan commitment fees, "LaSalle will refinance the debt for a further 10 years, stamp the Jerden note paid, and cancel the security agreement, at which time the master becomes the 'free and clear' 304 property of the purchaser." Under the loan commitment, LOB agreed to lend to petitioners or their partnerships an amount designed to be sufficient to repay the initial long-term note to Jerden plus accrued interest at maturity. In order to secure this advance loan commitment, petitioners or their partnerships agreed to pay to LOB an initial loan commitment fee of 1 percent of the committed loan amount, one-half of which was payable upon the execution of the loan commitment and one-half 1 year later. Thereafter petitioners or their partnerships were required to pay an annual loan commitment fee of one-half of 1 percent of the loan amount until the time the loan was funded. The LOB loan commitment agreement provided that payment of the annual loan commitment fee was a condition upon the continuing liability of LOB to refinance the Jerden note. LOB never sought nor secured financial statements from petitioners or other Jerden investors. The loan from LOB was to be unsecured. The terms of the LOB loan required that it was to be repaid in ten annual installments, the first of which was to be paid 1 year after the loan was funded. The first nine installments were to be equal to 1 percent305 of the principal amount of the loan and to be applied first to accrued interest and then to principal. The remaining principal balance and accrued interest on the note was due on the tenth anniversary of the loan, i.e., 20 years after the original transaction. The LOB loan commitment also gave petitioners or their partnerships an unusual payment option. On the due date of the first installment, petitioners or their partnerships could choose to make that and all future installments in U.S. currency or the U.S. currency equivalent of a mix of two foreign currencies chosen by petitioners or their partnerships from lists supplied by LOB. If petitioners or their partnerships chose to tie installments to the mix of foreign currency, the exchange rates for the first and all future installments would be determined by the exchange rates on the date of the first installment. Petitioners or their partnerships could choose to tie the annual installments to different pairs of foreign currency during each year of the term of the loan. It was anticipated that petitioners or their partnerships would elect to use this "basket of currencies" payment option. As a result petitioners or their306 partnerships would be able to make each installment in U.S. dollars based upon the exchange rates of the pair of foreign currencies that had experienced the greatest loss of value vis-a-vis the U.S. dollar. The payment option virtually assured that petitioners or their partnerships could satisfy the note at a fraction of its face value. The promotional materials provided to petitioners or their partnerships described the "basket of currency" option to retire the debt incurred in the purchase of a master recording with a purchase price of $351,000 in this manner: On the date of refinancing, LaSalle agrees that 120 foreign currencies, as defined in the advance loan commitment, are "pegged" to the U.S. Dollar. In other words, $100,000 U.S. is equal to the equivalent amount of all other currencies whether they be stated in Pounds, Piastres, Pesos, Cruzeiros, etc. LaSalle agrees that the purchaser may irrevocably elect at the time of first payment to pay off the refinanced debt in either U.S. Dollars or a combination of two other foreign currencies in any year. Assuming that the foreign currency method is elected for paying off the note, 50% of the $7,642 annual debt service must be307 paid off out of the 60 currencies grouped in Basket "A" and the other 50% from the other 60 currencies grouped in Basket "B". Between 1969 and 1979, the International Monetary Fund Yearbook of 1980 shows how foreign currencies fared against the U.S. Dollar. By reference to the Preliminary Information document dated March 1, 1982, you will see that by using the foreign currency method, historically an expense of $22,087 eliminates the original $764,245 refinanced amount, plus $1,005,316 interest accrued from the 10th through the 20th year for a total of $1,769,561. The currencies included in the "basket of currency" option are as follows: (I) the basket "A" countries are as follows: Afghanistan, Algeria, Argentina, Australia, Austria, Bahamas, Bahrain, Bangladesh, Barbados, Belgium, Benin, Bolivia, Botswana, Brazil, Burma, Burundi, Cameroon, Canada, Central Africa Republic, Chad, Congo, Cyprus, Denmark, Egypt, Ethiopia, Fiji, Finland, France, Gabon, Gambia, Ghana, Greece, Honduras, India, Indonesia, Iran, Iraq, Israel, Ivory Coast, Jamaica, Japan, Jordan, Kenya, Korea, Kuwait, Liberia, Libya, Madagascar, Malawi, Malaysia, Mali, Malta, Mauritania, Mexico, New Zealand, Nicaragua, 308 Panama, Paraguay, Peru, Suriname, Trinidad and Tobago; and (II) the basket "B" countries are as follows: Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Ecuador, Germany, Grenada, Guatemala, Guyana, Haiti, Iceland, Ireland, Italy, Lebanon, Mauritius, Morocco, Nepal, Netherlands, Niger, Nigeria, Norway, Oman, Pakistan, Papua New Guinea, Philippines, Portugal, Qatar, Rwanda, Saudi Arabia, Senegal, Seychelles, Sierra Leone, Singapore, Somalia, South Africa, Spain, SriLanka, Sudan, Swaziland, Sweden, Switzerland, Syrian Arab Republic, Tanzania, Thailand, Togo, Tunisia, Turkey, Uganda, United Arab Emirates, United Kingdom, Upper Volta, Uruguay, Venezuela, Western Samoa, Yugoslavia, Yemen Arab Republic, Yemen P.D. Republic, Zaire, Zambia. The following schedule showing the rapid devaluation of several unstable currencies was included in the Jerden promotional materials: CURRENCY SCHEDULE196919701971197219731974INFLATION ADJUSTEDDOLLAR VALUEUSA $100,00094,10090,05487,08381,59772,703BASKETARGENTINAPER US $100,000(A)87,50070,00070,00070,00070,000CHILEPER US $100,000(B)83,33362,50040,0002,778535BRAZILPER US $100,00(A)87,78777,19669,99169,93558,507COLOMBIAPER US $100,000(B)93,53185,38078,36572,03662,495ICELANDPER US $100,000(B)100,000100,77789,989104,88174,346ISRAELPER US $100,000(A)100,00083,33383,33383,33358,333PERUPER US $100,000(A)100,000100,000100,000100,000100,000TURKEYPER US $100,000(B)60,56963,88663,88663,88664,617URUGUAYPER US $100,000(B)100,00067,56734,15326,68015,096309 CURRENCY SCHEDULE196919751976197719781979INFLATION ADJUSTEDDOLLAR VALUEUSA $100,00066,01562,18758,14553,78547,708BASKETARGENTINAPER US $100,000(A)5,7471,275586349216CHILEPER US $100,000(B)11757352925BRAZILPER US $100,00(A)47,96035,23627,10220,79310,228COLOMBIAPER US $100,000(B)54,18249,17047,04543,73140,768ICELANDPER US $100,000(B)51,58046,44141,34227,69522,309ISRAELPER US $100,000(A)49,29540,00022,74218,4019,900PERUPER US $100,000(A)86,00055,78729,68219,72615,472TURKEYPER US $100,000(B)59,66954,24546,49435,80125,572URUGUAYPER US $100,000(B)9,1576,2504,6213,5442,953SOURCE: CONSUMER PRICE INDEX, EXCHANGE RATES. INTERNATIONAL FINANCIAL STATISTICS, INTERNATIONAL MONETARY FUND YEARBOOK 1980 The following presentation concerning payment of the final balloon installment under the "basket of currency" option was made to Jerden investors. The discussion refers to the currency schedule reproduced immediately above. Now, on the currency schedule, we're going310 to go to year ten on the currency schedule and we're going to kind of go up and down on the schedule and you can see that some are very high and some are very low. That's the remaining value of $100,000 of all these foreign currencies. By going back to the first one, which is Argentina, you can see that Argentina's currency has declined from a value of $100,000 down to $216. That happened because in 1975, you can see Argentina began experiencing catastrophic inflation and their dollar dropped from $70,000 to $5,747 to $1,275, etc. until it got to a total of $216. Chile, in Basket B, was worth $25 at that point because back here in 1972, Allende got in as a dictator and absolutely debauched the currency of Chile during that period of time and dropped it almost to being valueless - only being worth $25. So, naturally, we're going to be using Argentina Pesos to make 50% of our debt service and Chilean Pesos to make the other 50% of our debt service. Now, let's see the impact of that on the other schedule. Now, don't forget, we have to pay out a $1,700,783 in debt service here in the twentieth year. Let's see how much it costs us. Going back to the actual debt service, we can see311 in Argentinian Pesos, we have to pay $1,837 U.S. to come up with enough Argentine Pesos to pay off $850,000 worth of debt service. In the next column, Chile's even better. In Chilean Pesos, all we have to come up with is $212 U.S. to pay off the other $850,000 worth of debt service required under the note so the total U.S. dollars required is $2,049 to retire $1,700,000. * * * LOB was incorporated on April 1, 1980, under the laws of the Colony of Montserrat, British West Indies, which allowed LOB to carry on banking business in currencies other than East Caribbean dollars outside Montserrat. On April 4, 1980, C. Johnston and Goodwin purchased 100 percent of the stock of LOB. At all times relevant hereto, C. Johnston and Goodwin exercised complete dominion and control over LOB for their sole, joint personal benefit. LOB maintained a single checking account at Seattle First National Bank (Seafirst no. 84-21703). The major sources of deposits into Seafirst no. 84-21703 were loan commitment fees from investors in Jerden master recordings, purchases of LOB stock (mainly by entities also under the control of C. Johnston and Goodwin), and interest on term deposits. These deposits312 were almost entirely offset by withdrawals from Seafirst no. 84-21703 payable directly to C. Johnston and Goodwin or to nominee entities. LOB never held itself out to the general public as a banking institution nor transacted banking business with the general public. On May 29, 1981, Jerden and LOB executed a partnership agreement whereby Jerden agreed to contribute the long-term notes executed by petitioners or their partnerships and other investors in Jerden master recordings for a 50 percent partnership interest. In return for the remaining 50 percent partnership interest LOB agreed to contribute voting preferred stock. The ostensible purpose of the partnership, called Record Collections Company, was to collect the 50 percent share of net income received from the sale of records by First American payable under the Jerden notes. It was anticipated that, upon the maturity of the Jerden notes, Record Collections Company would be dissolved. Upon dissolution LOB would receive the Jerden notes and security agreements and Jerden would receive the LOB preferred stock. A total of 102 Jerden notes executed by petitioners or their partnerships and other investors were assigned to313 Record Collections Company on the date they were executed. Record Collections Company was dissolved on December 30, 1982. The partnership never collected any moneys due under the Jerden notes. Despite the purported assignment of the Jerden notes to Record Collections Company, Jerden personnel still treated the notes as assets of Jerden. Sometime prior to October 15, 1982, Dennis Herbert, vice president of Jerden, attempted to pledge these notes as collateral for a bank loan. The notes were refused as collateral. Petitioners did not make all payments due under the terms of the long-term note. Of the loan commitment fees agreed to be paid, Secoy paid not more than $7,455 in 1981 and $7,455 in 1982; Low paid not more than $1,505 in 1981, $1,502 in 1982, and $700 in 1984; Emerald Isle paid not more than $69,335 in 1982, $16,379.50 in 1983, and $10,450 in 1984. None of the 102 makers of long-term notes given in the master recording transactions paid off the fixed amount debt service due in 1984 and 1985. On October 15, 1984, a solicitor for LOB wrote to Jerden investors as follows: Re: ADVANCE LOAN COMMITMENTS AND TEN YEAR RECOURSE NOTESAs you are aware, in 1981 and/or314 1982, you requested that LaSalle Overseas Bank, Ltd. (LOB) make an advance loan commitment to you as borrower, to pay off your outstanding indebtedness, if any, to Jerden Industries, Inc. or assigns upon maturity of the ten year recourse note. Be advised that LOB, as the result of the dissolution of Record Collections Company, is now the owner and holder of the ten year recourse notes. For those loan commitment holders who have not paid their 1983 or 1984 loan commitment fees (LCF), this is to inform those individuals that, unless payment in full of all past due loan commitment fees (duplicate billing enclosed) is received by LOB on or before 31st October, 1984, LOB will consider the advance loan commitment to be in default and it will enforce the terms and conditions of the advance loan commitment. In addition, please be advised that since LOB is the owner and holder of the ten year recourse note, that the makers of the note must understand that LOB has to take all legal measures available to collect all principal and interest due including the annual debt service due beginning on the first day of the fourth year and continuing through the tenth year (seven annual315 payments plus balloon payment of final balance) on all aforesaid ten year recourse notes (billing enclosed). In conclusion, any failure to pay loan commitment fees and/or any debt service due could result in constructive or actual foreclosure on your master, loss of all past, present and future tax benefits, as well as enforcement of the terms and conditions of both the advance loan commitment and the ten year recourse note. On June 27, 1985, LOB, enclosing a copy of the October 15, 1984, letter offered to refinance the original long-term note effective January 1, 1986, rather than at maturity upon an immediate small principal payment and execution of a new 10-year note for the face amount of the original note plus accrued interest through December 31, 1985, less the small principal reduction. The letter directed that the payment and the newly executed note should be sent to LOB on or before August 1, 1985, and contained the following paragraph: Upon receipt by LOB your check with the newly executed ten year recourse note, LOB will return your original ten year recourse note stamped paid. It is important that you have evidence of payment of debt and refinancing because in the316 event of IRS audit, you will have to provide the IRS with evidence that all contractual obligations were paid and are satisfied. On December 10, 1985, LOB sent to Jerden investors a letter signed by C. Johnston stating in part as follows: RE: CONSEQUENCES TO MAKER FOR FAILURE TO PAY DEBT SERVICE PAYMENTS DUE UNDER RECOURSE NOTE AND FAILURE TO PAY LOAN COMMITMENT FEES DUE UNDER THE ADVANCE LOAN COMMITMENT Dear [investor]: Find enclosed a copy of an opinion letter by Rodney J. Waldbaum, attorney for Melvin and Dorothy McCain vs. Commissioner of Internal Revenue Service, Judge Goffe presiding, U.S. Tax Court Seattle, October 28 to November 1, 1985. His opinion letter was prepared after conclusion of this four and half day trial. All of you received a letter from Mr. McCain dated October 21, 1985, asking for your financial support. We are supporting Mr. McCain in his endeavor, and we strongly recommend that you do likewise. The transcript of this case was 935 pages long. From this Court Record we are enclosing pages 813 to 821 inclusive since they show that Judge Goffe ruled that the McCains had proved a Prima Facie case for the deductibility of the loan commitment fee and, 317 therefore, the validity and enforceability of their original ten-year recourse note (ORIGINAL NOTE) involved in the purchase of McCain's master. This ruling was made prior to the IRS putting on its case, which tried to allege that LaSalle Overseas Bank, Ltd. (L.O.B.) had no substance. A final decision on the overall case is not expected for approximately one year. We urge you all to read these nine pages from the Tax Court Record. We have underlined what we consider to be those of significance. They are: -- The names of all ORIGINAL NOTE holders are known to IRS (page 813). -- IRS knows that L.O.B. has not been paid either debt service or loan commitment fees (page 814). -- ORIGINAL NOTE holders felt that they were fully at recourse on the debt (page 816). -- IRS knows, and is watching to see if L.O.B. will enforce and collect its notes (pages 818, 819, 820). -- McCains made a Prima Facie case that their loan commitment fee was deductible and, with regard to L.O.B., the McCains made a Prima Facie showing with the case they put on (page 821). By reference to the letter from L.O.B. dated June 27, 1985, L.O.B. offered to refinance your ORIGINAL NOTE as of December 31, 1985, provided318 that makers reduce their ORIGINAL NOTE by making a principal payment in the amount stated therein, and below, as well as executing a new ten-year recourse note (RENEWAL NOTE), dated January 1, 1986, which also was sent to you with that letter. Upon receipt of your check, dated not later than December 31, 1985, and newly executed RENEWAL NOTE, L.O.B. will return your ORIGINAL NOTE to you, stamped "paid by renewal", thereby permitting the maker to pay off the RENEWAL NOTE using either "U.S. dollars" or "basket of currencies" options. See RENEWAL NOTE dated January 1, 1986, sent to you June 27, 1985. Once L.O.B. receives your check and executed RENEWAL NOTE, you, the maker, will pay no further loan commitment fees or debt service to L.O.B. under the advance loan commitment and the ORIGINAL NOTE respectively. For those makers who do not refinance and who remain in default, by not honoring their debt service commitments under the ORIGINAL NOTE, irrespective of whether they have settled with the IRS, be advised that L.O.B. will foreclose on the master effective December 31, 1985. The master owner will then be unable to continue using the master. Assuming that investment tax credit319 and depreciation deductions have been claimed and have not been challenged and disallowed, the master owner will be subject to both investment tax credit and depreciation recapture in 1985 by the taxing authorities, as well as remaining fully liable at maturity for paying L.O.B. the full principal of the ORIGINAL NOTE, plus all accrued interest. If you do not wish to pay the loan commitment fees and the annual debt service for at least five more years, depending upon the maturity of the original note, and if you wish to have both the "U.S. dollars" and "basket of currencies" options available to you now, we most strongly urge you to accept L.O.B.'s "refinance plan", effective December 31, 1985. Please forward your check in the U.S. dollar amount of * * , which is for debt reduction of the ORIGINAL NOTE and, therefore, is not tax deductible. Make your check payable to LaSalle Overseas Bank, Ltd. and mail it, together with an executed copy of your RENEWAL NOTE dated January 1, 1986, to: Clifford M. Johnston, 710 North 34th Street, Seattle, Washington 98103, before December 31, 1985. If you have any questions, call either Cliff Johnston or P. E. (Ted) Goodwin at * . In320 December 1985 or January 1986, Secoy and Low agreed to refinance their obligations with LOB, making payments of $15,221.00 and $2,076.36, respectively. As of trial of this case in May 1986, Weldon had not made any further payments or executed any refinancing documents. As of March 25, 1983, no more than two of the master recordings purportedly purchased by petitioners or their partnerships had been released. First American planned to market cassette tapes, not albums, from the masters at prices of approximately $2.00 or $2.50 per tape and projected the following expenditures of money and release dates for the titles in issue: Money forAlbum NameProductionRelease DateDiana Honey$2,400Aug.-Sept. 1983Lonesome City Kings2,400Oct.-Nov. 1983Thielemans/Svend300Nov.-Dec. 1983Johnny Horton300Nov.-Dec. 1983Ian Matthews300Dec. 1983-Jan. 1984Buddy Rich300Dec. 1983-Jan. 1984Files of First American reflecting expenditures in relation to the recordings in issue reflect only the following expenses: TitleAmountDateToots Thielemans$356Mar. 1982Johnny Horton3,240Oct. 1983-Jan. 1984Buddy Rich91Jan. 1982Diana Honey259Oct. 1982-Sept. 1983Mark Winkler12,944Oct. 1981-Feb. 1983Lonesome City Kings127Nov. 1983Ian Matthews667Sept.-Dec. 1982Hi-Fi Moods for Mallards14,051Mar. 1982-Dec. 1982321 At most a few hundred audio cassette copies of the master recordings in issue were ever produced. After the transactions in question, First American began sending petitioners or their partnerships bi-quarterly statements reporting purported sales performance of the master recordings. In fact, no sales had occurred and the reports merely reflected the accrual of the "guaranteed sales" assured in the sales agency agreements. Neither petitioners nor their partnerships received any cash from the purported sales. Subsequent to the transactions entered into with Jerden, petitioners failed to take any steps necessary to successful marketing of the master recordings, other than minimal inquiries to Goodwin or C. Johnston. None of petitioners made any effort to inform himself of the steps necessary to successful marketing or otherwise to educate themselves about the recording industry. None of petitioners fully understood the documents that he had executed or the financial obligations that he had purportedly undertaken. None of petitioners made any substantial effort to determine if or when the master recordings were placed in service and if or when copies in an amount necessary322 to successful commercial exploitation had been produced. None of them advanced the costs of producing marketable quantities of records or cassettes from their respective master recordings. In December 1982, Dennon sold Jerden to Pathe Discos, Ltd., and appears to have resigned as president and director. Pathe Discos, Ltd., became a United Kingdom corporation on May 1, 1981. Prior to that time Pathe Discos, Ltd., had no separate legal existence. Dennon arranged for the incorporation of Pathe Discos, Ltd., through attorneys in Seattle and London. Pathe Discos, Ltd., was to be owned by a Danish shell company owned by a business associate of Dennon's, David Hubert. At all times relevant to this case, Pathe Discos, Ltd., was under the direct control of Dennon. In January 1983, Dennon sold First American to Dennis A. Herbert and resigned as its president. Herbert, who had been vice president of Jerden and First American, became president of First American. On May 9, 1984, First American filed for bankruptcy. Following the demise of First American, petitioners made no independent efforts to promote or market their master recordings. On their tax returns for the years in issue, 323 petitioners claimed 10 percent investment tax credits and deducted depreciation and loan commitment fees based on their proportionate share in the stated purchase price of the master recordings. OPINION Procedural MattersApproximately a month before the date set for trial of the above cases, petitioners moved for a continuance based upon the pendency in the Ninth Circuit Court of Appeals of two cases, United States of America v. Leland G. Stahl and United States of America v. Ronald W. Matheson, in which the validity of the Sixteenth Amendment to the United States Constitution was challenged. Those motions were denied. At the time the cases were called for trial, petitioners moved to amend their petitions to assert the invalidity of the Sixteenth Amendment as well as an alternative theft loss theory. Amendments were unopposed and allowed as to the theft loss theory. The motions to amend with respect to the questioned validity of the Sixteenth Amendment were denied, however, because, in the Court's view, petitioners' theory was erroneous as a matter of law with respect to the questioned validity of the Sixteenth Amendment. The Court indicated that, in the event324 that the convictions of the defendants in the Stahl and Matheson cases were reversed by the Court of Appeals for the Ninth Circuit, the record in these cases would be reopened. The Court also gave permission to petitioners to argue the correctness of the Court's ruling in their briefs. In their briefs, they assert that the Court erroneously denied the motions to amend because the invalidity of the Sixteenth Amendment would render this Court without jurisdiction. The evidence and argument that petitioners tendered in support of their motions to continue and to amend were the same as those rejected in other cases including United States v. Stahl,792 F.2d 1438">792 F.2d 1438 (9th Cir. 1986), cert. denied U.S. (Jan. 12, 1987). See also United States v. Ferguson,793 F.2d 828">793 F.2d 828 (7th Cir. 1986); United States v. Foster,789 F.2d 457">789 F.2d 457 (7th Cir. 1986); and United States v. Thomas,788 F.2d 1250">788 F.2d 1250 (7th Cir. 1986). The Court sees no reason to reconsider its ruling. The amendments would be futile in view of the now final determination of the Court of Appeals for the Ninth Circuit in United States v. Stahl,supra.325 See Klamath-Lake Pharm. Assn. v. Klamath Med. Serv. Bureau,701 F.2d 1276">701 F.2d 1276, 1293 (9th Cir. 1983). McCain v. Commissioner, T.C. Memo. 1987-285The parties in these cases have incorporated in haec verba the entire record, including the briefs, in the case of McCain v. Commissioner,T.C. Memo. 1987-285. 6 We here incorporate by reference and adopt the reasoning in McCain, filed today. Specifically, as in McCain, we conclude that the Jerden master recording transactions contain all of the elements of generic tax shelters as identified in Rose v. Commissioner,88 T.C. 386">88 T.C. 386, 412 (1987), as follows: (1) Tax benefits were the focus of promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued in relation to tangible property included as part of the package; (4) the tangible assets were acquired or created at a relatively small cost shortly prior to the transactions in question; and (5) the bulk of the consideration was deferred by promissory326 notes, nonrecourse in form or in substance. * * * We, therefore, apply a unified approach emphasizing objective factors and, for the reasons set forth below, conclude that petitioners are not entitled to the investment tax credits claimed or to any deductions in relation to their transactions with Jerden Industries, Inc., and related entities. 327 The Dealings Between Petitioners and Jerden, First American, Et Al.Petitioners argue that Secoy, for himself, and Low, for Ridgewood Associates, did the best that they could to monitor their investment in master recordings in view of their limited background and limited time to spend on this activity. Low testified that he browsed through Billboard magazine on "a couple of occasions," and he knew some musicians when he was in high school. Petitioner Weldon, admitting total ignorance of the record industry, asserts that he was entitled to rely on the general partners of Emerald Isle, F. Johnston, and Watts. Petitioners assert that they should be held to a lesser standard than other individuals, such as McCain, because they were not sophisticated. This argument would put a premium on gullibility. In any event, it is inconsistent with the concepts set forth in regulations promulgated under section 183, which expressly direct consideration of the expertise of the taxpayer or his advisors (section 1.183-2(b)(2), Income Tax Regs.) and the time and effort expended by the taxpayer in carrying on the activity (section 1.183-2(b)(3), Income Tax Regs.) as factors in determining328 whether an activity is engaged in for profit. The promotional materials received by petitioners from C. Johnston and Goodwin focused almost exclusively on tax benefits. Except for Weldon's conversations with his accountant concerning the purported tax benefits, they did not consult anyone with tax expertise. Although Secoy and Low were aware of ongoing IRS challenges to Jerden promotions, they ignored all warning signs, including the "Tax Risks" listed in the promotional materials. They now claim that successful marketing was prevented by IRS investigations; this contention would be laughable were it not so perverse. At no time did petitioners seek the advice of any independent person familiar with the music or record industry about the merits of purchasing a master recording. They did not receive appraisals of the master recordings before agreeing to pay the alleged purchase price. The evidence is inconclusive as to whether they sought or received projections of potential sales of the number of copies to be produced from the master recordings. They have not produced or described in detail any such projections. If, however, they received the projections received by McCain, the329 assumed sales were totally unrealistic and patently unreasonable. As petitioners affirmatively assert, they engaged in no price negotiation and agreed to pay whatever Jerden had set as the price for a master. None of them even listened to the recordings before agreeing to the purchase transactions. The choice among different prices set by Jerden appears to have been made on the basis of the tax benefits sought rather than on any evaluation of the master. 7 There is no evidence that any of petitioners or their partnerships ever advanced any money to First American to produce any copies of the master recordings. There were certainly no efforts to produce the number of copies necessary to return the cash payments, much less to pay off any part of the long-term debt. 330 Petitioners have produced no evidence that Jerden had title to any of the master recordings in issue. As to some of the masters, Jerden documents purporting to show ownership were produced. Those documents are internally inconsistent, impeached by other documents and patently unreliable. Respondent has shown that four or five of the masters were the subject of licenses or sublicenses to First American from third parties. Petitioners now concede that "Jerden may have had only a license, rather than full title to petitioners' masters when it sold the masters to petitioners," but they assert that petitioners could rely on Jerden's warranty that it was conveying full title to petitioners. Minimal inquiry would have disclosed the absence of title in Jerden, and the purported size of the transactions certainly justified minimal inquiry. Again, petitioners' stance was one of indifference. Giving them the benefit of doubt as to their good faith, "in their haste to obtain tax deductions, taxpayers have put their common sense behind them and have become easy targets for tax shelter charlatans." Saviano v. Commissioner,765 F.2d 643">765 F.2d 643, 654 (7th Cir. 1985), affg. 80 T.C. 955">80 T.C. 955 (1983).331 Although they claim they were in telephone contact with Goodwin, C. Johnston, Dennon, and other persons from time to time concerning their investment, petitioners have not documented any specific inquiries or shown any reasonable effort to assure the profits that they purportedly anticipated. Their purported telephone contacts are far less than the post-acquisition activities engaged in by the taxpayers in Rose v. Commissioner,supra. We are not persuaded that petitioners were any less indifferent to the marketing success of the assets they purportedly acquired than the taxpayers who failed to secure tax benefits in Estate of Baron v. Commissioner,83 T.C. 542">83 T.C. 542 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986), and other master recording cases. 8 See also Beck v. Commissioner,85 T.C. 557">85 T.C. 557, 573-574 (1985). These are certainly cases where "greater weight is given to objective facts than to the taxpayer's mere statement of his intent." Section 1.183-2(a), Income Tax Regs.332 Weldon claims reliance on the "expertise" of F. Johnston and Watts, the general partners of Emerald Isle. F. Johnston was merely a tax shelter salesman whose main sales pitch emphasized, according to his testimony, that the "recourse" financing of the transactions "makes or preserves the integrity of the tax structure." He testified that he read or was familiar with music industry publications, i.e., he read Billboard magazine "once or twice" in 1981 and 1982. In Watts v. Commissioner,T.C. Memo. 1985-531, we concluded that Watts' master recording activities were directed only at hoped for tax benefits. Petitioners try to avoid that characterization by asserting that Watts subsequently developed experience in the music industry. The experience they rely upon, however, consists of purported talent scouting by Watts among various bars and taverns in the Seattle area. Although they had each invested in master recordings on other occasions, none of petitioners or Watts ever showed significant gross receipts from sales of records or cassettes, much less profit. See section 1.183-2(b)(5) (the success of the taxpayer in carrying on other similar or dissimilar333 activities), (6) (the taxpayer's history of income or losses with respect to the activity) and (7) (the amount of occasional profits, if any, which are earned), Income Tax Regs. None of petitioners or their partners have shown that their interest in the music industry extended beyond "elements of personal pleasure or recreation." Section 1.183-2(b)(9), Income Tax Regs. In summary, petitioners were totally unbusinesslike in the manner in which they carried on the activities. Section 1.183-2(b), Income Tax Regs.We acknowledge that Dennon and First American were, at least in part, engaged in the music business. The more profitable aspect of their business, however, was tax shelter promotion. Our conclusion as to his activities is that they were just as described in the March 1982 newspaper article quoted above in our findings (p. 12, supra), i.e., "nobody really cares what happens to the records." See also Beck v. Commissioner,85 T.C. at 579-580. The dealings between petitioners, on the one hand, and Jerden and its related entities, on the other, can be explained only in terms of anticipated tax benefits and not as any indication of economic substance. 334 Relationship Between Fair Market Value and Purchase PricePetitioners presented no evidence of fair market value of the subject masters. Respondent's experts, Thomas L. Bonetti and John F. Wiedenmann, appraised the master recordings in issue here as follows: TitlePriceFair Market ValueToots Thielemans$452,000$2,000 (Wiedenmann)500 (Bonetti)Johnny Horton533,0007,500 (Wiedenmann)1,000 (Bonetti)Buddy Rich533,0006,000 (Bonetti)Diana Honey533,0005,000 (Wiedenmann)Ian Matthews533,0005,000 (Wiedenmann)Lonesome City Kings533,0005,000 (Wiedenmann)Mark Winkler533,0005,000 (Wiedenmann)Hi-Fi533,0005,000 (Wiedenmann)Master recordings in which petitioners had invested in other transactions and in other years, with alleged purchase prices ranging from $850,000 to $1,225,900, were appraised by respondent's experts as having values ranging from $500 to $15,000. Petitioners testified that they received sales projections verbally or in writings that they did not retain. They also received purported appraisals after they entered into the transactions. The lack335 of reliability of projections and appraisals provided by Jerden and its sales representatives is fully discussed in McCain, and we see no reason to repeat that analysis when there is no such evidence specifically related to the masters in issue here. There is no factual support for the large values claimed by petitioners. We can only conclude from the evidence that the actual fair market values of the master recordings in issue did not exceed the amounts determined by respondent's experts as set forth above. The only reasonable inference from the evidence is that the cash required of petitioners was paid with the expectation that it would be more than recouped by a 10 percent investment tax credit and depreciation deductions to be claimed for the year of the transactions. For the reasons discussed below, we do not believe that petitioners ever intended to pay the face amount of the long-term notes. We do not, therefore, give the agreed "purchase price" any weight as evidence of fair market value. See Rose v. Commissioner,supra at 418. Compare Taube v. Commissioner,88 T.C. 464">88 T.C. 464, 487-488 (1987). Structure of the FinancingThe336 gimmickry involved in the "basket of currency" option is fully explained in McCain, and we incorporate and adopt that discussion in full. In summary, no payments were anticipated that would in reality be more than a small fraction of the face value of the notes. Petitioners here affirmatively assert that they expected to profit by paying off the notes in devalued currencies, thereby confirming the lack of reality to the face amount of the notes. They argue that they would pay tax on the gains realized on extinguishment of the debt. If correct, later consequences are irrelevant in the context of deductions and tax credits available only if the face amount of the notes reflects a certain (i.e., noncontingent) liability as of the date of the transaction. See Waddell v. Commissioner,86 T.C. 848">86 T.C. 848, 901-903 (1986), on appeal (9th Cir., Jan. 20, 1987), and cases there cited. Although the notes were labeled "recourse," LOB obtained no information about the assets of petitioners available to satisfy the alleged liability. The demands for payment and offers of refinancing were patently designed and expressly offered to provide "paid" notes to bolster the tax claims337 of the parties. The notes represented a flimsy attempt to overcome changes in the tax law with respect to determinations of amounts "at risk" and to overcome challenges that had arisen in tax shelter arrangements using nonrecourse financing. We conclude that the long-term notes were illusory and that the transactions as a whole lacked economic substance. There is no evidence or reason to believe that Congress intended to confer tax benefits on activities of the sort engaged in by petitioners. See McCain at 49-50. Thus the transactions do not give rise to the deductions for depreciation or "loan commitment fees" or to the investment tax credits claimed by petitioners. 9Theft Loss Deduction Under Section 165As in McCain, petitioners contend that, if we disallow the deductions and credits that they claim, they are entitled to deductions under section 165(c)(3) for theft losses to the338 extent of their cash investment. Again we incorporate and adopt the discussion in McCain. See West v. Commissioner,88 T.C. 152">88 T.C. 152 (1987). Petitioners have not shown that they suffered a theft. They purchased a package of purported tax benefits with the attendant risks set forth in the materials. They took those risks voluntarily and must now bear the consequences. Moreover, none of petitioners who testified at trial knew whether or not they had suffered a theft loss. On brief they contend that they cannot discover such a loss "until there is a judicial determination of title to the masters." It is thus apparent that petitioners cannot claim a theft loss during the years in issue in these cases, in that they do not even claim to have discovered the loss during those years. See section 1.165-8(a)(2), Income Tax Regs.10339 Additions to Tax Under Section 6659Because we have found that the transactions between petitioners and Jerden lacked economic substance, they cannot be recognized for tax purposes. Thus petitioners have no adjusted basis for purposes of depreciation or investment tax credit. See McCain v. Commissioner,supra; see also Rose v. Commissioner,supra;Zirker v. Commissioner,87 T.C. 970">87 T.C. 970, 979-980 (1986). Under section 6659(c) a valuation overstatement occurs if the adjusted basis of any property claimed on any return is 150 percent or more of the amount determined to be the correct amount of such adjusted basis. Here the values claimed on the tax returns, based on the exaggerated purchase prices claimed, far exceeded 250 percent of the correct basis, which is zero. Thus an addition to tax equal to 30 percent of the underpayment attributable to the valuation overstatement is appropriate. Section 6659(a) and (b). Petitioners here, as in McCain, argue that the "section 6659(e) waiver should apply for each petitioner." 11 That section, however, provides for a waiver by "the Secretary" and not for a determination340 by the Court. Assuming that such waiver would be an exercise of discretion subject to review by the Court, we would find no abuse of discretion in these cases. As indicated above, petitioners did not even see appraisals before they agreed to the prices demanded by Jerden. We see no reasonable basis for the adjusted basis claimed on petitioners' returns, and we doubt that those claims were made in good faith. Additional Interest Under Section 6621(c) [Formerly Section 6621(d)]As in McCain, we conclude that section 6621(c) applies to the underpayments in issue to the extent that they exceed $1,000 and are (1) investment tax credits or depreciation deductions resulting from a valuation overstatement or (2) loan commitment fees or other deductions arising from a tax-motivated transaction. See section 6621(c)(2) and (3)(A)(i) and (B) and section341 301.6621-2T, A-4(1) and (2), Proced. & Admin. Regs. (Temp.), 49 Fed. Reg. 59394 (Dec. 28, 1984). See also Rose v. Commissioner,supra.Additions to Tax Under Section 6653(a)It is not necessary to repeat here in full the analysis of petitioners' dealings with Jerden, set forth above in determining that the transactions in issue lacked economic substance, to conclude that the deficiencies attributable to the master recordings are due to negligence or to intentional disregard of rules and regulations. None of petitioners reasonably relied on anyone as to (1) whether he acquired sufficient interest in a master recording to claim depreciation or investment tax credit; (2) whether the master was placed in service during the year; (3) what the correct basis of the master was for tax purposes; or (4) how the transaction should be treated on his tax returns. Moreover, they all ignored the "Tax Risks" set forth in the promotional materials; Secoy and Low also ignored questions that had been raised during IRS investigations of their prior years' returns and/or Jerden. The additions to tax under section 6653(a) are fully justified. Other Observations342 Petitioners repeatedly assert that their masters were placed in service during the years in which they claimed investment tax credits and depreciation deductions. They have not, however, cited any evidence in support of those assertions. The files of First American reflect that, as of March 25, 1983, six of the master recordings in issue had not been released. No significant number of copies of the masters were ever produced. In our determination that the transactions lacked economic substance, we have taken into account the failure of petitioners to confirm the status of their recordings at any particular time. Our determination responds to arguments of the parties and disposes of all issues. It is apparent, however, that petitioners have not proven the prerequisites to investment tax credits or depreciation deductions. See sections 38(a), 46(a)(1), 46(a)(2), 46(c)(1); sections 1.46-3(a)(1), 1.167(a)-10(b), 1.167(a)-11(e)(1)(i), Income Tax Regs. See also Rockwell v. Commissioner,512 F.2d 882">512 F.2d 882 (9th Cir. 1975), affg. a Memorandum Opinion of this Court, and Rule 142(a), Tax Court Rules of Practice and Procedure.We here repeat our warning in McCain and343 in the cases there cited (slip opinion at pp. 58-60), that repetitious proceedings of this nature justify an award of damages under section 6673. Specifically with respect to taxpayers' claims of invalidity of the Sixteenth Amendment, damages were affirmed and additional sanctions were awarded in Pollard v. Commissioner,816 F.2d 603">816 F.2d 603 (11th Cir. 1987), affg. an unpublished order of this Court. Taxpayers similarly situated are thus on notice of the increasing likelihood of awards of damages in appropriate cases. Decision will be entered for the respondent in docket No. 7825-85.12Decisions will be entered under Rule 155 in docket Nos. 5280-85, 13512-85, and 13513-85.Footnotes1. Cases of the following petitioners are consolidated herewith: Patrick E. Saty and Regina M. Saty, docket No. 7443-85; Patrick M. Low and Pamela L. Low, docket No. 7825-85; Ronald A. Weldon, docket No. 13512-85; and Ronald A. Weldon and Carol M. Weldon, docket No. 13513-85.↩2. Unless otherwise specified, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue. plus an amount to be determined (i.e., 50 percent of the interest due on the underpayment attributable to negligence) under section 6653(a)(2).↩3. Subsec. (d) of sec. 6621 was redesignated subsec. (c) and amended by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744. We use the reference to the Internal Revenue Code as redesignated and amended.↩4. See Watts v. Commissioner,T.C. Memo. 1985-531↩.5. Respondent contends, and we conclude, that petitioners did not acquire valid title to the master recordings. For convenience, however, in this opinion we sometimes refer to the recordings as if they belonged to petitioners.↩6. The proposed findings of fact in respondent's 260-page opening brief repeat for no apparent reason findings material only to the McCain case and are in substantial part recitals of evidence ("Exhibit is ," "[the witness] testified * * *,") in this case, the McCain case, and Watts v. Commissioner,T.C. Memo. 1985-531. See Rule 151(e)(3), Tax Court Rules of Practice and Procedure. Notwithstanding our disagreement with the facts as stated in petitioners' proposed findings, we appreciate the effort to dedicate their brief to evidence different from that in McCain,↩ to organize their proposed findings in logical, chronological, order and limit them to material facts, and to respond to the Court's comments at the close of the trial. Partly as a result of dealing with the briefs in these cases, the Court anticipates setting limits on the number of pages in briefs in future comparable cases.7. Secoy testified at trial as follows: Q. Did you audition the Toots Thielemans recording before you decided to purchase it? A. No, I didn't. I received a demo, or whatever they call them, tape, soon afterwards and -- Q. A reference cassette? A. It was a cassette that I received. Q. How long after the purchase did you receive that? A. It was shortly. I can't tell you. It had -- it didn't have Side A or Side B. I notice that it played for about 38 minutes, so I was interested the other day, when I saw the finished cassette, to note that they had deleted two of the songs. Because of space requirements on Side A and Side B, they had to pull about three minutes of each -- pulled out six minutes off the recording. Q. Did they pull complete songs off or portions? A. Yes, they pulled two complete songs. Q. Were you familiar with any of the other selections, the identities of the artists, of the other selections that you were offered? A. I really didn't spend any time looking at them. I'll be honest with you. It was sort of an -- I saw what I liked and I liked what I saw, and I just said hey, fine, this is it.↩8. Flowers v. Commissioner,80 T.C. 914">80 T.C. 914 (1983); Hawkins v. Commissioner,T.C. Memo. 1987-233; Harmon v. Commissioner,T.C. Memo 1986-305">T.C. Memo. 1986-305; Grace v. Commissioner,T.C. Memo 1986-304">T.C. Memo. 1986-304; Seely v. Commissioner,T.C. Memo 1986-216">T.C. Memo. 1986-216; Holland v. Commissioner,T.C. Memo. 1985-626, on appeal (9th Cir., July 18, 1986); Watts v. Commissioner,T.C. Memo. 1985-531; Gessler v. Commissioner,T.C. Memo. 1985-390; Looney v. Commissioner,T.C. Memo. 1985-326, affd. without published opinion 810 F.2d 205">810 F.2d 205 (9th Cir. 1987); Call v. Commissioner,T.C. Memo. 1985-318; Cronin v. Commissioner,T.C. Memo. 1985-83; Snyder v. Commissioner,T.C. Memo. 1985-9; and Kovacevich v. Commissioner,T.C. Memo. 1986-513↩.9. Under Rose v. Commissioner,88 T.C. 386">88 T.C. 386↩ (1987), petitioners would be entitled to deduct any interest actually paid on the short-term notes given as part of their respective down payments. So far as we can tell, however, such interest is not in issue here.10. Sec. 1.165-8(a)(2), Income Tax Regs., provides as follows: (2) A loss arising from theft shall be treated under section 165(a) as sustained during the taxable year in which the taxpayer discovers the loss. See section 165(e). Thus, a theft loss is not deductible under section 165(a) for the taxable year in which the theft actually occurs unless that is also the year in which the taxpayer discovers the loss. However, if in the year of discovery there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, see paragraph (d) of section 1.165-1.↩11. Sec. 6659(e) provides as follows: (e) Authority to Waive. -- The Secretary may waive all or any part of the addition to the tax provided by this section on a showing by the taxpayer that there was a reasonable basis for the valuation or adjusted basis claimed on the return and that such claim was made in good faith.↩12. Petitioners Saty in docket No. 7443-85 have agreed to be bound by our findings with respect to petitioners Low, and the parties stipulated that the decision in docket No. 7443-85 will be submitted when the decision in docket No. 7825-85 becomes final within the meaning of sec. 7481.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623252/	STEVEN J. AND CATHERINE M. CANNATA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCannata v. CommissionerDocket No. 2749-89United States Tax CourtT.C. Memo 1990-502; 1990 Tax Ct. Memo LEXIS 555; 60 T.C.M. (CCH) 839; T.C.M. (RIA) 90502; September 24, 1990, Filed 555 Decision will be entered under Rule 155. Steven J. and Catherine M. Cannata, pro se. Robert W. Towler, for the respondent. PARR, Judge. PARRMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in and additions to petitioners' joint Federal income tax as follows: Additions to taxYearDeficiencySec. 6651(a)(1)Sec. 6653(a)(1)Sec. 6653(a)(2) Sec. 66611984$ 3,312-0-$ 166 -0-1985$ 25,550$ 6,388$ 3,719*$ 6,388 Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for the years in issue. In an amendment to his answer, respondent increased the addition to tax under section 6651(a)(1) for 1985 by $ 12,208 pursuant to section 6214(a). The increase557 results from respondent's initial miscalculation of the addition. Respondent concedes that petitioners are entitled to deduct $ 7,129 of the $ 17,497 they claimed as "other interest" on their 1984 return, and $ 9,990 of the $ 22,708 they claimed on their 1985 return. Moreover, the parties have agreed to be bound by Fink v. Commissioner, 1 docket No. 21099-86, once it becomes final in accordance with section 7481, on whether petitioners are entitled to deduct the excess "other interest" for taxable years 1984 and 1985. The decision in Fink has not been entered as of the filing date of this opinion. Respondent also concedes that petitioners are not liable for any addition to tax under section 6653(a)(1) and (a)(2) for taxable years 1984558 and 1985, and section 6661 for taxable year 1985. Moreover, he concedes that they are entitled to use income averaging in taxable year 1985. After concessions, the issues for decision are (1) whether petitioners are liable for the addition to tax under section 6651(a)(1) for 1985, and (2) if so, whether the tax reported on their return filed on October 14, 1986, reduces the amount on which the addition to tax is calculated. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulations of fact and accompanying exhibits are incorporated herein. Petitioners resided in San Francisco, Calif., at the time they filed their petition in this case. Unless otherwise indicated, all references to petitioner refer to Steven J. Cannata. Petitioner is an attorney whose practice focuses on antitrust matters. Petitioner neither gives tax advice, nor does he hold himself out as a tax specialist. Moreover, he took only one tax course in law school. Petitioner Catherine M. Cannata is a homemaker, and has taught elementary school. Petitioners had little knowledge or understanding of the tax laws, and therefore hired Dennis DiRicco (Mr. DiRicco) to advise559 them on all their tax matters, and to prepare their individual tax returns. At all relevant times, Mr. DiRicco was an attorney who specialized in tax law. Mr. DiRicco required all his clients to maintain their tax information by placing all potential tax items in folders labeled by categories, such as interest, business vs. personal deductions, and income. Petitioners always complied with this tax information filing system. In February of the subsequent tax year, Mr. DiRicco's office would set up appointments for his tax clients, or instruct them to send all their tax information to the office by March 15. Petitioners always sent their tax information to Mr. DiRicco's office by the end of March. Mr. DiRicco prepared petitioners' tax returns for taxable years 1977 through 1988. Additionally, he prepared any extensions, personally determined whether petitioners needed to pay any estimated tax with the extensions, and advised petitioners accordingly. Mr. DiRicco knew that petitioners relied on and followed his advice on all their tax matters. Between 1980 and 1984 petitioner was one of the attorneys involved in an antitrust litigation suit conducted in Stockton, Calif. However, 560 due to a fee dispute with another attorney, petitioner did not receive his portion of the contingent fee, $ 195,825.90, until 1985. In January or February of 1986 petitioner received a Form 1099-MISC (1099-MISC) reflecting the $ 195,825.90 payment. Petitioner placed the 1099-MISC in the appropriate tax folder. In March 1986 petitioner forwarded the folder containing the 1099s, including the 1099-MISC, along with all the other folders containing their tax information, to Mr. DiRicco's office. Mr. DiRicco's office received petitioners' tax information before April 5, 1986. In or around June 1, 1985, petitioner and two other individuals, Lawrence Papale (Mr. Papale) and Judy Genovese, formed a law partnership named Cannata Genovese & Papale. The partnership's information return for 1985 was to be prepared by Mr. Papale's accountant, rather than by Mr. DiRicco. Sometime before April 15, 1986, Mr. DiRicco spoke with Mr. Papale and was informed that the partnership would have substantial write-offs and investment tax credits. He also learned that petitioner's Form 1065, Schedule K-1, for 1985 would not be available until after April 15, 1986. Accordingly, Mr. DiRicco planned to561 file a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, on behalf of petitioners for their 1985 taxable year. To determine whether petitioners would have to pay any taxes with the extension, Mr. DiRicco had his personal secretary remove and read aloud the tax information contained in petitioners' folders, as he wrote down the numbers. Then he added and subtracted the figures to determine taxable income and self-employment income. Somehow, however, Mr. DiRicco missed the 1099-MISC, i.e., $ 195,825.90, when he calculated petitioners' 1985 estimated tax liability. Although Mr. DiRicco knew in April 1986 that the antitrust case had been settled, he was not personally aware that petitioner's contingent fee dispute had been settled, or that petitioner had actually received any of the contingent fees in 1985. Furthermore, Mr. DiRicco personally did not look in petitioners' tax folders before he filed the automatic extension. Thus he was not aware that the Form 1099-MISC was missing from his calculation. Taking into account Mr. Papale's estimated tax picture of the partnership, Mr. DiRicco determined petitioners' 1985 estimated tax liability562 was zero. Sometime before the automatic extension was filed, petitioner called Mr. DiRicco's office to inquire what amount of tax had to be paid with the extension. Mr. DiRicco's secretary told petitioner that no tax was due. Petitioner questioned that, but after the secretary verified that information with Mr. DiRicco, she again informed petitioner that there was no taxable income, and that if there was it would be a nominal self-employment tax, and maybe a couple of dollars of penalties. Petitioner, knowing that Mr. Di Ricco had spoken with Mr. Papale regarding the partnership tax situation, accepted Mr. DiRicco's determination that he did not have to pay any tax with the extension. Petitioner was not aware that Mr. DiRicco had not considered the $ 195,825.90 in estimating the tax liability. On or about April 5, 1986, Mr. DiRicco filed the automatic extension reporting the "zero" estimated tax liability, but in accordance with standard office procedure, he did not provide petitioners with a copy of the extension. On August 15, 1986, Mr. DiRicco filed on behalf of petitioners, a Form 2688, Application for Extension of Time to File U.S. Individual Income Tax Return, until563 October 15, 1986. The second extension was approved by the Director of the Fresno Service Center. In late September 1986 Mr. DiRicco began preparing petitioners' 1985 tax return even though he had not received the K-1 from petitioner's law partnership. As he was thumbing through the folders he came across the 1099-MISC which he had never seen before. He contacted petitioner immediately and asked him what the money represented. Petitioner informed him it was his portion of the contingent fee from the 1984 settlement of the antitrust case. On or around October 1, 1986, petitioner sent Mr. DiRicco's law office his K-1 law partnership form. The K-1 reported income of $ 7,500 and no more than $ 1,824 of investment tax credits from the partnership. In early October 1986 petitioners were outside of the United States. Therefore, Mr. DiRicco prepared and signed petitioners' joint individual Federal income tax return for calendar year ending December 31, 1985, as preparer and on behalf of petitioners under a power of attorney. On October 14, 1986, he filed the return with the Internal Revenue Service Center at Fresno, Calif. The return reported a tax due of $ 48,838. Petitioners564 did not, however, pay the tax until March 25, 1987. Accordingly, respondent assessed a $ 3,418.31 addition to tax for failure to pay, which petitioners paid on March 25, 1987. The addition for failure to pay is not in issue. OPINION The first issue for decision is whether petitioners failed to timely file their 1985 tax return without reasonable cause. See sec. 6651(a)(1).2 The resolution of this issue turns on whether petitioners "properly estimated" their tax liability on the automatic extension. See sec. 1.6081-4(a)(4), Income Tax Regs.If they failed to "properly estimate" their tax liability, then the automatic extension (and the second extension) is invalid, and their return was untimely. Crocker v. Commissioner, 92 T.C. 899 (1989). 565 Pursuant to the authority granted in section 6081(a), the Secretary promulgated section 1.6081-4, Income Tax Regs., which provides that an automatic four-month extension shall be granted if the taxpayer (1) files a signed Form 4868, "Application for Automatic Extension of Time to File U.S. Individual Income Tax Return," sec. 1.6081-4(a)(2), Income Tax Regs.; (2) files the application with the appropriate internal revenue officer on or before the due date prescribed for filing the taxpayer's return, sec. 1.6081-4(a)(3), Income Tax Regs.; and (3) shows the full amount properly estimated as tax for such taxpayer for such taxable year, and fully remits with the application the amount of tax properly estimated which is unpaid as of the date prescribed for the filing of the return, sec. 1.6081-4(a)(4), Income Tax Regs.Respondent, relying on our decision in Crocker v. Commissioner, supra, contends that the application for automatic extension was invalid and the566 extension received thereon was void ab initio, because petitioners failed to properly estimate their tax liability. In Crocker v. Commissioner, 92 T.C. at 908, we stated: In our view, a taxpayer should be treated as having "properly estimated" his tax liability, within the meaning of section 1.6081-4(a)(4), Income Tax Regs., when he makes a bona fide and reasonable estimate of his tax liability based on the information available to him at the time he makes his request for extension. [Citation omitted]. This requires the taxpayer to judge or determine his tax liability generally, but carefully. * * Based on the foregoing, we find that Mr. DiRicco made a bona fide and reasonable attempt to estimate petitioners' tax liability, based on petitioners' records, even though the Form 1099-MISC was inadvertently overlooked. Accordingly, we conclude that under the particular circumstances of this case petitioners' automatic and the second extensions are valid. Thus, they are not liable for the addition to tax under section 6651(a)(1). 567 To reflect the foregoing, Decision will be entered under Rule 155. Footnotes. 50 percent of the interest due on the entire underpayment.↩*. 50 percent of the interest due on the entire underpayment.↩1. Fink v. Commissioner, docket No. 21099-86, was consolidated with the case of Alexander v. Commissioner, docket No. 15015-86, as well as others. Our opinion in Alexander v. Commissioner, T.C. Memo. 1990-141↩, was filed on March 19, 1990.2. Sec. 6651 provides as follows: (a) Addition to the Tax. -- In the case of failure -- (1) to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), * * 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/4669068/	C-Track E-Filing Nevada Appellate Courts Appellate Case Management System C-Track, the browser based CMS for Appellate Courts Case Search Participant Search	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4537836/	Judiciary \| Opinions Skip to Content Follow us on Twitter Follow us on Facebook Follow us on Youtube General Information General Information Contact Information Pay Traffic Fines Online Scam Alerts Job Opportunities Hawaii Courts Mobile App Jury Service Judiciary Overview Court Administration Business with Judiciary Sealing Court Records News & Reports News & Reports Press Releases Legislative Update Reports In the Media Oral Arguments Media Guidelines Speeches Judicial Financial Disclosure Statements Self-Help Self-Help Court Forms Pay Traffic Fines Online Collections Agency (MSB) Victim Services Request Court Records Traffic Cases Self-Help Centers Protective Orders Mortgage Foreclosure Sealing Court Records Small Claims Regular Claims Divorce Landlord-Tenant Claims Tips on Going to Court Services Services ADA Court Interpreting Language Assistance Law Library Mediation/ADR Children’s Justice Centers Victim Services Volunteer Court Navigators at Maui District Court Volunteer Settlement Master Process Vehicle Tracker Courts Courts Supreme Court Intermediate Court of Appeals Circuit Court District Court Family Court Land and Tax Appeal Courts Administrative Adjudication Commission on Judicial Conduct Judicial Performance Reviews Judicial Selection Commission Judicial Financial Disclosure Statements Legal References Legal References Search Court Records Proposed Rule Changes Supreme Court Various Orders Opinions and Orders Court Rules Internet Resources Community Outreach Community Outreach Courts in the Community Civic Education Volunteer Opportunities Judiciary History Center Divorce Law Seminar Court Tours Special Projects & Events Special Projects & Events Appellate Pro Bono Program Courts in the Community Criminal Pretrial Task Force DWI Court Environmental Court Girls Court Hawaii Courts Mobile App HOPE Probation Kona Judiciary Complex Project Mental Health Court STAE (Steps to Avoid Eviction) Veterans Treatment Court Home For Public Oral Arguments Schedule Contact Information Pay Traffic Fines Online Court Forms Scam Alerts Bar Examination Results Divorce Law Seminar Press Releases Volunteer Volunteer Court Navigators at Maui District Court Child Custody Evaluators Registry Judicial Performance Reviews Judicial Financial Disclosure Statements Feedback Form For Litigants Court Forms Pay Fines Search Court Records Law Library Internet Legal Resources Attorney Information Billingual Attorneys Child Custody Evaluators Registry Feedback Form For Attorneys General Information Civil JEFS Info Page Efiling Bar Application Billingual Attorneys Oral Arguments Jury Instructions Membership Status Continuing Legal Education Hawaii Lawyers’ Fund Hawaii State Bar Association Office of Disciplinary Counsel Child Custody Evaluators Registry Feedback Form For Jurors Jury Service Information Court Information Contact Information Feedback Form For Media Media Guidelines Press Releases Search Court Records Contact Information Opinions and Orders Judicial Performance Reviews Judicial Financial Disclosure Statements Facilities Use Application Language Access Language Assistance Policy Language Access Services List of Interpreters Request a Court Interpreter Sign Language Interpreters Use a Court Interpreter Become a Court Interpreter Contact Information ADA ADA Accommodations Request an Accommodation Sign Language Interpreters Service Animals Contact Information Access to Justice Access to Justice Commission Access to Justice Initiatives Appellate Pro Bono Program Access to Justice Rooms Hawaii Self-Help Interactive Forms Hawaii Legal Services Portal Hawaii Online Pro Bono Judiciary’s 20/20 Vision Small Claims Court Q&A Volunteer Court Navigators at Maui District Court Contact Us Home » Hawaii Appellate Court Opinions and Orders » Opinions COVID-19 & the COURTS: FOR UPDATES, CLICK HERE Opinions For 2009 and older, Case Number link will display content as an html page. PDF link will display a scanned image with file date stamp and judicial signatures. Beginning in 2010, Case Number link will display a scanned image with file date stamp and judicial signatures. ADA link will display an accessible file compatible with online reader devices. Click here to view Opinions and Orders from 1998 to 2009. Date Ct. Case Number Case Name Appealed From Reporter Citation May 28, 2020 ICA CAAP-XX-XXXXXXX [ADA] Honolulu Student Housing One, LLC. v. Gonzalez (Order Dismissing Appeal). District Court, 1st Circuit, Honolulu Division May 28, 2020 ICA CAAP-XX-XXXXXXX [ADA] Quiring v. The Association of Apartment Owners of Papakea (Order Granting May 18, 2020 Motion to Dismiss Appellate Court Case Number CAAP-XX-XXXXXXX for Lack of Appellate Jurisdiction). Circuit Court, 2nd Circuit May 28, 2020 ICA CAAP-XX-XXXXXXX [ADA] Schmidt v. Princekong Inc. et.al. (Order Dismissing Appeal). District Court, 1st Circuit, Honolulu Division May 27, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Enos (Amended Opinion). ICA s.d.o., filed 04/30/2019 [ada], 144 Haw. 375. Application for Writ of Certiorari, filed 08/26/2019. S.Ct. Order Accepting Application for Writ of Certiorari, filed 10/10/2019 [ada]. S.Ct. Opinion, filed 05/27/2020. Circuit Court, 1st Circuit May 27, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Key (Order Rejecting Application for Writ of Certiorari). ICA s.d.o., filed 01/29/2020 [ada], 146 Haw. 118. Application for Writ of Certiorari, filed 03/30/2020. District Court, 1st Circuit, Wahiawa Division May 27, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Enos. ICA s.d.o., filed 04/30/2019 [ada], 144 Haw. 375. Application for Writ of Certiorari, filed 08/26/2019. S.Ct. Order Accepting Application for Writ of Certiorari, filed 10/10/2019 [ada]. S.Ct. Amended Opinion, filed 05/27/2020 [ada]. Circuit Court, 1st Circuit May 26, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Scriven (Order Approving Stipulation for Voluntary Dismissal of the Appeal). Circuit Court, 5th Circuit May 26, 2020 ICA CAAP-XX-XXXXXXX [ADA] Bergmann v. Hawai‘i Residency Programs, Inc. (Order Approving Stipulation to Dismiss Appeal With Prejudice). Circuit Court, 1st Circuit May 26, 2020 ICA CAAP-XX-XXXXXXX [ADA] Cornelio v. State (s.d.o., affirmed). Circuit Court, 2nd Circuit May 26, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Thronas-Kaho‘onei (s.d.o., affirmed). Circuit Court, 5th Circuit May 26, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Liao (s.d.o., affirmed). District Court, 1st Circuit May 22, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] Xu v. Ochiai (Order Denying Petition for Writ of Mandamus). Petition for Writ of Mandamus, filed 05/06/2020. Original Proceeding May 22, 2020 ICA CAAP-XX-XXXXXXX [ADA] DB v. BB (Order Dismissing Appeal for Lack of Appellate Jurisdiction and Dismissing as Moot All Pending Motions in CAAP-XX-XXXXXXX). Family Court, 1st Circuit May 21, 2020 ICA CAAP-XX-XXXXXXX [ADA] Wilmington Trust v. Association of Apartment Owners of Waikoloa Hills Condominium (Order Granting Motion to Dismiss Appeal). Circuit Court, 3rd Circuit May 21, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] Prudential Locations, LLC v. Gagnon (Order Dismissing Application for Writ of Certiorari). Consolidated with CAAP-XX-XXXXXXX. ICA mem. op., filed 04/15/2020 [ada]. Application for Writ of Certiorari, filed 05/15/2020. Circuit Court, 1st Circuit May 21, 2020 ICA CAAP-XX-XXXXXXX [ADA] JZ v. JZ (mem. op., affirmed, vacated and remanded). Family Court, 1st Circuit May 20, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Baker (Order of Correction). ICA s.d.o., filed 04/18/2019 [ada], 144 Haw. 334. Application for Writ of Certiorari, filed 07/24/2019. S.Ct. Order Accepting Application for Writ of Certiorari, filed 08/30/2019 [ada]. S.Ct. Opinion, filed 03/13/2020 [ada]. District Court, 1st Circuit, Honolulu Division May 20, 2020 ICA CAAP-XX-XXXXXXX [ADA] Schmidt v. Schmidt (Order Dismissing Appeal). Family Court, 1st Circuit May 20, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Trubachev (Order Dismissing Appeal). Circuit Court, 3rd Circuit May 20, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Grandinetti (Order Dismissing Appeal for Lack of Appellate Jurisdiction and Dismissing All Pending Motions as Moot). Circuit Court, 3rd Circuit May 20, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Grandinetti (Order Dismissing Appeal for Lack of Appellate Jurisdiction and Dismissing All Pending Motions as Moot). Circuit Court, 3rd Circuit May 20, 2020 ICA CAAP-XX-XXXXXXX [ADA] Grace v. Yett Property Management, LLC (Order Dismissing Appeal). Labor and Industrial Relations Appeals Board May 20, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] Porter v. The Queen’s Medical Center (Order Accepting Application for Writ of Certiorari). ICA Opinion, filed 02/21/2020 [ada]. Motion for Reconsideration, filed 02/27/2020. ICA Order Denying Motion for Reconsideration, filed 03/04/2020. Amended Order Denying Motion for Reconsideration, filed 03/10/2020 [ada]. Application for Writ of Certiorari, filed 03/11/2020. S.Ct. Order Dismissing Application for Writ of Certiorari, filed 03/19/2020 [ada]. Application for Writ of Certiorari, filed 04/13/2020. Labor and Industrial Relations Appeals Board May 20, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] LO v. NO (Order Accepting Application for Writ of Certiorari). ICA mem. op., filed 02/06/2020 [ada]. Application for Writ of Certiorari, filed 04/03/2020. Family Court, 1st Circuit May 19, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] Office of the Public Defender v. Connors (Fifth Interim Order). S.Ct. Interim Order re: Initial Summary Report and Initial Recommendations of the Special Master, filed 04/09/2020 [ada]. Consolidated with SCPW-XX-XXXXXXX. S.Ct. Interim Order, filed 04/15/2020 [ada]. S.Ct. Third Interim Order, filed 04/24/2020 [ada]. Concurrence re: Interim Order [ada]. S.Ct. Fourth Interim Order, filed 05/04/2020 [ada]. Original Proceeding May 19, 2020 ICA CAAP-XX-XXXXXXX [ADA] KG v. AG (Order Dismissing Appeal for Lack of Appellate Jurisdiction). Family Court, 2nd Circuit May 19, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Martin (Order). ICA s.d.o., filed 03/29/2019. ICA Amended s.d.o., filed 03/29/2019 [ada], 144 Haw. 153. Application for Writ of Certiorari, filed 08/07/2019. S.Ct. Order Accepting Application for Writ of Certiorari, filed 09/18/2019 [ada]. S.Ct. Opinion, filed 04/22/2020 [ada]. S.Ct. Order of Correction, filed 04/23/2020 [ada]. Motion for Reconsideration, filed 05/14/2020. Circuit Court, 3rd Circuit May 19, 2020 ICA CAAP-XX-XXXXXXX [ADA] RSM Inc. v. Middleton (Order Dismissing Appeal). District Court, 3rd Circuit, North and South Hilo Division May 19, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] In re Taniguchi Trust (Order Rejecting Application for Writ of Certiorari). ICA s.d.o., filed 02/24/2020 [ada]. Application for Writ of Certiorari, filed 04/07/2020. Circuit Court, 1st Circuit May 19, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Uchima. Opinion by Recktenwald, C. J. Concurring in Part and Dissenting in Part, And Concurring in the Judgment [ada]. Opinion by Nakayama, J., Dissenting From the Judgment [ada]. ICA s.d.o., filed 02/15/2018 [ada], 141 Haw. 396. Application for Writ of Certiorari, filed 05/24/2018. S.Ct. Order Accepting Application for Writ of Certiorari, filed 07/05/2018 [ada]. Dissent by Nakayama, J., with whom Recktenwald, C.J., joins. District Court, 1st Circuit, Honolulu Division May 15, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] In re Lauro (Order Denying Petition for Writ of Mandamus). Petition for Writ of Mandamus, filed 04/30/2020. Original Proceeding May 15, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] HawaiiUSA Federal Credit Union v. Monalim (Order Denying Motion for Partial Reconsideration). ICA s.d.o., filed 05/17/2018 [ada] 142 Haw. 216. Application for Writ of Certiorari filed 09/17/2018. S.Ct. Order Accepting Application for Writ of Certiorari, filed 11/14/2018 [ada]. S.Ct. Opinion, filed 04/30/2020 [ada]. Concurring and Dissenting Opinion by Nakayama, J. in which Recktenwald, C.J., Joins [ada]. Motion for Partial Reconsideration, filed 05/11/2020. Circuit Court, 1st Circuit May 15, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] In re Harshman (Order Denying Petition for Writ of Mandamus). Petition for Writ of Mandamus, filed 04/07/2020. Original Proceeding May 15, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] Young v. Chang (Order Denying Petition for Writ of Prohibition). Petition for Writ of Prohibition, filed 03/23/2020. Original Proceeding May 15, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Gallagher. Dissenting Opinion by Recktenwald, C.J. [ada]. Dissenting Opinion by Nakayama, J. [ada]. ICA s.d.o., filed 12/20/2017 [ada], 141 Haw. 247. Application for Writ of Certiorari, filed 03/01/2018. S.Ct. Order Accepting Application for Writ of Certiorari, filed 04/13/2018 [ada]. Circuit Court, 2nd Circuit May 15, 2020 S.Ct SCOT-XX-XXXXXXX [ADA] Lāna‘ians for Sensible Growth v. Land Use Commission. Dissenting Opinion as to Parts III (E) and IV By Wilson, J.[ada] Opinion Concurring in the Judgment and Dissenting by Recktenwald, C.J., in Which Nakayama, J., Joins.[ada]. Land Use Commission May 15, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] Yamano v. Ochiai (Order Denying “Application for Writ of Prohibition/Mandamus”). “Application for Writ of Prohibition/Mandamus”, filed 05/06/2020. Original Proceeding May 15, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Shaw (mem. op., vacated and remanded). Circuit Court, 1st Circuit May 14, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] Ted’s Wiring Service, Ltd. v. Department of Transportation (Order Rejecting Application for Writ of Certiorari). ICA mem.op., filed 12/26/2019 [ada], 146 Haw. 31. Application for Writ of Certiorari, filed 04/03/2020. Circuit Court, 1st Circuit May 14, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Tavares (Order Dismissing Certiorari Proceeding). ICA mem. op., filed 11/29/2019 [ada], 145 Haw. 299. Application for Writ of Certiorari, filed 01/23/2020. S.Ct. Order Accepting Application for Writ of Certiorari, filed 05/05/2020 [ada]. Circuit Court, 1st Circuit May 13, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] Pennymac Corp. v. Godinez (Order Accepting Application for Writ of Certiorari). ICA s.d.o., filed 12/06/2019 [ada], 145 Haw. 442. Application for Writ of Certiorari, filed 03/11/2020. Circuit Court, 2nd Circuit May 12, 2020 ICA CAAP-XX-XXXXXXX [ADA] Taylor v. Attorneys At Law, Crudele & De Lima (Order Dismissing Appeal for Lack of Appellate Jurisdiction and Dismissing All Pending Motions as Moot). Circuit Court, 3rd Circuit May 11, 2020 S.Ct SCWC-XX-XXXXXXX [ADA] State v. Jaentsch (Order Accepting Application for Writ of Certiorari). ICA s.d.o., filed 12/31/2019 [ada], 146 Haw. 32. Application for Writ of Certiorari, filed 04/01/2020. Family Court, 1st Circuit May 8, 2020 S.Ct SCPW-XX-XXXXXXX [ADA] Austin v. Browning (Order Denying Petition for Writ of Prohibition). Petition for Writ of Mandamus, filed 02/28/2020. Original Proceeding May 8, 2020 ICA CAAP-XX-XXXXXXX [ADA] In re The Estate of Stirling (Order Approving Stipulation to Dismiss Appeal). Circuit Court, 2nd Circuit May 8, 2020 ICA CAAP-XX-XXXXXXX [ADA] Pattioay v. State (Order Dismissing Appeal For Lack Of Appellate Jurisdiction, Dismissing All Pending Motions As Moot, And Directing Circuit Court To Treat Notice Of Appeal As Non-Conforming HRPP Rule 40 (c) (2) Petition For Post-Conviction Relief And Open A Circuit Court Special Proceeding). Circuit Court, 1st Circuit May 8, 2020 ICA CAOT-XX-XXXXXXX [ADA] Purugganan v. State (Order Dismissing Case Number CAOT-XX-XXXXXXX for Lack of Jurisdiction and Dismissing All Pending Motions as Moot). Non-Conforming Petition May 8, 2020 ICA CAAP-XX-XXXXXXX [ADA] Kadomatsu v. County of Kaua‘i (mem. op., affirmed). Circuit Court, 5th Circuit May 7, 2020 S.Ct SCMF-XX-XXXXXXX [ADA] February 2020 Notice of Passing the Hawai‘i Bar Examination. May 6, 2020 ICA CAAP-XX-XXXXXXX [ADA] State v. Jason (Order Granting Motion to Dismiss Appeal). Circuit Court, 3rd Circuit 1 2 3 … 7 Next » Site Search eCourt Kokua* For access to traffic cases; District Court, Circuit Court, and Family Court criminal; District Court and Circuit Court civil; Land Court and Tax Appeal Court; and appellate case information Hoʻohiki For access to Family Court civil case information Jobs Search for jobs at the Judiciary Efiling Case information Placeholder Language Services Language Access Services Home 廣東話 / 广东话 \| Cantonese Kapasen Chuuk \| Chuukese Ilokano \| Ilokano 日本語 \| Japanese 한국어 \| Korean Kosrae \| Kosraean 國語 / 普通话 \| Mandarin Kajin Majôl \| Marshallese Pohnpei \| Pohnpeian Gagana Samoa \| Samoan Español \| Spanish Tagalog \| Tagalog Lea faka-Tonga \| Tongan Tiếng Việt \| Vietnamese for Public Oral Arguments Schedule Contact Information Pay Fines Court Forms Scam Alerts Bar Examination Results Divorce Law Seminar Press Releases Volunteer Volunteer Court Navigators at Maui District Court Child Custody Evaluators Registry Judicial Performance Reviews Judicial Financial Disclosure Statements Feedback Form for Litigants Court Forms Pay Fines Search Court Records Law Library Internet Legal Resources Attorney Information Bilingual Attorneys Child Custody Evaluators Registry Feedback Form for Attorneys General Information Efiling Civil JEFS Info Bar Application Billingual Attorneys Oral Arguments Jury Instructions Membership Status Continuing Legal Education Hawaii Lawyers’ Fund Hawaii State Bar Association Office of Disciplinary Counsel Child Custody Evaluators Registry Feedback Form for Jurors Jury Service Information Court Information Contact Information Feedback Form Language Access Language Assistance Policy Language Access Services List of Interpreters Request a Court Interpreter Sign Language Interpreters Use a Court Interpreter Become a Court Interpreter Contact Information for Media Media Guidelines Press Releases Search Court Records Contact Information Opinions and Orders Judicial Performance Reviews Judicial Financial Disclosure Statements ADA Assistance ADA Accommodations Request an Accommodation Sign Language Interpreters Service Animals Contact Information Access to Justice Access to Justice Commission Access to Justice Initiatives Access to Justice Rooms Hawaii Self-Help Interactive Forms Hawaii Legal Services Portal Hawaii Online Pro Bono Judiciary’s 20/20 Vision Small Claims Court Q&A Volunteer Court Navigators at Maui District Court General Information General Information Contact Information Pay Traffic Fines Online Scam Alerts Job Opportunities Jury Service Judiciary Overview Court Administration Business with Judiciary Sealing Court Records News & Reports Press Releases Legislative Update Reports In the Media Oral Arguments Media Guidelines Speeches Judicial Financial Disclosure Statements Self-Help Court Forms Pay Traffic Fines Online Traffic Cases Request Court Records – Oahu Collection Agency (MSB) Self-Help Centers Victim Services Protective Orders Mortgage Foreclosure Sealing Court Records Small Claims Regular Claims Divorce Landlord-Tenant Claims Tips on Going to Court Services ADA Court Interpreting Language Assistance Law Library Mediation/ADR Children’s Justice Centers Victim Services Volunteer Court Navigators at Maui District Court Volunteer Settlement Master Process Vehicle Tracker Courts Supreme Court Intermediate Court of Appeals Circuit Court District Court Family Court Land and Tax Appeal Courts Administrative Adjudication Commission on Judicial Conduct Judicial Performance Reviews Judicial Selection Commission Judicial Financial Disclosure Statements Legal References Search Court Records Proposed Rules Changes Supreme Court Various Orders Opinions Court Rules Internet Resources Community Outreach Courts in the Community Civics Education Volunteer Opportunities Judiciary History Center Divorce Law Seminar Court Tours Special Projects & Events Appellate Pro Bono Program Courts in the Community Criminal Pretrial Task Force DWI Court Environmental Court Girls Court Hawaii Courts Mobile App HOPE Probation Kona Judiciary Complex Project Mental Health Court STAE (Steps to Avoid Eviction Veterans Treatment Court Contact Us Administrative Offices of the Courts Courts of Appeal Oahu – First Circuit Maui – Second Circuit Hawaii – Third Circuit Kauai – Fifth Circuit District Court Addresses We Value Your Opinion Survey Follow us on Twitter Follow us on Facebook Follow us on Youtube © 2020 Hawaii State Judiciary. All rights reserved. Privacy Policy \| Terms of Use \| Accessibility Information *The Hawaii Judiciary is not affiliated with Sustain Technologies, Inc. or with eCourt, which is a registered trademark of Sustain Technologies, Inc	01-04-2023	05-29-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623303/	ACTIVE LIPID DEVELOPMENT PARTNERS, LTD., NATURAL PHARMACEUTICAL CORPORATION, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentActive Lipid Dev. Partners, Ltd. v. CommissionerDocket No. 30177-88United States Tax CourtT.C. Memo 1991-522; 1991 Tax Ct. Memo LEXIS 571; 62 T.C.M. (CCH) 1046; T.C.M. (RIA) 91522; October 21, 1991, Filed 571 Decision will be entered under Rule 155. Norman S. Kulla, for the petitioner. Jack H. Klinghoffer, for the respondent. PARR, Judge. PARRMEMORANDUM FINDINGS OF FACT AND OPINION Respondent disallowed all of Active Lipid Development Partners, Ltd.'s (Active Lipid or the partnership) expenses for tax year 1983, as follows: Research and Development Expense$ 540,000Amortized Organization Costs200Amortized Start-Up Costs17Total Disallowed Expenses$ 540,217The issues for decision are: (1) Whether the $ 540,000 the partnership paid to a related research and development corporation was in connection with its trade or business within the meaning of section 174; 1 and (2) whether the partnership is entitled to amortize its organizational and start-up costs. FINDINGS OF FACT The stipulation of facts, together with attached exhibits, is incorporated herein by this reference. Active Lipid572 is a California limited partnership whose principal place of business is in the State of California. Scientists at the Weizmann Institute of Science in Rehovot, Israel (Weizmann Institute) invented and initially developed a membrane fluidizer referred to as AL-721. AL-721 appeared to have promise with respect to the effects of senile dementia and withdrawal syndromes from alcohol and opium addiction. In 1981 James M. Jacobson, Jr. (Jacobson) entered into a licensing agreement for AL-721 with Yeda Research and Development Co., Ltd. (Yeda), an Israeli company which engages in the commercial exploitation of scientific developments at the Weizmann Institute. The license agreement required the Weizmann Institute to conduct research for Jacobson, and Jacobson planned to file with the Food and Drug Administration (FDA), arrange for clinical trials, and engage in research and development in the United States. Based on a priority patent filed by the Israelis, Jacobson (with the help of counsel) filed patent applications during 1982 for AL-721 in the United States, Australia, Finland, Norway, Japan, and the European patent countries (designated countries include the United Kingdom, West573 Germany, France, Italy, The Netherlands, Switzerland, Liechtenstein, Sweden, Belgium, and Luxembourg). Jacobson incorporated Natural Pharmaceuticals Corporation, a California Corporation (NPC) on April 13, 1983, as its president, sole officer, and 100 percent stockholder. NPC was created to market AL-721. On May 10, 1983, NPC submitted an Investigational New Drug application (IND) to the FDA in order to obtain permission to begin clinical testing of AL-721 on humans. On July 12, 1983, the FDA requested that NPC provide additional data and postpone clinical testing. On February 13, 1984, NPC filed the requested supplement to its IND. During June of 1984 certain animal studies were conducted. The FDA responded to the supplemental filing on August 24, 1984, and indicated it would agree to the initiation of limited clinical testing in humans upon being provided with the additional information requested and the results of the animal (toxicology) tests. NPC supplied the additional requested information on November 16, 1984. Finally, on February 22, 1985, the FDA approved commencement of toxicology testing of AL-721 in humans. On September 20, 1983, Active Lipid was formed with574 eleven limited partners and NPC acting as its general partner and tax matters partner. Jacobson wanted limited partners who by virtue of their positions outside of the limited partnership could be helpful in the furtherance of the project. Active Lipid was formed to fund the research and development needed to bring AL-721 to market. The September 20, 1983 Confidential Private Placement Memorandum for Active Lipid projected the after-tax position of a 50-percent tax bracket limited partner's investment of $ 100,000 for the first three years as follows: CumulativeNetNetCashTax Savings/After TaxAfter TaxYearInvestment(Cost)Cash InvestmentCash Investment1983$ (35,000)$ 38,800$ 3,800$ 3,8001984(32,500)2,300(30,200)(26,400)1985(32,500)300(32,200)(58,600)In actuality, during tax year 1983 the $ 540,000 research and development deduction on Active Lipid's return resulted in a flow-through loss of $ 76,373 for a limited partner contributing $ 100,000. Accordingly, the actual tax savings for a limited partner in the 50-percent tax bracket who contributed $ 100,000 is $ 38,186.50, which is remarkably close to the $ 38,800 projected575 tax benefits. Jacobson contributed $ 7,100 to Active Lipid on December 22, 1983. All of the limited partners paid their subscriptions timely, in full, as follows: Name ofAmount ofPayment of SubscriptionLtd. PartnerSubscription12/833/841/85N. Becker$ 100,000$ 35,000$ 32,500$ 32,500M. Brittan50,00017,50016,25016,250& V. TaubJ. Coburn100,00035,00032,50032,500B. Goldsmith100,00035,00032,50032,500L. Gonda100,00035,00032,50032,500J. Jacobson25,0008,7508,1258,125R. Katz25,00025,00000J. Shalant100,00035,00032,50032,500Tilles, Webb25,0008,7508,1258,125& KullaJ. Widzer50,00017,50016,25016,250D. Zeh25,0008,7508,1258,125TOTALS:$ 700,000$ 261,250$ 219,375$ 219,375Limited partners who elected to pay the subscription price in installments executed a limited partner's investment note and an assumption agreement subjecting them to personal liability to Mitsui Manufacturers Bank for an amount not to exceed the unpaid balance of their subscription. Active Lipid recorded its certificate of limited partnership on December 22, 1983. On September 21, 1983, NPC created576 a wholly owned subsidiary, Matrix Research Laboratories, Inc., a California corporation (Matrix). Jacobson created Matrix to limit NPC's liability and to keep the marketing (to be carried on by NPC) and research and development (to be carried on by Matrix) separate. During 1983 NPC, Active Lipid, and Matrix were all located in Jacobson's house. Additionally, during 1983 Active Lipid had no employees; Matrix had one employee; NPC employed Jacobson, his brother-in-law, and a few part-time people. On December 22, 1983, Jacobson assigned the Yeda license agreement to NPC. On December 23, 1983, Active Lipid entered into two agreements: A development agreement with NPC and a research and development subcontract with Matrix. The "Development Agreement" and "R & D Subcontract" in pertinent parts provide: DEVELOPMENT AGREEMENT * * * WHEREAS, NPC desires to engage the Partnership to perform, or to supervise the performance of, such clinical trials and research and other developmental activities; * * * 3. Research and Development Services. The Partnership hereby undertakes to perform all clinical trials and research and developmental activities set out in the statement of work577 attached to this Agreement as Exhibit A (hereinafter referred to as the "Initial R&D Activities") and to hire all personnel and provide all services required therefor. * * 4. Royalties or Other Consideration. At any time prior to or upon the completion of the Research and Development Project the Partnership can authorize and instruct NPC to enter into a sublicense agreement with a major pharmaceutical company whereby that pharmaceutical company will be obligated to complete any and all clinical trials and tests necessary to obtain FDA approval, obtain FDA approval, and thereafter manufacture and sell AL within the United States only. In consideration for this sublicense, NPC will receive a royalty or other consideration. In such event the Partnership, as consideration for its services herein, will be entitled to receive twenty percent (20%) of the net royalties or other consideration received by NPC in connection with the sale of the Pharmacological Formulations of AL in the United States. "Net royalties or other consideration" shall mean the gross royalties or other consideration received by NPC from the granting of any such sublicense less the costs of negotiating and578 administering the sublicense and less all royalties or other consideration which NPC is obligated to pay its licensor, Yeda. * * As an alternative to the above, the Partnership can elect to have NPC complete the development process and obtain FDA approval for the sale of Pharmacological Formulations of AL itself, in which case NPC would be required to obtain additional financing. Should the Partnership choose this alternative, then its right to share in the net royalties outlined in the first alternative above shall terminate and, instead, the Partnership or the individual Limited Partners will receive a twelve and one-half (12 1/2%) equity interest in whatever entity is utilized to complete the commercialization of AL. In addition to the foregoing, the Partnership shall also be entitled to receive seven and one-half percent (7 1/2%) of the Net Profits which may be realized by NPC in connection with the sale in the United States of Non-pharmacological Formulations of AL. * * * 8. Ownership of Work Product and Patent Rights. (a) NPC shall have, and the Partnership shall cause to be vested in NPC the full and exclusive right, title and interest in and to: (i) all proprietary579 information and inventions developed, acquired or conceived of, by or on behalf of the Partnership and its subcontractors with respect to the Research and Development Project or otherwise pertaining to AL in performing their obligations under this Agreement; (ii) all physical manifestations or embodiments of such proprietary information and related technical information, including, without limitation, all documents and writings, including clinical and other studies, and all copies thereof developed or made by or on behalf of the Partnership and its subcontractors, including, without limitation, all patent rights, patentable information, patent applications, copyrights, copyright applications, manufacturing information, schematics, specifications, inspection procedures and test procedures; and, (iii) All FDA licenses, approvals and authorizations applied for, including investigational new drug submissions ("IND") and new drug application ("NDA"), and such FDA licenses, approvals and authorizations shall be maintained in the name of NPC. * 12. Technical Assistance. NPC agrees to make available to the Partnership or its designee, at reasonable times and places and on580 reasonable notice, the services of technical personnel to consult with, instruct and assist NPC and/or the Partnership or its designee with respect to the Research Project. 13. Assignment. This Agreement may not be assigned by the Partnership without the prior written consent of NPC. * * EXHIBIT A The Partnership will undertake the following: 1. Prepare and file all necessary documents with the FDA in connection with INDAs for the proposed clinical trials. 2. Prepare and file Drug Master File with FDA for the production of Active Lipid. 3. Cause 200,000 grams of AL to be produced, packaged and labeled for the basic research and clinical trials. 4. Conduct subchronic toxicology studies in two species, if required by FDA. 5. Cause a short-term Phase I trial to be conducted and monitored. 6. Initiate Phase II trials to be conducted and monitored in the proposed indications which have obtained INDs. (See attached list). 7. Meet and liase [sic] with the FDA to expedite the filing processes to whatever degree possible. R&D Co. will use its best efforts to convince FDA to allow Phase II to begin without conducting items #4 and 5. In the event581 this is successful such funds will be applied to continue Phase II clinical trials.R & D SUBCONTRACT* * * WHEREAS, the Partnership desires to engage R & D Corporation to perform, or to supervise the performance of, such clinical research, tests, trials, and other developmental activities; and, * * * 3. Research and Development Services. R & D Corporation hereby undertakes to perform all clinical trials and research and development activities, set out in the statement of work attached to the Agreement as Exhibit A, (hereinafter sometimes referred to as the "Research Project") and to hire all personnel and provide all services required therefor. R & D Corporation shall complete the work set out in Schedule A within 12 months from the date hereof (barring circumstances beyond its control). Further, R&D Corporation hereby agrees to make itself available to perform such additional clinical research tests, trials and research and developmental activities (hereinafter sometimes referred to as the "Additional R&D Activities") that the Partnership may be obligated to conduct pursuant to the Development Agreement, on the same terms and conditions as are provided in this582 Agreement for the performance of the work described on Exhibit A. * * No portion of the fees to be paid to R & D Corporation under Section 4.1 hereof will be refundable. 4. Fees. 4.1 Payments. In consideration for the services to be performed by R & D Corporation hereunder, the Partnership agrees to pay to R & D Corporation a research and development fee in the amount, subject to Section 4.2 hereof, of $ 550,600.00, payable on or before December 23, 1983, for the work described on Exhibit A, and in such amount and at such time or times as may be mutually agreed upon for the Additional R&D Activities. 7. Inspection and Consultation Resorts.(a) R & D Corporation will grant to the Partnership and its designated agents, attorneys and accountants, including such technical consultants as may be engaged by the Partnership from time to time and approved by the Partnership, access at all reasonable times to the premises in which services are being performed hereunder and to books and records maintained by the R & D Corporation pertaining to such services, during all business hours. (b) R & D Corporation will also furnish to the Partnership within 45 days from the end583 of each calendar quarter such periodic progress reports as the Partnership may reasonably require. * * (c) It is understood and agreed that the methods of research and use of equipment and personnel shall be within the sole discretion of R & D Corporation, and the Partnership shall have no right to control or direct any employee of either R & D Corporation or of any subcontractor in the performance of such services. 8. Ownership of Work Product and Patent Rights. (a) NPC shall have, and R & D Corporation shall cause to be vested in NPC the full and exclusive right, title and interest in and to: (i) all proprietary information and inventions developed, acquired or conceived of, by or on behalf of R & D Corporation and its subcontractors with respect to the Research Project or otherwise pertaining to AL in performing their obligations under this Agreement; (ii) all physical manifestations or embodiments of such proprietary information and related technical information, including, without limitation, all documents and writings, including clinical and other studies, and all copies thereof developed or made by or on behalf of R & D Corporation and its subcontractors, including, 584 without limitation, all patent rights, patentable information, patent applications, copyrights, copyright applications, manufacturing information, schematics, specifications, inspection procedures and test procedures; and, (iii) all FDA licenses, approvals and authorizations applied for, including investigational new drug submissions ("IND") and new drug application ("NDA"), and such FDA licenses, approvals and authorizations shall be maintained in NPC's name. * 13. Indemnity. R & D Corporation will indemnify and hold the Partnership and NPC harmless from and against any damage, loss, cost or expense (including reasonable attorneys' fees) arising out of the clinical trials and research performed by or on behalf of R & D Corporation during the term of the Research Project, provided that R & D Corporation has been notified promptly by the Partnership of any claim giving rise to rights of indemnification hereunder R & D Corporation will, at its own expense, defend the Partnership from and against any such claim with counsel reasonably satisfactory to the Partnership; provided, however, that R & D Corporation will permit the Partnership to participate in any such action585 to the extent such participation is reasonable and the Partnership deems it appropriate; and, provided further, that R & D Corporation will not agree to settlement of any such action without the prior written consent of the Partnership, which consent will not be unreasonably withheld. 14. Assignment. This Agreement may not be assigned by R & D Corporation without the prior written consent of the Partnership. * * EXHIBIT A Identical to Exhibit A in the Development Agreement.Besides the execution of the Development Agreement and the R & D Subcontract, Active Lipid also paid Matrix $ 540,000 on December 23, 1983. The $ 540,000 was derived from $ 261,250 worth of Active Lipid's cash subscriptions and $ 278,750 Active Lipid borrowed from Mitsui Manufacturers Bank. The $ 278,750 loan was fully secured by the limited partners' investment notes, standby letters of credit, and assumption agreements. Jacobson considered the $ 540,000 a prepayment which gave Matrix sufficient capital to go forward with the research of AL-721 and to deal with and close various contracts and other matters. Statement 2 attached to Matrix's 1983 tax return (for the period 7/1/83 through586 6/30/84) indicates that on 6/30/84 the liability account entitled "deferred contract income" equaled $ 540,000 and Matrix held $ 300,000 in certificates of deposit. Matrix's total deductions during tax year 1983 are as follows: Compensation of officers$ 21,802Salaries/wages7,200Taxes200Auto1,728Bank service charge18Dues and subscriptions53Misc.918Office supplies and postage2,254TOTAL$ 34,173Jacobson did not plan to take the companies public in 1983; however, in January of 1985 all of the shareholders of NPL and all of the limited partners of Active Lipid exchanged their respective shares and interests for shares of common stock in Praxis, a public company. Praxis received written approval to begin preliminary clinical testing on humans on February 22, 1985. However, in late 1985 or early 1986, Jacobson and the limited partners, now shareholders of Praxis, discussed pursuing the application of AL-721 to viruses, including the AIDS virus. Praxis could not accomplish this goal and became dormant. OPINION The first issue for decision is whether Active Lipid is entitled to a deduction for research and experimental expenditures for 1983. Section587 174(a)(1) allows a taxpayer to currently deduct research and experimental expenditures paid or incurred in connection with the taxpayer's trade or business. A current deduction is also available for expenditures paid or incurred for research or experimentation carried on in a taxpayer's behalf by another person or organization. Sec. 1.174-2(a)(2), Income Tax Regs.Respondent asserts that Active Lipid's expenditure of $ 540,000 under the R & D Subcontract was not "in connection with" a trade or business because there was no realistic probability Active Lipid would ever engage in an active trade or business. Petitioner contends that Active Lipid is entitled to the section 174 deduction because Active Lipid could have been in a trade or business in some form or other with respect to AL-721. In Snow v. Commissioner, 416 U.S. 500">416 U.S. 500, 40 L. Ed. 2d 336">40 L. Ed. 2d 336, 94 S. Ct. 1876">94 S. Ct. 1876 (1974), revg. 482 F.2d 1029">482 F.2d 1029 (6th Cir. 1973), affg. 58 T.C. 585">58 T.C. 585 (1972), the Supreme Court established that a taxpayer did not have to currently be producing or selling a product in order to obtain a section 174(a)(1) deduction for research and experimental expenses. However, the Snow decision did not588 eliminate the section 174 trade or business requirement altogether. The taxpayer "must still be engaged in a trade or business at some time, and we must still determine, through an examination of the facts of each case, whether the taxpayer's activities in connection with a product are sufficiently substantial and regular to constitute a trade or business for purposes of such section [174]." Green v. Commissioner, 83 T.C. 667">83 T.C. 667, 686-687 (1984) (Emphasis in original; fn. ref. and citations omitted). The limited partnership in Green, LaSala, financed the research and development of four inventions, but retained no control over their actual development, production, or marketing. We held LaSala was not conducting research in connection with a trade or business within section 174. LaSala acquired the four inventions and immediately contracted with an unrelated party, NPDC, to develop the inventions in exchange for the exclusive, worldwide right to manufacture, use, and sell the inventions for their patentable lives. After contracting with NPDC, LaSala acted only in a ministerial capacity. We found that LaSala "functioned only as a vehicle for injecting risk589 capital into the development and commercialization of the four inventions. Its activities never surpassed those of an investor. It was not the up-and-coming business which section 174 is intended to promote." Green v. Commissioner, supra at 687 (Emphasis in original). In Levin v. Commissioner, 87 T.C. 698 (1986), affd. 832 F.2d 403">832 F.2d 403 (7th Cir. 1987), we held the limited partnerships, Dispoard and Labless, entered into manufacturing and marketing agreements which in substance "deprived the partnerships of control over the manufacture, use, and sale of the developed machines for virtually the entire lives of the partnerships." 87 T.C. at 726-727. We found that when Dispoard and Labless were organized in 1979, they never intended to engage in trades or businesses at any time in the future, and this conclusion is supported by the limited nature of their activities in the years following. The role of the partnerships was similar to that of a shareholder who contributes money to a corporation. Even though the corporation may engage in research and experimentation in connection with its trade or business, 590 the shareholder is not in the trade or business and is not entitled to a deduction under section 174. See Deputy v. du Pont, supra. The partnerships, like the shareholders, were mere investors. Therefore, because they did not incur research and experimental expenses "in connection with" trades or businesses, Dispoard and Labless are not entitled to deductions for such expenses in 1979. [87 T.C. at 728.]Like the limited partnerships in Green and Levin, Active Lipid's activities indicate that it never surpassed the level of an investor. Jacobson issued a confidential private placement memorandum for Active Lipid on September 20, 1983, which projected a direct tax write-off in excess of the amount of cash invested in 1983 by a taxpayer in the 50 percent tax bracket. Active Lipid recorded its certificate of limited partnership on December 22, 1983, one day before it entered into the Development Agreement and the R & D Subcontract. Both of these agreements, executed a little more than a week before the end of 1983, clearly point out the limited role Active Lipid played in the research and development of AL-721. Petitioner, through Jacobson, 591 argues Active Lipid's role was to fund the AL-721 research and development and to participate in the making of business decisions concerning its development. The Development Agreement sets out the research and development activities Active Lipid was required to perform for NPC. Active Lipid subcontracted out all of its research and development duties under the Development Agreement to Matrix in the R & D Subcontract. Paragraph 7(c) of the R & D Subcontract grants Matrix complete and exclusive control over the research and development. Accordingly, Active Lipid did nothing more than collect and borrow funds which it transferred to Matrix, which carried out and arranged all research and development activities NPC desired with respect to AL-721. In substance, NPC formulated the research and development activities it desired and contracted with Active Lipid, of which it is the sole general partner, to perform these duties. Active Lipid in turn subcontracted everything to NPC's 100-percent owned subsidiary, Matrix. NPC's retention of all work product produced by the fruits of Active Lipid's and Matrix's efforts further evidences the transparency of the claim that Active Lipid was592 engaged in a trade or business. The interrelatedness between Jacobson, NPC, Active Lipid, and Matrix does not change the fact that NPC owns everything with respect to AL-721, except for its obligation to Yeda, and Active Lipid owns nothing. Active Lipid contracted away all of its obligations to Matrix. The performance of at least some of these duties would indicate that Active Lipid could be engaged in a trade or business for purposes of section 174. Active Lipid's only involvement with respect to the development of AL-721 is the right to authorize and instruct NPC to enter into a sublicense agreement with a major pharmaceutical company to complete work on AL-721, or Active Lipid could elect to have NPC complete the research and development process itself. Active Lipid's power with respect to these two options indicates that it had a say in how it would receive either its royalty or equity interest. It is not the type of substantial and regular activities in connection with a product necessary to constitute a trade or business for purposes of section 174. Green v. Commissioner, 83 T.C. 667">83 T.C. 667, 686-687 (1984). Active Lipid functioned only as a passive investment593 vehicle for injecting risk capital into the development and commercialization of AL-721, while providing substantial pass-through tax benefits to its limited partners. Active Lipid was not the up-and-coming business that section 174 is intended to promote. Green v. Commissioner, supra at 687. The next issue we must decide is whether petitioner is entitled to amortize start-up costs of $ 17. Section 195 permits a taxpayer to amortize start-up expenditures under certain circumstances. One requirement for amortizing start-up expenditures is that they must be incurred in connection with an active trade or business. Sec. 195(c)(1)(A). The legislative history of section 195 emphasizes that section 162 controls for purposes of the active trade or business requirement in section 195. S. Rept. 96-1036 (1980), 2 C.B. 723">1980-2 C.B. 723. In Snow, the Supreme Court found the trade or business requirement in section 174 is more lax than section 162. Snow v. Commissioner, 416 U.S. 500">416 U.S. 500, 502-504, 40 L. Ed. 2d 336">40 L. Ed. 2d 336, 94 S. Ct. 1876">94 S. Ct. 1876 (1974). We have already held that Active Lipid was not engaged in a trade or business, but instead functioned merely as a passive investor. 594 Since Active Lipid failed to qualify as a trade or business under the more lax section 174 requirements, Active Lipid falls short of carrying on a trade or business for section 162 purposes. The absence of a trade or business within section 162 prevents Active Lipid from amortizing its start-up costs under section 195. We so hold. The final issue for decision is whether Active Lipid may amortize its organizational fees pursuant to section 709(b). Respondent argues that because Active Lipid was not engaged in a trade or business, it was not entitled to begin amortizing these expenses. A partnership is not required to be in a trade or business in order to begin business for purposes of section 709. Diamond v. Commissioner, 92 T.C. 423">92 T.C. 423, 446 (1989), affd. 930 F.2d 372">930 F.2d 372 (4th Cir. 1991). Section 1.709-2(c), Income Tax Regs., states that "a partnership begins business when it starts the business operations for which it was organized." Active Lipid was organized to fund the research and development of AL-721. In the latter part of December 1983 Active Lipid raised $ 261,250 and borrowed $ 278,750 which Active Lipid used to fund the research and *595 development of AL-721 through Matrix. Accordingly, we find the $ 200 organizational expenses were properly amortized in tax year 1983. To reflect our findings and conclusions herein, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the year in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1867737/	188 S.W.3d 296 (2006) Vernon G. JOHNSON, Appellant, v. BAYLOR UNIVERSITY, Appellee. No. 10-05-00195-CV. Court of Appeals of Texas, Waco. February 15, 2006. 299 LaNelle L. McNamara, Waco, for appellant. Stuart Smith and Roy Barrett, Naman Howell Smith & Lee PC, Waco, for appellee. Before Chief Justice GRAY, Justice VANCE, and Justice REYNA. OPINION BILL VANCE, Justice. Introduction and Background Vernon Johnson sued Baylor University, asserting four causes of action. Baylor obtained summary judgment; Johnson appeals. We will affirm in part and reverse and remand in part. Johnson, a pilot working for Baylor from 1992 to 1994, was fired for chronic obesity and poor grammar and diction, which Baylor believed diminished its image to people who flew on Baylor's aircraft. Baylor's president at the time, Dr. Herbert H. Reynolds, however, repeatedly praised Johnson's skills as a pilot. In August 1997 (while his discrimination suit[1] against Baylor was pending), Johnson obtained employment on a probationary basis with Kitty Hawk Air Cargo, Inc., an air freight carrier, and began training. In his preemployment interview with Kitty Hawk, Johnson informed Kitty Hawk that he had been terminated by Baylor because of his obesity and not because of his performance as a pilot. Kitty Hawk received a pre-employment background reportprepared by Accu-Screen, Inc. from information obtained from Baylorthat Johnson had been involuntarily terminated for misconduct and that he was ineligible for rehire. Kitty Hawk sought Johnson's employment records from Baylor,[2] but Baylor erroneously responded that Johnson's personnel records were not available. About a month laterand after receiving the report from Accu-Screen and having no records from BaylorKitty Hawk dismissed Johnson.[3] About sixteen months later, after Johnson had obtained copies of the documents that Accu-Screen and Baylor had sent Kitty Hawk, Johnson sued Baylor again, this time alleging tortious interference with a 300 contract and with a prospective contractual relationship, and contending that Baylor's statements to Kitty Hawk were false and had caused his employment with Kitty Hawk to be terminated.[4] Johnson later added defamation and negligent misrepresentation claims. Ultimately, the trial court granted summary judgment for Baylor on all of Johnson's claims. Johnson raises three issues, asserting that the trial court erred in granting summary judgment on his tortious interference, defamation, and negligent misrepresentation claims, respectively. Standard of Review We review the decision to grant a summary judgment de novo. Provident Life & Accident Ins. Co. v. Knott, 128 S.W.3d 211, 215 (Tex.2003). The standards for reviewing a traditional motion for summary judgment are well established. Nixon v. Mr. Prop. Mgmt. Co., 690 S.W.2d 546, 548 (Tex.1985). The movant has the burden of showing that no genuine issue of material fact exists and that it is entitled to the summary judgment as a matter of law. American Tobacco Co. v. Grinnell, 951 S.W.2d 420, 425 (Tex.1997); Ash v. Hack Branch Distributing Co., 54 S.W.3d 401, 413 (Tex.App.-Waco 2001, pet. denied). The reviewing court must accept all evidence favorable to the nonmovant as true. Nixon, 690 S.W.2d at 549; Ash, 54 S.W.3d at 413. Every reasonable inference must be indulged in favor of the nonmovant and all doubts resolved in his favor. American Tobacco, 951 S.W.2d at 425; Ash, 54 S.W.3d at 413. Consistent with the standard of review, we present the background facts in the light most favorable to the nonmovant. See Turner v. KTRK TV., Inc., 38 S.W.3d 103, 109 (Tex.2000); see also Forbes, Inc. v. Granada Biosciences, Inc., 124 S.W.3d 167, 172 (Tex.2003) (appellate court views record in light most favorable to nonmovant when reviewing no-evidence summary judgment motion). If the movant for summary judgment is a defendant, then the movant must negate at least one of the elements of the nonmovant's cause of action, or alternatively, the movant must conclusively establish each element of an affirmative defense. Clifton v. Hopkins, 107 S.W.3d 755, 757 (Tex.App.-Waco 2003, pet. denied). The nonmovant need not respond to the motion for summary judgment unless the movant meets its burden of proof. Rhone-Poulenc, Inc. v. Steel, 997 S.W.2d 217, 222-23 (Tex.1999). But if the movant meets its burden of proof, the nonmovant must present summary judgment evidence to raise a fact issue. Centeq Realty, Inc. v. Siegler, 899 S.W.2d 195, 197 (Tex.1995). We apply the same standard in reviewing the grant of a no-evidence summary judgment motion as we would in reviewing a directed verdict. Ash, 54 S.W.3d at 413. We review the summary judgment evidence in the light most favorable to the nonmovant, disregarding all contrary evidence and inferences. Id. A no-evidence motion will be defeated if more than a scintilla of probative evidence exists to raise a genuine issue of material fact on the element challenged by the movant. Id. More than a scintilla of evidence exists if it would allow reasonable and fairminded people to differ in their conclusions. Forbes, Inc., 124 S.W.3d at 172. 301 When a trial court's order granting summary judgment does not specify the ground or grounds relied on for the ruling, summary judgment will be affirmed on appeal if any of the theories advanced are meritorious. State Farm Fire & Cas. Co. v. S.S., 858 S.W.2d 374, 380 (Tex.1993); Larsen v. Carlene Langford & Assocs., Inc., 41 S.W.3d 245, 249 (Tex.App.-Waco 2001, pet. denied). Analysis Defamation We first address Johnson's second issue, which asserts that the trial court erred in granting summary judgment on his defamation claim. Baylor filed traditional and no-evidence motions for summary judgment on this claim. Its traditional motion asserted that Johnson's defamation claim was barred by the one-year statute of limitations. The trial court granted both motions without stating any grounds. The summary judgment evidence shows Johnson began working work for Kitty Hawk in August of 1997, starting his initial training on a probationary basis. After completing the first phase of training, Johnson took leave before he was to resume training at the end of September 1997. But Kitty Hawk sent Johnson a letter dated September 25, 1997, stating that he was being removed from Kitty Hawk's training schedule and that he was relieved from any further Kitty Hawk training or attendance. In an August 14, 1997 letter to Baylor, Kitty Hawk had requested that Baylor provide it with Johnson's personnel records for the previous five years, as required by the PRSA. The basis of Johnson's defamation claim was Baylor's written statement to Kitty Hawk (through an August 25, 1997 pre-employment background report prepared by Accu-Screen, Inc. from information obtained from Baylor) that Johnson's employment with Baylor as a pilot had been terminated "involuntarily" for "conduct" reasons and that he was ineligible for rehire. Johnson claims that these statements were false. Johnson stated in his affidavit that, when he inquired about the reason for Kitty Hawk's decision, he was told that the decision was based on information from Baylor. In March of 1998, Johnson obtained a copy of the documents that Kitty Hawk had received. He filed this suit on January 19, 1999, about sixteen months after being terminated by Kitty Hawk. The statute of limitations for a defamation cause of action is one year. TEX. CIV. PRAC. & REM.CODE. ANN. § 16.002(a) (Vernon 2002). Ordinarily, the cause of action accrues on the date the defamatory matter is published. See Langston v. Eagle Publishing Co., 719 S.W.2d 612, 615 (Tex.App.-Waco 1986, writ ref'd n.r.e.). The discovery rule applies to libel actions, and under this rule, the statute of limitation does not begin to run until the injured party learns of, or, in the exercise of reasonable diligence, should have learned of the injury or wrong giving rise to the action. Id. (citing Kelley v. Rinkle, 532 S.W.2d 947, 949 (Tex.1976)); see also KPMG Peat Marwick v. Harrison County Fin. Corp., 988 S.W.2d 746, 749 (Tex.1999) ("accrual occurs when the plaintiff knew or should have known of the wrongfully caused injury"). The plaintiff need not know the specific nature of each wrongful act that may have caused the injury. KPMG, 988 S.W.2d at 749. Because Johnson pled the discovery rule, Baylor had the burden of negating the discovery rule by proving as a matter of law that no fact issue existed on when Johnson discovered or should have discovered 302 the nature of the injury. Rhone-Poulenc, Inc., 997 S.W.2d at 223; Burns v. Thomas, 786 S.W.2d 266, 267 (Tex.1990). Baylor argues that, because Johnson's injury (the loss of his job with Kitty Hawk) occurred in September 1997 and he was told then that his termination occurred because he had a "problem" with Baylor (i.e., the information that Kitty Hawk had received from Baylor), Johnson's defamation claim accrued then and the statute of limitations began to run. We agree with Baylor that Johnson knew or should have known of his wrongfully caused injury when he was dismissed by Kitty Hawk and told that it was because of the information Kitty Hawk had received from Baylor. Johnson knew or should have known then the facts that he later allegedthat his injury was the result of the wrongful conduct of others, i.e., Baylor's providing information to Kitty Hawk. Because Johnson's defamation claim accrued more than one year before he filed suit, summary judgment on Baylor's limitations defense was proper. We overrule Johnson's second issue. Negligent Misrepresentation: First Element (Defendant Provides Information) Johnson's third issue asserts that the trial court erred in granting summary judgment on his negligent misrepresentation claim. Baylor filed traditional and noevidence motions for summary judgment on this claim. Its traditional motion asserted that Johnson had released Baylor, while its no-evidence motion was based on the first, fourth, and fifth elements of negligent misrepresentation. The trial court granted both motions without stating any grounds. Johnson pled that Baylor made false representations to Kitty Hawk about his discharge from Baylor. He also pled that Baylor falsely represented to Kitty Hawk that Johnson's personnel records were not available. The elements of negligent misrepresentation are: 1. a defendant provides information in the course of his business, or in a transaction in which he has a pecuniary interest; 2. the information supplied is false; 3 the defendant did not exercise reasonable care or competence in obtaining or communicating the information; 4. the plaintiff justifiably relies on the information; and 5. the plaintiff suffers damages proximately caused by the reliance. Federal Land Bank Ass'n v. Sloane, 825 S.W.2d 439, 442 (Tex.1991); Larsen, 41 S.W.3d at 249-50; see also McCamish, Martin, Brown, & Loeffler v. F.E. Appling Interests, Inc., 991 S.W.2d 787, 791 (Tex. 1999) (citing Sloane and quoting section 552 of the Restatement (Second) of Torts). Baylor moved for summary judgment on the ground that Baylor made representations to Kitty Hawk, not to Johnson, and that Johnson's negligent misrepresentation claim thus fails on the first element. Citing the above three cases, Baylor asserts that the first element of a negligent misrepresentation claim is that the defendant made a representation to the plaintiff in the course of the defendant's business or in a transaction in which the defendant had an interest. None of these cases, however, requires that the misrepresentation be made to the plaintiff.[5]See, 303 e.g., Cook Consultants, Inc. v. Larson, 700 S.W.2d 231, 233-36 (Tex.App.-Dallas 1985, writ ref'd n.r.e.) (surveyor that was hired by builder was liable to homeowner for surveyor's negligent misrepresentation). In Cook Consultants, the court cited the following factors as considerations in determining whether the duty described in section 552 is owed in a particular case: (1) the extent to which the transaction was intended to affect the plaintiff; (2) foreseeability of harm to the plaintiff; (3) the closeness of the connection between the defendant's conduct and the injury suffered; and (4) the potential liability. Id. at 234-35. Kitty Hawk's request to Baylor for Johnson's records included Johnson's authorization to provide the records to Kitty Hawk. Applying these four factors, we find that Baylor owed Johnson a duty to exercise reasonable care in supplying his personnel records to Kitty Hawk, and more than a scintilla of evidence exists that Baylor made a representation to Kitty Hawk for Johnson's benefit; upon receiving Kitty Hawk's request for Johnson's personnel records, Baylor knew or should have known that Johnson was relying on Baylor to properly supply his records to Kitty Hawk. Summary judgment on this ground and element was error, and we sustain Johnson's third issue in this respect. Negligent Misrepresentation: Fourth Element (Justifiable Reliance) Baylor moved for summary judgment on the ground that there was no evidence that Johnson justifiably relied on the information supplied by Baylor to Kitty Hawk. At his pre-employment interview with Kitty Hawk, Johnson informed Kitty Hawk that he had been terminated by Baylor because of his obesity, not because of his performance as a pilot. It is a reasonable inference that Johnson knew his personnel records, which included his annual evaluations and Dr. Reynolds's letters to Johnson about his problem with Johnson's obesity, grammar, and diction, would verify to Kitty Hawk that he had been terminated by Baylor because of his obesity, not because of his performance as a pilot. Further, Johnson knew and Baylor knew or should have known that the information Baylor would be providing to Kitty Hawk would influence Kitty Hawk's employment relationship with Johnson; Baylor (which had at least constructive knowledge of the PRSA's provisions on obtaining a pilot's personnel records) knew or should have known that Johnson was relying on Baylor to supply his records to Kitty Hawk because Kitty Hawk's request to Baylor for Johnson's records included Johnson's authorization to provide the records to Kitty Hawk. There is thus more than a scintilla of evidence that Johnson justifiably relied on Baylor's representations to Kitty Hawk about Johnson's personnel records. Summary judgment on this ground and element was error, and we sustain Johnson's third issue in this respect. Negligent Misrepresentation and Tortious Interference: Causation Baylor moved for summary judgment on the ground that there was no evidence that its alleged negligent misrepresentation caused Johnson's injury. The trial court had earlier granted Baylor's noevidence motion for summary judgment on 304 causation on Johnson's claims for tortious interference with contract and tortious interference with prospective contract, which is the basis of Johnson's first issue.[6] Thus, we will address causation as to these three claims together, addressing the remainder of issue three and issue one as to causation. The elements of a claim for tortious interference with contract are: (1) a contract subject to interference exists; (2) the alleged act of interference was willful and intentional; (3) the willful and intentional act proximately caused damage; and (4) actual damage or loss occurred. ACS Investors, Inc. v. McLaughlin, 943 S.W.2d 426, 430 (Tex.1997). The elements of a claim for tortious interference with prospective contract are: (1) a reasonable probability that the parties would have entered into a contractual relationship; (2) an "independently tortious or unlawful" act by the defendant that prevented the relationship from occurring; (3) the defendant did such act with a conscious desire to prevent the relationship from occurring, or it knew that the interference was certain or substantially certain to occur as a result of the defendant's conduct; and (4) the plaintiff suffered actual harm or damage as a result of the defendant's interference. Ash, 54 S.W.3d at 414-15. "Independently tortious" means conduct that would violate some other recognized tort duty. Wal-Mart Stores, Inc. v. Sturges, 52 S.W.3d 711, 713 (Tex.2001). The Dallas Court of Appeals recently addressed the causation element for a tortious interference with prospective contract claim: The second element of this tort requires that the independently tortious or wrongful act "prevented the relationship from occurring." The Texas Supreme Court has addressed the causation aspect of this element. See Prudential Ins. Co. of Am. v. Fin. Review Servs. Inc., 29 S.W.3d 74, 83 (Tex.2000) (causation inquiry is whether defendant's alleged business disparagement caused injury to plaintiff's prospective contracts); Hurlbut v. Gulf Atl. Life Ins. Co., 749 S.W.2d 762, 767 (Tex.1987) (business disparagement case; statement must play a "substantial part" in inducing others not to deal with the plaintiff, resulting in special damage, i.e., lost trade or other dealings). We construe this element to require, at minimum, that the tortious conduct constitute a cause in fact that prevented the prospective business relationship from coming to fruition in the form of a contractual agreement. The test for cause in fact, or "but for causation," is whether the act or omission was a substantial factor in causing the injury "without which the harm would not have occurred." Doe v. Boys Clubs of Greater Dallas, Inc., 907 S.W.2d 472, 477 (Tex.1995). COC Servs., Ltd. v. CompUSA, Inc., 150 S.W.3d 654, 679 (Tex.App.-Dallas 2004, pet. filed). We agree with this test and will apply it to Johnson's claim for tortious interference with prospective contract. In his affidavit, Johnson stated: "When I inquired about the reason for Kitty 305 Hawk's decision, I was told that the decision was based on information furnished (and not furnished) by Baylor." It is not disputed that: In a letter dated August 14, 1997, in accordance with the PRSA, Kitty Hawk requested Johnson's personnel records from Baylor for the preceding five years because it was considering Johnson for employment as a pilot. Kitty Hawk's letter included a "Pilot Record Request Form" stating that it was a "request pursuant to U.S.C. Title 49 § 44936 also known as Title V Pilot Record Sharing of the Federal Aviation Reauthorization Act of 1996," and that it was requesting that Baylor provide the records within thirty days. Baylor received Kitty Hawk's August 14 letter on August 18. Despite the PRSA's requirement (49 U.S.C. § 44703(h)(6)(A)) that Baylor notify Johnson that his records had been requested and that he had a right to receive a copy of his records, it did not notify Johnson. Baylor received records from Accu-Screen showing that Kitty Hawk was requesting information on Johnson's employment from 1991 to 1994. Baylor, in a September 11, 1997 letter to Kitty Hawk, responded that it did "not have personnel files readily available for individuals who worked for us this far back." But deposition testimony of Baylor personnel shows that Johnson's personnel records were accessible; they had been retained in the personnel office and then were transferred to the General Counsel's office. They had also been made a part of the record in Johnson's federal discrimination suit against Baylor. Kitty Hawk then wrote Johnson on September 25, 1997 that he was being relieved from any further training or attendance. The PRSA (the PRIA) provides in pertinent part: (1) In general. Subject to paragraph (14), before allowing an individual to begin service as a pilot, an air carrier shall request and receive the following information: (A) FAA records. . . . (B) Air carrier and other records. From any air carrier or other person. . . that has employed the individual as a pilot of a civil or public aircraft at any time during the 5-year period preceding the date of the employment application of the individual, . . . (ii) other records pertaining to the individual's performance as a pilot that are maintained by the air carrier or person concerning (I) the training, qualifications, proficiency, or professional competence of the individual, including comments and evaluations made by a check airman designated in accordance with section 121.411, 125.295, or 135.337 of such title; (II) any disciplinary action taken with respect to the individual that was not subsequently overturned; and (III) any release from employment or resignation, termination, or disqualification with respect to employment. (C) National driver register records. In accordance with section 30305(b)(8) of this title, from the chief driver licensing official of a State, information concerning the motor vehicle driving record of the individual. 306 49 U.S.C. § 44703(h)(1) (emphasis added).[7] Under the PRSA, Kitty Hawk was prohibited from allowing Johnson to begin working as a pilot until it had received Johnson's personnel records for the preceding five years from Baylor. Baylor had actual or constructive knowledge that Kitty Hawk had to receive Johnson's personnel records to be able to allow him to work as a pilot. We conclude that Johnson's affidavit testimony that Kitty Hawk's decision to dismiss Johnson was based on the records and information that Baylor did, and did not, furnish, combined with the applicable provisions of the PRSA and the undisputed fact that Baylor misrepresented to Kitty Hawk that Johnson's records were not readily available, is some evidencemore than a scintillathat a cause in fact of Kitty Hawk's dismissal of Johnson was the misrepresentation and information that Kitty Hawk received from Baylor about Johnson's personnel records. There is some evidence that Baylor's misrepresentation about Johnson's personnel records was a substantial factor in Kitty Hawk's dismissal of Johnson. Accordingly, it was error to grant Baylor's no-evidence motion for summary judgment on causation with respect to Johnson's tortious interference and negligent misrepresentation claims. We sustain Johnson's first and third issues in this respect. Tortious Interference with Prospective Contract: Malice Baylor also moved for summary judgment on Johnson's claim for tortious interference with prospective contract on the ground that there was no evidence on what Baylor asserted was the second element of that claim: that Baylor acted with malice as to Johnson's prospective employment with Kitty Hawk. Specifically, Baylor asserted that there is no evidence "that any act of Baylor was malicious and intervened with the formation of the relationship. . . ." In so moving for summary judgment, and in its appellate brief, Baylor, citing Richter v. Wagner Oil Co., states that it moved for summary judgment on the "malice element."[8] It argues that Johnson offered no evidence to show malice and cites section 41.001(7) of the Civil Practice and Remedies Code,[9] asserting that the most that Johnson could show was that Baylor was negligent in the way that it responded to Kitty Hawk's record request. As we have noted above, the elements of a claim for tortious interference with prospective contract are: (1) a reasonable probability that the parties would have entered into a contractual relationship; (2) an "independently tortious or unlawful" act by the defendant that prevented 307 the relationship from occurring; (3) the defendant did such act with a conscious desire to prevent the relationship from occurring, or it knew that the interference was certain or substantially certain to occur as a result of the defendant's conduct; and (4) the plaintiff suffered actual harm or damage as a result of the defendant's interference. Ash, 54 S.W.3d at 414-15. We disagree with the elements set out in Richter. Malice, or malicious intent, is not an element of a claim for tortious interference with prospective contract, and Johnson was not required to present evidence of malice in response to Baylor's no-evidence summary judgment motion. See id. Summary judgment on this ground was error, and we sustain Johnson's first issue in this respect. Release Baylor asserted the defense of release as the summary judgment ground in its traditional motion for summary judgment on Johnson's negligent misrepresentation.[10] Johnson's third issue asserts that summary judgment on this ground was improper. Kitty Hawk's "Pilot Record Request Form" to Baylor included the following provision that had been signed by Johnson: In accordance with U.S.C. Title 49 § 44936(f)(2)(B) this is to certify that I, __________ release from all liability for any claim arising from or furnishing of the above information to Kitty Hawk AirCargo, Inc., or the use of such information to Kitty Hawk AirCargo, Inc. (other than a claim arising from furnishing information known to be false and maintained in violation of a criminal statute.) The PRSA's written consent provision states: (2) Written consent; release from liability. An air carrier making a request for records under paragraph (1) (A) shall be required to obtain written consent to the release of those records from the individual that is the subject of the records requested; and (B) may, notwithstanding any other provision of law or agreement to the contrary, require the individual who is the subject of the records to request to execute a release from liability for any claim arising from the furnishing of such records to or the use of such records by such air carrier (other than a claim arising from furnishing information known to be false and maintained in violation of a criminal statute). 49 U.S.C. § 44703(h)(2). The PRSA's liability limitation states: (1) Limitation on liability.No action or proceeding may be brought by or on behalf of an individual who has applied for or is seeking a position with an air carrier as a pilot and who has signed a release from liability, as provided for under paragraph (2), against (A) the air carrier requesting the records of that individual under subsection (h)(1); (B) a person who has complied with such request; 308 (C) a person who has entered information contained in the individual's records; or (D) an agent or employee of a person described in subparagraph (A) or (B); in the nature of an action for defamation, invasion of privacy, negligence, interference with contract, or otherwise, or under any Federal or State law with respect to the furnishing or use of such records in accordance with subsection (h). (2) Preemption.No State or political subdivision thereof may enact, prescribe, issue, continue in effect, or enforce any law (including any regulation, standard, or other provision having the force and effect of law) that prohibits, penalizes, or imposes liability for furnishing or using records in accordance with subsection (h). (3) Provision for knowingly false information. Paragraphs (1) and (2) shall not apply with respect to a person who furnishes information in response to a request made under subsection (h)(1), that (A) the person knows is false; and (B) was maintained in violation of a criminal statute of the United States. Id. § 44703(i) (emphasis added). Johnson asserts that his PRSA release that Kitty Hawk sent to Baylor does not bar his negligent misrepresentation claim because Baylor did not comply with Kitty Hawk's request, and the PRSA requires such compliance for the release and limitation of liability to apply. Section 44703(i)(1)(B) plainly provides that a person such as Johnson ("an individual who has applied for or is seeking a position with an air carrier as a pilot and who has signed a release from liability") may not bring an action against "a person who has complied with such request." Johnson argues that, because Baylor did not comply with Kitty Hawk's request and failed to provide his personnel records, Baylor is not entitled to rely on his PRSA release and liability limitation. In support, Johnson relies on a Colorado case that apparently was one of first impression on the PRSA's liability limitation provision. See Sky Fun 1 v. Schuttloffel, 27 P.3d 361 (Colo.2001). In that case the pilot applicant, like Johnson, signed a consent and release form under the PRSA that allowed the prospective employer to obtain the pilot's prior employment records. Id. at 364. The prior employer responded to the request form with a note stating, "CALL ME!" but providing no records. The prospective employer called the prior employer, who stated that the pilot should not be hired because he was a threat to passenger safety. The prior employer called back several times and urged the prospective employer not to hire the plaintiff. Eventually, the prior employer prepared and sent a document titled "Termination Report" that detailed three incidents where the pilot allegedly acted dangerously. The pilot was hired anyway, and when his prior employer sued him for property damage, the pilot counterclaimed for defamation. The trial court found for the pilot on his defamation claim, and on appeal the prior employer argued that the PRSA consent and liability limitation immunized it from liability for defamation. After discussing the statutory provisions and legislative history of the PRSA, the Colorado Supreme Court held that the PRSA liability limitation did not preempt the defamation claim against the prior employer where the defamatory verbal statements were not based on records supplied in response to the PRSA request, consent, and release. Id. at 365, 368. Applying these principles of statutory construction, the common law of torts, federal preemption, and federalism in the case before us, we hold that the 309 limited liability provision of the Act prevents suits based on the pilot records provided to a potential employer, including the personnel records, and oral statements made in connection with explaining the circumstances and contents of such records. This interpretation carries out the Act's purpose of protecting public safety in matters of air commerce. On the other hand, the wording of the Act and its committee report plainly demonstrate that Congress was also solicitous of a pilot's reputation and employment opportunities. Protecting the public safety depends on the availability of qualified pilots. Accordingly, Congress determined that pilot hiring decisions should be based on facts regarding the pilot's training, skill, performance, and safety record. The pilot applicant must sign a release of the records for the prospective employer and must anticipate that some verbal interchange will occur between past and prospective employers concerning the applicant and the records provided. However, Congress did not broadly immunize oral statements; rather, it chose to utilize the term "record" as the operative though undefined term in the limitation of liability provision. We conclude that the preemptive terms of the Act do not affect Colorado common law defamation actions involving verbal assertions that the speaker knew to be false or the speaker made in reckless disregard of the truth, when the verbal statements are not based upon the previous employer's records. Such is the case before us, which involves verbal statements calculated to ruin Schuttloffel's professional reputation and prevent his employment as a pilot. Id. at 368 (emphasis added). We agree with the Colorado court's construction and application of the PRSA, which essentially is that a prior employer must comply with the PRSA to avail itself of the act's consent, release, and liability limitation provisions. The PRSA does not broadly immunize a prior employer's conduct in responding to a request for personnel records. Instead, it contains a quid pro quo: if the prior employer complies with the request for personnel records, its liability is limited. Johnson wanted Baylor to provide his personnel records to Kitty Hawk because he knew they would verify what he had already told Kitty Hawk in his pre-employment interview. He signed an authorization and agreed to release Baylor from liability in contemplation of Baylor providing Kitty Hawk with his records, which show that Baylor had terminated him for reasons (i.e., obesity) other than his performance as a pilot. Johnson performed under the statute; Baylor did not. Baylor responded by misrepresenting that Johnson's records were not available. A person such as Johnson ("an individual who has applied for or is seeking a position with an air carrier as a pilot and who has signed a release from liability") may not bring an action against "a person who has complied with such request." 49 U.S.C. § 44703(i)(1)(B). Baylor did not comply with Kitty Hawk's request. We thus hold that Baylor cannot avail itself of Johnson's PRSA release or the PRSA's liability limitation in the context of Johnson's negligent misrepresentation claim, and summary judgment on this ground was error. We sustain Johnson's third issue in this respect. Baylor also asserted that it was entitled to summary judgment based on the release contained in the following authorization: 310 I certify that information in this Application and related documentation is true and complete without qualification. I understand that Kitty Hawk may investigate my work and personal history and verify all data given on this application, on related papers and in interviews, and I authorize Kitty Hawk to do the same. This inquiry may include information as to my character, general reputation and personal characteristics, and I consent to the conduct of this inquiry and to the consideration of any statements or references of former employers that are given in response to the inquiry. I authorize all individuals, schools and employers given in response to the inquiry. I authorize all individuals, schools and employers named except as specifically limited on this Application, to provide information requested about me, and I release them from liability for damages in providing this information. I understand and acknowledge that any misrepresentation or omission of fact by me can result in immediate discharge. [Emphasis added.] Releases that are general and categorical are narrowly construed. Victoria Bank & Trust Co. v. Brady, 811 S.W.2d 931, 938 (Tex.1991); Boales v. Brighton Builders, Inc., 29 S.W.3d 159, 167 (Tex.App.-Houston [14th Dist.] 2000, pet. denied). If a release is capable of a certain or definite legal meaning or interpretation, then effect must be given to the parties' intentions as expressed within the language of the release. See Coker v. Coker, 650 S.W.2d 391, 393 (Tex.1983). A release will be construed in light of the facts and circumstances surrounding its execution. See Tricentrol Oil Trading, Inc. v. Annesley, 809 S.W.2d 218, 221 (Tex. 1991). As with the PRSA release, Johnson argues that this general release was predicated on Baylor providing his personnel records to Kitty Hawk. We agree and will construe the release narrowly and in light of the facts and circumstances of its execution. Johnson authorized Baylor to provide his personnel records and information and agreed to release Baylor "from liability for damages in providing this information." But as we emphasized above, the gist of Johnson's negligent misrepresentation claim is not that Baylor provided Kitty Hawk with negative information about him,[11] but that Baylor negligently misrepresented that Johnson's records were not available and did not provide them. Like with the PRSA release, the purpose of this general release was not realized, and we hold that it does not bar Johnson's negligent misrepresentation claim. Summary judgment on this release was error, and we sustain Johnson's third issue in this respect. Conclusion The trial court properly granted summary judgment on Johnson's defamation claim, and we affirm that ruling. The trial court erred in granting summary judgment on Johnson's tortious interference and negligent misrepresentation claims. We reverse the trial court's rulings on those claims and remand the cause to the 311 trial court for further proceedings consistent with this opinion. Chief Justice GRAY provides a Special Note to clarify his participation in this case. Chief Justice GRAY provides this Special Note to clarify his participation in this case. I have not had an adequate amount of time to consider and vote on this case. I have just concluded two extensive dissenting opinions. One was an accelerated appeal and the other a much older criminal case, both of which were issued only one week before this case. Roberts v. Roberts, No. 10-05-00134-CV, 2006 WL 301099, 2006 Tex.App. LEXIS 1090 (Tex.App.-Waco Feb. 8, 2006, no pet. h.) (Gray, C.J., concurring and dissenting); Tingler v. State, No. 10-04-00224-CR, 2006 WL 300817, 2006 Tex.App. LEXIS 1087 (Tex. App.-Waco Feb. 8, 2006, no pet. h.) (Gray, C.J., dissenting). As Justice Vance is very aware, currently I am deeply involved in reviewing the draft opinion and working on an analysis of an appeal of a termination of parental rights case, also an accelerated appeal. That analysis has required that I read the entire record. I also had to review an opinion on a Petition for Discretionary review with a deadline that could not be moved. See TEX.R.APP. P. 50. All these cases have a higher priority than this one. Of course, there are many other draft opinions and orders that have been submitted for my review during the relevant time period that I have reviewed and approved or commented upon, so that the bulk of the business of the Court continues to move forward, except on a few selected cases on which I need additional time for analysis. So in this case, as well as other cases that Justices Reyna and Vance have chosen to issue without giving me adequate time to conduct my analysis, I will continue with the application of what I believe to be the priorities assigned by the legislature and the applicable rules. See Cathey v. Meyer, 115 S.W.3d 644, 673-674 (Tex. App.-Waco 2003) (Gray, C.J., dissenting), aff'd in part, rev'd in part, Meyer v. Cathey, 167 S.W.3d 327 (Tex.2005). I do not think that the internal administrative rules adopted by Justices Reyna and Vance can override those priorities set by the legislature and the high courts of this State. It appears the desired result of the internal administrative rules is to keep me from conducting the analysis that I believe is necessary, including depriving me of the time necessary to prepare a dissenting or concurring opinion when I believe it is appropriate. To some extent it has already had that effect because they have chosen to issue opinions on the vote of only two justices and it has hastened or truncated my opinions in others. I might could better understand, indeed justify, a procedure calling for some deadline by which an opinion should move on in the circulation process if we had not had a year-to-date clearance rate of 112% and an average time for a case to be pending in this Court of only just over 12 months at the time the internal rules were adopted in May of 2005. We have continued to be one of the highest producers for the disposition of cases of the 14 intermediate appellate courts in Texas, and would be so even without the majority issuing a few cases before I have finished my analysis and voted on the result. So, I must ask, as should you: Why rush any case out the door without letting every judge have the time needed for their own review and analysis? I have waited for over five months for Justice Vance to vote on the disposition of a case. The majority's purported desire for a speedy disposition 312 is especially ironic when you factor into the mix that I have almost a dozen draft opinions prepared that Justice Reyna now refuses to review under the procedures that have been in place in this Court for the past two years, long before and long after the majority's adoption of the internal administrative rules they so cherish. Likewise, Justice Vance refuses to review them. I will adjust, as I must if I want any of the cases assigned to me to ever be issued, though this will only result in a delay in the issuance of my opinions. Thus, because I have not had an adequate amount of time to review the merits of this case, I am not prepared to cast a vote concurring or dissenting in the judgment of the other two justices. See Tex. Genco, LP v. Valence Operating Co., 187 S.W.3d 118, 125-26 (Tex.App.-Waco, 2006, no pet. h.) (Special Note by Chief Justice Gray issued Jan. 25, 2006); Krumnow v. Krumnow, 174 S.W.3d 820, 830-842 (Tex. App.-Waco Aug.24, 2005, pet. filed) (Special Note by Chief Justice Gray issued Aug. 31, 2005). NOTES [1] Johnson unsuccessfully sued Baylor for disability discrimination. See Johnson v. Baylor Univ., 129 F.3d 607 (5th Cir.1997). [2] The records were sought under the Pilot Records Sharing Act (PRSA), 49 U.S.C. § 44936(f-h). The operative provisions of this statute were later transferred to 49 U.S.C. § 44703, the Pilot Records Improvement Act (PRIA). These provisions require air carriers to obtain the complete personnel records of pilot applicants who have been employed as a pilot with other air carriers for the preceding five years. See 49 U.S.C. § 44703(h-j). Neither party asserts that the current version of the PRSA's pertinent provisions differ from the provisions in effect in 1997, so we will apply the current version in this appeal. [3] Ironically, in the discrimination suit, Dr. Reynolds stated in an affidavit that "Johnson could work as a pilot for an overnight delivery service or for an air freight service ... [or] for other companies which might have different standards for their employees' appearance, dress, grooming and grammar." [4] Asserting federal preemption under the PRSA, Baylor removed this case to federal district court, which denied Johnson's motion to remand and granted Baylor's motion to dismiss, but on appeal the Fifth Circuit reversed the district court, holding that the PRSA did not preempt Johnson's state law claim and that Baylor's removal was improper. See Johnson v. Baylor Univ., 214 F.3d 630 (5th Cir.2000). [5] Section 552 narrows the class of potential claimants and requires that any claimant justifiably rely on the alleged negligent misrepresentation. McCamish, 991 S.W.2d at 793-94. Under section 552(2), liability is limited to loss suffered: (a) by the person or one of a limited group of persons for whose benefit and guidance [one] intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that [one] intends the information to influence or knows that the recipient so intends or in a substantially similar transaction. Id. at 794 (quoting RESTATEMENT (SECOND) OF TORTS § 552(a)). [6] Only the no-evidence motion was granted on Johnson's tortious interference claims. [7] The purpose of the PRSA is to promote air safety through the hiring of qualified pilots, and it accomplishes its goal by ensuring the free exchange of pilot's records among pilot employers. Sky Fun 1 v. Schuttloffel, 27 P.3d 361, 367 (Colo.2001). [8] Richter states that the elements of tortious interference with prospective contract are: (1) a reasonable probability the plaintiff would have entered a contractual relationship with a third-party; (2) an intentional and malicious act that intervened with the formation of that relationship; (3) the defendant lacked privilege or justification to interfere; and (4) actual damage, loss, or harm resulted from the defendant's interference. Richter v. Wagner Oil Co., 90 S.W.3d 890, 897 (Tex.App.-San Antonio 2002, no pet.). [9] Malice is defined as "a specific intent by the defendant to cause substantial injury or harm to the claimant." TEX. CIV. PRAC. & REM.CODE ANN. § 41.001(7) (Vernon Supp.2005). [10] In its traditional motion for summary judgment on Johnson's tortious interference claims, Baylor moved for summary judgment on its defenses of release and consent, but the trial court did not grant Baylor's traditional motion; it only granted Baylor's no-evidence motion on Johnson's tortious interference claims. [11] For this reason, we find Smith v. Holley, 827 S.W.2d 433 (Tex.App.-San Antonio 1992, writ denied), relied on by Baylor, to be factually inapposite. Unlike the plaintiff there, Johnson's claim is not based on the content of the information that the prior employer provided or the mere fact that the prior employer provided information when the plaintiff claimed that it should not have. Johnson's claim is based on Baylor's negligent misrepresentation that his records were not available and the fact that Baylor did not provide them; Johnson was relying on Baylor to produce his records.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4623304/	ESTATE OF C. WILLIAM MEINECKE, THE TRUST COMPANY OF NEW JERSEY AND EDWARD BOSE, EXECUTORS, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Meinecke v. CommissionerDocket No. 107147.United States Board of Tax Appeals47 B.T.A. 634; 1942 BTA LEXIS 671; August 21, 1942, Promulgated 671 Held, no binding contract governing the sale of patents by decedent to the Davol Rubber Co. was entered into prior to March 24, 1938, the date of decedent's death. Theodore L. Harrison, Esq., for the petitioner. Robert S. Garnett, Esq., for the respondent. VAN FOSSAN 634 The respondent determined a deficiency of $9,529.57 in the income tax of C. William Meinecke for the period from January 1, 1938, to March 24, 1938. The sole issue is the taxability of an alleged gain from the sale of certain patents to the Davol Rubber Co. The precise point in controversy is whether or not, prior to March 24, 1938, the date of his death, Meinecke entered into an effective agreement of sale disposing of such patents. FINDINGS OF FACT. The facts were stipulated and as so stipulated are adopted as our findings of fact. They are substantially as follows: C. William Meinecke, hereinafter called the decedent, died at 5:20 a.m. on March 24, 1938. At the time of his death he was and for some years prior thereto had been a resident of East Orange, County of Essex, State of New Jersey. On April 5, 1938, the last will and testament of the decedent672 was duly admitted to probate in the Surrogate's Court, Essex County, New Jersey, and letters testamentary thereon were issued to Edward Bose and the Trust Co. of New Jersey, as executors of said last will and testament, and the said executors thereupon duly qualified as such and at all times subsequent thereto have been and now are acting as such executors. A Federal income tax return for the period January 635 1, 1938, to March 24, 1938, for the decedent was filed by the executors of his estate with the collector of internal revenue at the fifth district of New Jersey. In the Federal estate tax return filed under date of March 14, 1939, by the executors of the decedent's estate there was included under schedule F as miscellaneous property of the estate, the following: Value at date of death1. Agreement between Christian William Meinecke and Co. for purchase of patents. Amounts payable in sums of $725.00 per month$43,500.002. Funds received from Davol Rubber Co. re following:Royalty on goods sold in February 1938$1,149.85Royalty on goods sold first 18 days of March 1938928.58Redeemed Postal Cards11.342,089.77673 Prior to his death the decedent was the owner of certain United States letters patents for bottle closures and nipples, No. 1583019, dated May 2, 1926, and No. 1748731, dated February 25, 1930, issued to Henry A. Reisman, and also seven other foreign patents, including two Canadian patents issued to Elta Simmons and the said Reisman, respectively. On or about April 9, 1927, the decedent and the Davol Rubber Co., a Rhode Island corporation, hereinafter called Davol, entered into a license agreement in writing wherein the decedent licensed Davol to make use of the Simmons patent. The license agreement was to run for the life of the Simmons patent and was subsequently modified so as to include the use of the Reisman patent by the licensee. During the period subsequent to April 9, 1927, Davol had used the said letters patents and had made payments of royalties to the decedent pursuant to the terms and conditions of the license agreement. Prior to March 18, 1938, the decedent and Davol entered into negotiations contemplating the termination of the license agreement and the sale of the Simmons and Reisman patents by the decedent to Davol. On March 18, 1938, the decedent executed674 two copies of a certain written instrument, hereinafter called the proposed agreement, and duly transmitted it to William E. Warland, his attorney. The proposed agreement described the license agreement of April 9, 1927, and recited the fact that the parties thereto desired to cancel it. The agreement then provided that the license agreement would be canceled. The decedent agreed to execute to Davol an assignment, in proper form, of his right to the patents and Davol agreed to pay to the decedent $725 per month until $43,500 should have been paid. Provisions were made for a failure to pay the monthly installments and the possible invalidity of the Simmons patent. 636 On March 18, 1938, the decedent executed assignments to Davol of the patents heretofore mentioned in the proposed agreement and transmitted them to William E. Warland, his attorney. On March 18, 1938, the decedent duly executed a power of attorney in favor of William E. Warland. On March 18, 1938, the decedent prepared a letter dated on that day addressed to R.I. * * And I have caused such new agreement to be prepared in writing and dated as of this date and have signed the said agreement so that675 the same will be fully binding upon me and my executors and administrator; and I herewith offer said instrument for acceptance by you provided the same is satisfactory to you and is accepted by you in writing on or before the 25th day of March 1938 and whether the same shall be so accepted by you during my lifetime or thereafter. I also agree with you, in consideration of $1.00 paid by you to me, to keep this offer open until said 25th day of March, 1938. The said instrument which I have signed will be forwarded to you by my attorney, Mr. William E. Warland. I agree that the offer which I make to you, as evidenced by said instrument, may be modified by you before the acceptance thereof by making minor changes therein, such as correction of inaccuracies in the numbers of Letters Patents which are involved and any other incidental changes of like character, such changes, however, to be approved by my attorney, Mr. Warland, above mentioned, and, if accepted by you with any such changes, will be fully binding upon me as if such changes had been made prior to my execution of the instrument. On March 19, 1938, William E. Warland prepared a letter dated on that day addressed to676 Co., Providence, R.I.", and duly mailed it at New York City, together with the enclosures therein referred to. In that letter Warland stated that he enclosed the decedent's letter of March 18, 1938, to Davol and a copy of the proposed agreement and that Meinecke's letter gives you an option until March 25th two original copies of the proposed agreement and the assignments of the patents, in his office. He also wrote: passed on the matter you can then sign the two copies which Mr. Meinecke has signed and I will deliver all the assignments of the patents. On March 23, 1938, Davol prepared a letter dated on that day addressed to Row, New York City Island. That letter stated that the proposed agreement was very satisfactory, suggested two superficial corrections therein and contained the sentence, the contracts to us, they will immediately be signed." On March 24, 1938, William E. Warland prepared a letter dated on that day addressed to "Mr. Ernest I. Kilcup, care Davol Rubber Co., 637 Providence, R.I.", and duly mailed it at New York City. Enclosed were the copies of the writings and assignments of patents referred to in the letter. In this letter Warland called attention677 to the fact of Meinecke's death, that his power of attorney was thereby terminated, and that the agreement was not signed by the company in Meinecke's lifetime. The two original copies of the proposed agreement and the assignments of ten patents :including Porto Rico Patent 2778, inadvertently omitted from the proposed agreement) were enclosed with the letter. On March 25, 1938, Davol, by Ernest I. Kilcup, as president and treasurer of Davol Rubber Co., executed the proposed agreement and inserted the date thereon On March 25, 1938, Davol prepared a letter dated on that day addressed to "Mr. William E. Warland, Hauff & Warland, 41 Park Row, New York, N.Y. The proposed agreement referred to in that letter was enclosed therewith. The letter stated: on the matter of assignment of patents and royalty the agreement had been signed subject to the approval of the decedent's executors and trustees. On March 28, 1938, Warland prepared a letter dated on that day addressed to "Mr. Ernest I. Kilcup, Davol Rubber Company, Providence, R.I.", and duly mailed it at New York City. That letter related to the ratification of the agreement by the decedent's executors. On the same day Warland678 prepared a letter dated on that day addressed to N.J.", enclosing copies of the letters of March 25, 1938, from Davol and of March 28, 1938, to Davol, and referring to the prospective ratification. He duly mailed it at New York City. On April 8, 1938, Warland wrote routine letters to the Trust Co. of New Jersey and to Davol, relating to ratification. The proposed agreement was the result of negotiations between decedent directly and through his attorney with representatives of Davol. These negotiations were carried on by private conversations, telephone conversations, and the exchange of letters between the parties. As a result of the negotiations the parties were in substantial accord as to the terms of sale of the letters patent involved in the agreement, both as to the amount of payment, manner of payment, and the rights to be transferred. This accord was incorporated and reflected in the terms of the written agreement signed by decedent on March 18, 1938, and was on the same date, after further discussion between decedent's attorney and the attorney for Davol, amended in certain respects at the request of the representative of Davol. Such amendments in no way altered679 the essence of the understanding and accord arrived at between the parties and incorporated in the original 638 agreement. The agreement as redrawn was also signed by the decedent on March 18, 1938. At the time of the megotiations which culminated in an agreement signed by the decedent on March 18, 1938, the decedent was approximately 80 years of age, in poor health, and was about to enter a hospital for the purpose of undergoing an operation. At that time he was desirous of permanently arranging his business affairs. Prior to March 18, 1938, when the proposed agreement between the decedent and Davol was under consideration, Kilcup, president and treasurer of Davol, personally discussed the matter of the proposed agreement with three or four of the directors cf Davol, who were apprised of the possibility that Kilcup might execute such an agreement for Davol. No meeting of the board of directors of Davol was held and no record of the agreement was made in the minutes of the board of directors, as the bylaws of the company did not require ratification of such an agreement made by the president of the company. No action of any kind was taken by the executors of the680 estate of the decedent to change or alter the proposed agreement and assignments signed by him during his lifetime and the executors never ratified the agreement or assignments by endorsement on the original agreement or in a separate instrument. Davol did not require ratification by the executors of the Meinecke estate of the proposed agreement or of the assignments of the patents. Davol has at all times abided by the terms of the proposed agreement as executed and made the payments provided for therein. The Commissioner determined that a gain of $43,500 from the sale of patents was taxable in accordance with section 42 of the Revenue Act of 1938. OPINION. VAN FOSSAN: The central question in this case is whether from the record of negotiations, letters, agreements, and other documents we can spell out a completed or executed contract before 5:20 a.m. of March 24, 1938, the date of decedent's death, or whether the option or offer to sell proposed by decedent did not mature into a contract until actually accepted by Davol on March 25. Or, as stated by counsel for the Government at the hearing, "The sole question is: was this agreement a binding agreement while Meinecke lived? 681 If it was, he individually was taxable on the profit made from that agreement. If the agreement did not become binding and enforceable during Meinecke's lifetime then the profit from that agreement is not taxable to Meinecke individually. A reading of the facts leads us clearly to the conclusion that petitioner is correct in his position and that no completed or enforceable contract was entered into during decedent's lifetime. There can be 639 no question that the parties so considered it. See Commissioner v. Segall, 114 Fed.(2d) 706. In the letter of March 18, 1938, transmitting the proposed agreement to Davol, the decedent stated: * * * I herewith offer said agreement for acceptance by you - provided the same is satisfactory to you and is accepted by you in writing on or before the 25th day of March 1938. In this letter decedent twice referred to the proposed agreement as an offer, stating: I agree that the offer which I make to you, as evidenced by said instrument, may be modified by you before the acceptance thereof by making minor changes therein * * * such changes, however, to be approved by my attorney, Mr. Warland, above mentioned, *682 and, if accepted by you with any such changes, will be fully binding upon me as if such changes had been made prior to my execution of the instrument. In Warland's letter to Davol, dated March 19, the arrangement is referred to as 23 to Warland, suggesting two typographic changes, states: these two changes, if you will forward the contracts to us, they will immediately be signed." Thus the matter stood when Meinecke died. The offer or option had not been accepted. The contracts had not been signed. Although on March 23 Davol fully intended to consummate the contracts, there existed a locus poenitentiae within which they could have changed their minds and elected not to sign and complete the contracts. The signature of Davol was affixed on March 25. At that time the offer ripened into a completed contract. Then and not before did Davol assume any enforceable obligations. Petitioner decedent was not taxable in his lifetime on the profit arising from the contract of March 25, 1938. See Lucas v. North Texas Lumber Co.,181 U.S. 11">181 U.S. 11. Decision will be entered under Rule 50.	01-04-2023	11-21-2020

Subsets and Splits

No community queries yet

The top public SQL queries from the community will appear here once available.