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https://www.courtlistener.com/api/rest/v3/opinions/4476013/	OPINION. Hill, Judge: Issues 1 and 2 are in reality a single issue and in this opinion will be treated as such. Petitioner as endorser guaranteed the debts of Sherrill Sherman, her husband, who had borrowed money and used the proceeds of the loan to provide working capital for a corporation, the stock of which was owned by the petitioner and Sherrill Sherman. During 1944 and 1945 the FDIC liquidated certain collateral of the petitioner held by it and applied the proceeds in payment of the pi'incipal of the note of Sherrill Sherman identified as Asset No. 1939, which the petitioner had endorsed and guaranteed. These payments were in the amounts of $9,767.70 and $4,575.74, respectively. In 1944 the petitioner had net long term capital gains of $825, no short term capital gains and no capital losses other than the amounts here in controversy. She treated the sum of $9,767.70 as a nonbusiness bad debt and claimed a short term capital loss under section 23 (k) (4)1 of $1,825 in her 1944 income tax return. In her 1945 return she claimed a capital loss carry-over of $7,942.70 ($9,767.70 minus $1,825, the sum of the net long term capital gains for 1944 plus $1,000), plus the 1945 payment of $4,575.74 as a short term capital loss under the provisions of section 23 (k) (4). When, as here, the endorser of a note is forced to answer and fulfill his obligation of guaranty, the law raises a debt in favor of the guarantor against the principal debtor. In short, the guarantor is subro-gated to the rights of the creditor against the primary debtor. Agnes 1. Fox, 14 T. C. 1160; Warren Leslie, Sr., 6 T. C. 488. The petitioner bases her claim to a nonbusiness bad debt deduction on this theory, claiming debts by subrogation against Sherrill Sherman which were worthless in the years in which they arose due to his insolvency. The respondent bases his opposition to the petitioner on this issue upon two grounds. First, the respondent argues that the sums in question do not. constitute bona fide debts and, second, that assuming the existence of a debtor-creditor relationship the debts did not become worthless in 1944 and 1945. The respondent argues that-the facts before us constitute a gift rather than a debt. He draws this conclusion from the close relationship between Sherrill Sherman and the petitioner. They were husband and wife. To support his conclusion the respondent relies upon Estate of Carr v. Van Anda, 12 T. C. 1158, where we said: Intrafamily transactions are subject to rigid scrutiny, and transfers from husband to wife are presumed to be gifts. However, this presumption may be rebutted by an affirmative showing that there existed at the time of the transaction a real expectation of repayment and intent to enforce the collection of the indebtedness. * * * Applying the “rigid scrutiny” of the Van Anda case to the facts before us, we find that the petitioner had no intention of making a gift to Sherrill Sherman at the time she endorsed Asset No. 1939 or at the time she endorsed the original notes out of which Asset No. 1939 grew. The respondent states that Sherrill Sherman never promised to pay the petitioner with respect to the sum in controversy. The respondent forgets that the obligation placed upon Sherrill Sherman by the petitioner’s payments upon her endorsement of his note is not dependent upon a promise to pay but rather upon an obligation implied by the law. If Sherrill Sherman had expressly repudiated his obligation, his action would have been immaterial to the collection of the debt-due and owing from him to the petitioner as the result of the payments made by her under her endorsement of his note. The obligation rests in a promise implied by the law. If we follow the respondent’s argument we would have to find as a fact that at the time of making the endorsement the petitioner agreed to waive any rights against Sherrill Sherman which might arise out of his inability to pay his debt when due. The facts negative any such finding. The petitioner was no mere accommodation endorser. She stood to benefit substantially. Sherrill Sherman made the note in order to secure funds with which to provide working capital for Sherman Sales Company, Inc. The petitioner and Sherrill Sherman were the sole stockholders of that corporation. If the funds loaned by Sherrill Sherman to the corporation had been sufficient to secure its safe passage through the depression the petitioner would have benefited substantially. To substantiate his theory of gift, the respondent also relies upon the fact that the petitioner never made a formal demand for payment against Sherrill Sherman. While under some circumstances this would be evidence of a gift, we do not think it important here. As will be pointed out shortly, Sherrill Sherman was completely insolvent during the years 1944 and 1945. For the petitioner to be entitled to a nonbusiness bad debt deduction under the provisions of section 23 (k) (4), it is not necessary for her to do a useless act. As to the respondent’s contention that the debts were not worthless in 1944 and 1945, our finding of fact is dispositive. Sherrill Sherman was completely insolvent at the time the debts arose in 1944 and 1945. Our finding is based upon the balance sheets submitted by Sherrill Sherman for the years 1944 and 1945 and upon the record as a whole. The taxpayer is not required to be an incorrigible optimist. The mere possibility that Sherrill Sherman, a man of 62 years in 1945. might one day recoup his losses and regain financial stability is not enough to warrant the respondent’s conclusion that the debts were not bad for the years in which the petitioner claimed her bad debt losses The petitioner is entitled to a nonbusiness bad debt deduction in 1945 of $12,518.44, (the capital loss carry-over of $7,942.70, plus the 1945 payment of $4,575.74) to be treated as a short term capital loss under the provisions of section 23 (k) (4). The third issue raises the question of the deductibility of certain claimed interest payments. Assets Nos. 1934, 1935, and 1936 held by' the FDIC were notes made by the petitioner. They called for interest at the rate of 6 per cent per annum. In 1945 the FDIC liquidated certain of petitioner’s assets which were held as collateral security for the payment of petitioner’s debts, debited the collateral accounts and credited the interest accounts on these notes in the amounts of $357.32, $320.88, and $275.82, respectively. It would appear without question that the petitioner is entitled to a deduction of $954.02 under section 23 (b)2 of the Code for interest paid. However, the respondent argues that this is not the case. He reasons that the petitioner’s interest payments were not voluntary but were the act of the FDIC in liquidating her collateral and applying the sums mentioned above towards the interest account on her notes. We find this reasoning specious. Affirmative action by the debtor in the payment of interest is not necessary where in fact his assets are applied to the payment of interest. Cf. Gertrude Rosenblatt, 16 T. C. 100. Further, the respondent argues that, since the petitioner and the FDIC were in dispute as to the amount of interest due on her obligations, the petitioner is not entitled to a deduction at the rate of 6 per cent which the FDIC collected but rather at the rate of which she contended was due, or 2 per cent. That the rate of interest was ir dispute, we think, is immaterial. It is settled that a cash basis taxpayer is entitled to a deduction for amounts paid within the taxable year. Cf. Chestnut Securities Co. v. United States, 62 F. Supp. 574; G. C. M. 25298, 1947-2 C. B. 39. That in a later year not before this Court the FDIC made an adjustment in the rate of interest theretofore charged is also irrelevant. At any rate, as shown by the record, petitioner never recovered any amounts which she paid to the FDIC in years prior to 1946, the year of the adjustment. Asset No. 1939 was made by Sherrill Sherman and endorsed by the petitioner. The interest rate thereon was at the rate of 6 per cent per annum. In 1945 the FDIC liquidated certain of petitioner’s assets held as collateral security for the payment of her debts, debited the collateral account and credited the interest account of Asset No. 1939 in the amount of $192.14. The petitioner claimed an interest deduction in the amount of $192.14. The respondent disallowed the deduction on the ground that the interest paid by the petitioner was interest paid on tbe indebtedness of Sherrill Sherman and hence nondeductible. In support of his position he relies upon Chester A. Sheppard, 37 B. T. A. 279, holding that interest payments made on the obligation of another do not meet the statutory requirement of interest deductions. However, this truism does not sustain the respondent’s position here, for the payment made by the petitioner was upon her obligation. When the FDIC found it necessary to go against the petitioner on her endorsement the petitioner was obligated not only for the principal due on Asset No. 1939 but the interest due and payable as well. See United States Fidelity & Guaranty Co., 40 B. T. A. 1010, 1019, 2 C. B. 113. The petitioner is entitled to deduct the sum of $1,146.16 as interest paid during the taxable year 1945. Decision will he entered for the petitioner. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing not income there shall be allowed as deductions; «•• (k) Bap Debts.— [[Image here]] (4) Non-bosiness debts. — In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the' loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term “non-business debt” means a debt other than a debt evidenced by a security as defined in paragraph (31- and other than a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade or business. (b) Interest. — All interest paid or accrued within the taxable year* on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other tbaif obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer), the interest upon which is wholly exempt from the taxes imposed by this chapter.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623306/	555, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent555, Inc. v. CommissionerDocket No. 18640United States Tax Court15 T.C. 671; 1950 U.S. Tax Ct. LEXIS 44; November 20, 1950, Promulgated 1950 U.S. Tax Ct. LEXIS 44">44 Decision will be entered under Rule 50. Primarily for the purpose of encouraging and retaining its employees, petitioner's directors on September 29, 1943, passed a resolution appropriating not more than $ 37,000 establishing an employees' pension plan, and the same day a tentative trust agreement was executed. Both the resolution and the tentative trust agreement recite that the fund shall be consistent with regulations governing same. On September 30, 1943, the close of the fiscal year, petitioner's employees were informed of this action. On November 27, 1943, petitioner mailed its check in the amount of $ 37,000 to the escrow agent and petitioner has continued to make contributions in all years through 1949. Ultimate compliance with all of the provisions of sections 23 (p) and 165 (a) was made within the grace period. Petitioner, on the accrual basis, deducted on its return for the fiscal year ending September 30, 1943, $ 33,177.15 as a contribution to an employees' pension plan. Held, respondent erred in determining that for the fiscal year ended September 30, 1943, petitioner's contribution was not deductible under section 23 (p) of the Internal Revenue Code. E. Chas. Eichenbaum, Esq., for the petitioner.John W. Alexander, Esq., for the respondent. Black, Judge. BLACK 15 T.C. 671">671 This proceeding involves a deficiency in declared value excess profits tax for the taxable year ended September 30, 1943, in the amount of $ 2,178.37 and deficiencies in excess profits tax for the taxable years ended September 30, 1943, and September 30, 1944, in the respective amounts of $ 27,333.50 and $ 2,106.98.The deficiencies result from numerous adjustments to petitioner's net incomes and an adjustment to petitioner's invested capital as disclosed by its returns for the taxable years ended September 30, 1943 and 1944. The portion of the deficiencies in contest results from respondent's determination that petitioner is not entitled to a claimed deduction of $ 33,177.15 for the taxable year ended September 30, 1943. This was explained in a statement attached to the deficiency notice as follows:(b) On your return for the taxable year ended September 30, 1943, you claimed a deduction of $ 33,177.15 as an accrued contribution to an employees' pension plan. It has been determined that no pension1950 U.S. Tax Ct. LEXIS 44">47 plan was in effect during the taxable year ended September 30, 1943, because the "Tentative Trust Agreement" executed September 29, 1943, did not set forth terms sufficient in detail for the operation of the plan proposed thereby, and the pension plan was not actually in existence until the execution of a complete trust indenture on December 31, 1943, more than 60 days after the close of the taxable year. The 15 T.C. 671">672 deduction of $ 33,177.15 has been denied, therefore, in accordance with the provisions of section 23 (p) of the Internal Revenue Code.By appropriate assignment of error petitioner contests this adjustment. Other adjustments to which petitioner originally assigned error and to which petitioner assigned error by amendment to petition have either been settled by stipulation or abandoned and will be handled in a recomputation under Rule 50.FINDINGS OF FACT.Most of the facts were stipulated and are so found. Other facts are found from the evidence.Petitioner, an Arkansas corporation, with its principal offices and place of business in Little Rock, Arkansas, is now and was during the taxable years herein engaged in the distribution of petroleum products, automotive1950 U.S. Tax Ct. LEXIS 44">48 supplies, mechanical equipment and appliances, and other items of merchandise. For all taxable years relative to this proceeding petitioner kept its books and filed its returns on an accrual basis and on a fiscal year ending September 30th. Petitioner filed its returns with the collector for the district of Arkansas.The following excerpt is from the minutes of September 29, 1943, of petitioner's board of directors:A report was had of current business activities and a resume of year-end operations was heard from the Chairman. Mr. R. A. Lile, auditor, was invited to discuss with the Directors the profit-sharing and pension trust plan, and after discussion the following resolution was passed, with no dissenting votes: "Be it resolved, That 555, Inc., create a profit-sharing fund for the benefit of the employees of the Company so as to provide retirement, old age, disability and death benefits on their having served the said Company a suitable period and having attained the age of retirement or suffered death or disability; that the said fund shall provide, consistent with regulations governing same, retirement income of 50% of annual salary at maximum benefit, with commensurate1950 U.S. Tax Ct. LEXIS 44">49 interim benefits based upon appropriate formula, to be determined by auditorial, legal and actuarial consultants."That an amount not to exceed $ 37,000.00 be forthwith appropriated expressly for the purpose of contribution by the company from 1943 fiscal year operations to the said fund, subject to the following:(1) That such portion of the $ 37,000.00 as shall not be required shall be returned to the company;(2) That the said funds be deposited in escrow subject to approval of the Internal Revenue Bureau of the said plan as proposed and/or amended, and that all of the said funds be returned to the company, in the event that approval be not given;(3) That the same conditions of escrow noted above shall prevail with reference to approval of the said plan by the War Labor Board and the Salary Stabilization Unit of the Treasury Department, so that no wage or salary stabilization regulations may be contravened thereby.15 T.C. 671">673 (4) That the said amount so escrowed shall be placed within sixty days in suitable depository for full compliance with requirements of regulations governing such plans.Be it further resolved that appropriate Trustees be named, to-wit:Wm. F. Shipp, Jr.C. 1950 U.S. Tax Ct. LEXIS 44">50 W. BlackwoodWm. J. Chamberlain,and that if any of the said Trustees be not qualified, that appropriate successors be hereafter chosen by the Company."On September 29, 1943, the following "Tentative Trust Agreement" was executed:This Tentative Agreement entered into this 29th day of September, 1943 by and between 555, Inc., 555 of Stuttgart, Inc., 555 of Pine Bluff, Inc., and R. E. Stueber, Consignee, parties of the first part, hereinafter referred to as the Company, and Wm. F. Shipp, Jr., C. W. Blackwood, and Wm. J. Chamberlain, all of Little Rock, Arkansas, parties of the second part, hereinafter referred to as the Trustees: witnessethWhereas, 555, Inc., concurred in by the other participants listed above, has had a directors' meeting appropriating a fund not to exceed $ 37,000.00 for the purpose of creating a Trust Fund for the benefit of employees of the Company, so as to provide retirement, old age, disability and death benefits on their having served the said Company a suitable period and having attained the age of retirement or suffered death or disability; that the said fund shall provide, consistent with regulations governing same, retirement income of 50% of annual1950 U.S. Tax Ct. LEXIS 44">51 salary at maximum benefit, with commensurate interim benefits based upon appropriate formula, to be determined by auditorial, legal and actuarial consultants: andWhereas, it is recognized that the final draft of this Trust Agreement will require a considerable amount of time and be subject to numerous revisions in order to fulfil the desire of the company and to meet the requirements of various governmental units having authority over same. It is mutally [sic] agreed that this tentative agreement shall serve to create the trust subject to final drafting of the trust agreement and the securing of approval of said trust agreement and that the parties hereto agree that the funds appropriated by the company shall be placed in estop [sic] in the Union National Bank pending the drafting of the completing instrument of trust.In witness whereof, the parties hereto have executed this Tentative Agreement this 29th day of September 1943.Trustees:[Signed] Wm. J. Chamberlain.Wm. J. Chamberlain.[Signed] Wm. F. Shipp, Jr.Wm. F. Shipp, Jr.[Signed] C. W. Blackwood.C. W. Blackwood.Company:555, Inc.,By [Signed] R. E. Stueber,President.[Signed] C. W. Blackwood,Secretary1950 U.S. Tax Ct. LEXIS 44">52 .15 T.C. 671">674 Affiliates:555 of Pine Bluff, Inc.,By [Signed] R. E. Stueber,President.[Signed] C. W. Blackwood,Secretary,555 of Stuttgart, Inc.,By [Signed] R. E. Stueber,President.[Signed] C. W. Blackwood,Secretary.[Signed] R. E. StueberR. E. Stueber,Consignee.By [Signed] R. E. StueberFollowing the meeting of petitioner's directors on September 29, 1943, the employees of petitioner were informed that a pension plan had been established for their benefit. Petitioner was losing numerous valued employees to other higher paying jobs and it was to stop in part this loss of personnel that petitioner entered into the tentative trust agreement in accordance with the resolution of its directors. Petitioner had been considering this action for months prior to September 29, 1943.On November 27, 1943, petitioner wrote a letter to the Union National Bank of Little Rock, Arkansas, the body of which is as follows:ATTENTION: Trust DepartmentThere is enclosed our check drawn on your bank payable to your order, as escrow agent, in the sum of $ 37,000.00. This amount is to be held by you in escrow in connection with the following matter.We have instituted an employees1950 U.S. Tax Ct. LEXIS 44">53 profit sharing plan. This plan contemplates an employees trust fund in which we should like for you to act as trustee. The preliminary draft of the trust instrument is now being revised and we expect it to be complete within the next few days. Upon completion of the trust instrument and the acceptance of the trust by you, you are to retain the amount required to be deposited under the trust in accordance with the plan ut [sic] of the funds paid to you today; the balance, if any, is to be returned to us. If there is a deficit we will immediately pay the deficit to you.Will you kindly acknowledge receipt of these funds to be held in accordance with this letter by signing and returning to us the enclosed carbon copy hereof?The following notation was made on the letter by a trust officer of the bank: "Received November 29, 1943. Union National Bank. By [signed] J. H. Bowen, V. P. and Trust Officer."The trust agreement and pension plan recognized by respondent in the deficiency letter as conforming with the requirements of sections 23 (p) and 165 (a) of the Internal Revenue Code and with the Regulations promulgated by the Commissioner in respect of such sections reads, in1950 U.S. Tax Ct. LEXIS 44">54 part, as follows:15 T.C. 671">675 PROFIT-SHARING TRUST AGREEMENT of 555, INC.Agreement made this 31 day of December, 1943, by and between 555, Inc., a corporation, of Little Rock, Arkansas, Party of the First Part, herein referred to as the "Corporation", and William F. Shipp, Jr., C. W. Blackwood, and William J. Chamberlain, Parties of the Second Part, herein referred to as the "Trustees".Witnesseth: ThatWhereas, The Corporation desires to create a profit-sharing trust for the benefit of its employees who qualify under the terms and conditions hereof, in order to provide certain financial protection for such employees upon retirement, and in the event of their death, for their dependents and beneficiaries:Now, therefore, in consideration of the mutual agreements herein contained, the parties hereto mutually agree as follows:I. Name of trust.The Profit-sharing trust hereby created shall be known as 555, INC., PROFIT-SHARING TRUST.Subsidiaries, affiliates, and/or wholly owned operations, preserving separate records, may be included under this trust agreement, subject to their written concurrence herein. Wherever the word "Corporation" is used hereinafter, it is to be denoted to mean1950 U.S. Tax Ct. LEXIS 44">55 the 555, Inc., and such concurring subsidiary, affiliate, and wholly owned operations. * * XX. Disclaimer by the corporation. The Corporation hereby relinquishes and disclaims all right, title and interest in any and all assets of the Trust, and the Trustees accept such disclaimer, save and except * * * (b) In no event shall any funds or property of the trust revert to the Corporation and no payment or other distribution to the Corporation shall be made by the Trustees except to pay to the Corporation the principal of and interest on moneys borrowed from it by the Trustees for the purpose of the Trust or to reimburse the Trustor (Corporation) for moneys advanced by it to others on behalf and with the consent of the Trustees for the benefit of the Trust or for moneys paid by the Corporation to the Trustees through mistake or error. In no event shall any part be used for, or diverted to, purposes other than for the exclusive benefit of the eligible employees as in this agreement provided.* * * XXVII. This Trust Agreement, hereinafter executed by the Corporation and its affiliates and the Trustees hereunder, shall serve as: (1) Declaration of Trust on behalf of1950 U.S. Tax Ct. LEXIS 44">56 the Corporation, and(2) Indenture of Trust, accepted by, ratified by, and promulgated on behalf of the said Trustees hereunder, andis executed in multiplicate, one each for the Corporation and each of the Trustees hereunto subscribed.In witness whereof the parties hereto have executed this Agreement, consisting of thirteen (13) pages, the day and year first above written, the said Trust to be and become effective as of September 30, 1943.On December 18, 1944, petitioner deposited $ 18,500 to its trust account. On November 24, 1945, $ 30,000 was deposited in this account 15 T.C. 671">676 and thereafter in 1946, 1947, 1948, and 1949 additional deposits have been made.In its return for the taxable year ended September 30, 1943, petitioner claimed a deduction of $ 33,177.15 for a contribution to an employees' pension trust. Respondent disallowed the deduction on the ground that the payment was not in conformance with section 23 (p) of the Internal Revenue Code.The petitioner in computing invested capital for the purpose of arriving at its excess profits credit for the fiscal year ended September 30, 1944, failed to take into consideration a reserve of $ 30,000 which had theretofore1950 U.S. Tax Ct. LEXIS 44">57 been created out of earnings of the Company and is designated on its books as a reserve for bad debts. This reserve is an item which should be taken into account in the computation of petitioner's invested capital for the fiscal year 1944.OPINION.The only question in this proceeding is whether petitioner is entitled to a deduction of $ 33,177.15 claimed by petitioner as a contribution to an employees' pension trust in the taxable year ended September 30, 1943.Respondent contends that petitioner's contribution is not deductible because: (1) it was not a contribution to a pension plan under section 23 (p) of the Internal Revenue Code, and (2) it was not a contribution paid to an employees' trust exempt under section 165 (a) and in effect during the taxable year ended September 30, 1943. Petitioner contends that the contribution is deductible because there was a plan on September 30, 1943, and the employees' trust was exempt under section 165 (a).In accordance with the Revenue Act of 1942 all contributions of an employer to an employees' pension plan must now come within section 23 (p) of the Internal Revenue Code or the contributions are not deductible. Tavannes Watch Co. v. Commissioner, 176 Fed. (2d) 211,1950 U.S. Tax Ct. LEXIS 44">58 and Times Publishing Co., 13 T.C. 329, affd. (CA-3), 184 Fed. (2d) 376. Section 23 (p) provides that contributions to an employees' pension plan are deductible if made to an employees' trust exempt under section 165 (a) of the Internal Revenue Code, or if to a trust not so exempt the individual employee must receive a nonforfeitable right in the contribution. Times Publishing Co., supra.Petitioner herein does not contend that each individual employee received a nonforfeitable right but rather that the contribution was to an employees' trust exempt under section 165 (a).At the time of petitioner's contribution it was not necessary that the employees' trust meet all the requirements of section 165 (a), for 15 T.C. 671">677 the Revenue Act of 1942 as finally amended by Section 2 of Public Law No. 511, December 20, 1944, provides as follows:1942 ACT, SEC. 162. PENSION TRUSTS.(d) Taxable Years to Which Amendments Applicable. -- The amendments made by this section shall be applicable as to both the employer and employees only with respect to taxable years of the employer beginning after December 1950 U.S. Tax Ct. LEXIS 44">59 31, 1941, except that -- * * * (2) A stock, pension, profit-sharing, or annuity plan -- (A) put into effect after September 1, 1942, and prior to January 1, 1945, shall be considered as satisfying the requirements of section 165 (a), (3), (4), (5), and (6) for the period beginning with the date on which it was put into effect and ending with June 30, 1945, if all provisions of the plan which are necessary to satisfy such requirements are in effect by the end of such period and have been made effective for all purposes with respect to the portion of such period after December 31, 1943;Petitioner does not contend that on September 30, 1943, the trust complied with the provisions of section 165 (a) (3), (4), (5), and (6). However as shown above such compliance was not necessary if ultimate compliance with these subsections was within the grace period. Respondent's requested findings of fact concede that within the allowed period, the trust was in complete conformance with section 165 (a); however, respondent contends that on September 30, 1943, even conceding a valid plan in existence under section 23 (p), the trust did not comply with subsections (1) and (2) of section1950 U.S. Tax Ct. LEXIS 44">60 165 (a) 1 of the Internal Revenue Code which subsections were not within the grace period above referred to provided by section 162 (d) of the Revenue Act of 1942.1950 U.S. Tax Ct. LEXIS 44">61 Petitioner argues, and we think rightly so, that on September 30, 1943, there was not only a pension plan but an employees' trust which met the requirements of section 23 (p) and subsections (1) and (2) of section 165 (a), when the retroactive provisions of section 23 (p) (1) (E) are considered. It is perfectly true that petitioner made no contribution to the tentative pension trust created September 29, 1943, at the time it was created, but it did make such a contribution 15 T.C. 671">678 in escrow on November 27, 1943, and this was within the 60-day grace period granted by section 23 (p) (1) (E).Having seen that there was a clearly designated trust res there remains to be seen whether or not there was an effective delivery to the trustees. The facts are that on November 27, 1943, which was within 60 days of the close of petitioner's tax year, a check in the designated amount was delivered to the Union National Bank of Little Rock, Arkansas, under cover of an escrow letter, now a part of the record and given in our findings of fact. Upon the delivery of property by the owner in escrow, with a declaration of his intent that at a later date or upon the happening of a specified event1950 U.S. Tax Ct. LEXIS 44">62 the holder should make delivery of the subject matter to a designated trustee to hold in trust without having reserved the power of revocation, a valid trust is created as of the date of delivery in escrow. Smith v. Youngblood, 68 Ark. 255">68 Ark. 255, 58 S.E. 42 (pay over on death of settlor); Hudgens v. Taylor, 206 Ark. 507">206 Ark. 507, 176 S. W. (2d) 244; Nolen v. Harden, 43 Ark. 307">43 Ark. 307, 51 Am. Rep. 563">51 Am. Rep. 563; and Williams v. Smith, 66 Ark. 299">66 Ark. 299, 50 S.W. 513 (delivery later date); Restatement, Trusts, Sec. 32, Comment c. This latter comment contained in subparagraph (c), § 32, Restatement of Trusts, reads as follows:c. Deposit in escrow. Where the owner of property delivers in escrow the subject matter or an instrument of transfer, manifesting an intention that upon the happening of a certain event the depositee should hold the property in trust or should deliver the subject matter or the instrument to a third person as trustee, and the owner does not reserve a power of revocation, a trust is created at the1950 U.S. Tax Ct. LEXIS 44">63 time of the delivery in escrow. Although the title to the property does not pass to the trustee until the happening of the event, in the meantime he holds in trust such rights as are created in him as a result of the deposit in escrow. At the time of the delivery in escrow there is a presently created trust and not merely a trust to arise in the future, although the trust property is at first the rights under the deposit in escrow, and, later, on the happening of the condition, the trust property is the property transferred. It is not a deposit in escrow, however, and no trust arises at the time of the deposit, if the depositor reserves a power of revocation or if the specified event is merely the depositor's future mental desire or intention (compare Restatement of Contracts, § 103).In petitioner's case the contingent event designated in the escrow declaration was the approval of the plan by the Internal Revenue Bureau. It is further worthy of note that when the Commissioner of Internal Revenue later on approved the plan and the trust the fund was then deposited to the account of the trust itself to which all subsequent contributions by the company have been made. These subsequent1950 U.S. Tax Ct. LEXIS 44">64 contributions have been allowed as deductions by the Commissioner.In order that we may understand that petitioner did make a contribution to the trust within the time required by law certain excerpts from sections of the Revenue Code under which petitioner claims its 15 T.C. 671">679 deductions are quoted and combined to form the following sentence: "In computing net income there shall be allowed as deductions": (section 23, I. R. C.) "Contributions of an Employer to an Employees' Trust * " (section 23 (p), I. R. C.) "in the taxable year when paid, * " (section 23 (p) (1) (A), (B), and (C). [Emphasis added.]The effect of the above quoted clause in section 23 (p) (1) (A), (B), and (C) is to place all taxpayers on a cash basis. 2 To remedy this situation section 23 (p) (1) (E), I. R. C., was added to the bill as originally introduced in the House of Representatives and the Senate. 3 Subparagraph (E) provides:(E) For the purposes of subparagraphs (A), (B), and (C), a taxpayer on the accrual basis shall be deemed to have made a payment on the last day of the year of accrual if the payment is on account of such taxable year and is made within sixty days after the close of the1950 U.S. Tax Ct. LEXIS 44">65 taxable year of accrual.Section 23 (p) (1) (E) "is intended to permit a taxpayer on the accrual basis to deduct such accrued contribution or compensation, provided payment is actually made within 60 days after the close of the year of accrual." Regulations 111, section 29.23 (p)-1.Let us assume that an accrual taxpayer at the close of the taxable year establishes a trust fund and a pension plan which meet all of the requirements of sections 23 (p) and 165 (a). The taxpayer, however, merely accrues his contribution but makes actual payment within 60 days of the close of the year of accrual. What would be the purpose of section 23 (p) (1) (E) if we said that the contribution was not deductible because there was no trust res at the close of the taxable year and, therefore, no trust within section 165 (a)? The very1950 U.S. Tax Ct. LEXIS 44">66 purpose of section 23 (p) (1) (E) was to relieve a taxpayer who did not make his payment within his taxable year but did make it within 60 days thereafter.The construction which we have given above to section 23 (p) (1) (E) seems to be the same as that given by the Commissioner in Mim. 5985, 1946-1 C. B. 72. In that mimeograph the Commissioner says:1. Section 23 (p) (1) (A) and (C) of the Internal Revenue Code provides for deductions of contributions paid into a trust which is exempt under section 165 (a) of the Code. A trust is exempt under the latter section upon compliance with certain requirements, one of which is that it be part of a stock bonus, pension, or profit-sharing plan. Thus, the plan must be in effect before the trust is entitled to exemption under that section. Further, there must be a valid and existing trust to which the contribution is made. If an essential element of a trust is lacking there is, in effect, no trust. Thus, if the trust corpus is lacking, it can not be said that a trust is in existence. The corollary, therefore, is that exemption under section 165 (a) applies to an existing trust, complete in all respects, inclusive1950 U.S. Tax Ct. LEXIS 44">67 of possession of the corpus.15 T.C. 671">680 2. Section 23 (p) (1) (E) of the Code provides that a taxpayer on the accrual basis shall be deemed to have made a payment, for the purposes of subparagraphs (A), (B), and (C), on the last day of the year of accrual if the payment is on account of such taxable year and is made within 60 days after the close of the taxable year of accrual. Subparagraph (A) pertains to a pension trust and subparagraph (C) to a stock bonus or profit-sharing trust. Thus, if there is a trust, the taxpayer on the accrual basis is permitted to make his contribution thereto within 60 days after the close of the year of accrual. Subparagraph (E), however, does not create a trust or relate a trust back to a period when in fact it had no existence.3. The effect of the aforesaid requirements is that contributions to an employees' trust, to constitute allowable deductions, must be made pursuant to a plan in effect and to a valid existing trust which is recognized as such under the law prevailing in the jurisdiction to which the trust is subject.4. Under the authority of section 3791 (b) of the Internal Revenue Code, the aforesaid rule will be deemed to have1950 U.S. Tax Ct. LEXIS 44">68 been complied with for taxable years ending on or before February 28, 1946, in the case of a taxpayer on the accrual basis, if all requisites have been met on or before the last day of the year of accrual except the furnishing of the trust corpus, which must be supplied within 60 days after the close of such taxable year of accrual. [Emphasis added.]It is our view that the tentative trust set up by petitioner September 30, 1943, was complete and effective in so far as section 165 (a) (1) and (2) is concerned, except the paying in of the trust corpus. That defect was cured by the payment which petitioner made on November 27, 1943. The resolution of petitioner's directors and the tentative trust agreement both state that the petitioner's action was for the purpose of creating a fund "for the benefit of employees of the company * * * consistent with regulations governing same * * ." We construe this to mean that conformance with section 165 (a) (1) and (2) was thereby made and that a pension plan as required by 23 (p) was thus complied with, except as to certain details which required the Commissioner's approval. The resolution of September 29, 1943, speaks of creating a pension1950 U.S. Tax Ct. LEXIS 44">69 trust plan and goes on to say, as stated above, that it was to be consistent with regulations governing same. The avowed purpose was that the contribution meet the requirements of the law within which petitioner seeks to bring its contribution. In Tavannes Watch Co. v. Commissioner, supra, the court said in holding that a corporation was a trust within section 165 (a) that:* * * "Trust" is not a term of art or of fixed content, and its meaning for the purposes of this section is not necessarily the same as under state law or as under other sections of the Internal Revenue Code.We think that the word "plan" is also to be given a broad construction consistent with the intent of the parties and that on September 29, 1943, petitioner created a pension plan within the meaning of section 23 (p) and an employees' trust as contemplated by section 165 (a). 15 T.C. 671">681 We think this was so, even though some important details had yet to be worked out.Petitioner's plan, as completed, has been approved by respondent and contributions to the trust have been made each year from 1943 to 1949, inclusive.Respondent argues that the tentative trust agreement does1950 U.S. Tax Ct. LEXIS 44">70 not make it impossible for the fund to be diverted to purposes other than for the exclusive benefit of the employees or their beneficiaries as required by section 165 (a) (2). The resolution of September 29, 1943, states:* * * That the fund shall be deposited in escrow subject to the approval of the Internal Revenue Bureau of said plan as proposed and/or amended, and that all of said funds be returned to the Company in the event approval be not given.This recital does not take the trust outside of section 165 (a) (2) and thereby prevents the deduction of contributions thereto for we held in Surface Combustion Corporation, 9 T.C. 631, affd., 181 Fed. (2d) 444, that a contribution to an otherwise valid plan contingent on respondent's approval was a contribution which was irrevocable and, therefore, deductible. 41950 U.S. Tax Ct. LEXIS 44">71 Respondent's final argument points to phrases in the trust instrument executed December 31, 1943, such as this, "Whereas the corporation desires to create * ." Respondent suggests that there was no reason for "desiring" to create a trust on December 31, 1943, if one was already in existence. We think that this argument only serves to cloud the issue for the December 31, 1943, instrument sets out that it relates back to September 30, 1943, and the original instrument recognized that revision would be necessary, and that the tentative trust was to serve only until final drafting was completed. These revisions were the ones contemplated by the tentative agreement in order that the trust ultimately conform with section 165 (a) (3), (4), (5), and (6). It was as to these latter subparagraphs that Congress extended the grace period up to 1945.The parties have stipulated that the actuarial data submitted to respondent with reference to the deduction of contributions to 555, Inc. Pension Trust for the fiscal years 1943 and 1944 is made a part of the record and shall be available for a computation under Rule 50. In the computation under Rule 50 petitioner's excess profits tax credit1950 U.S. Tax Ct. LEXIS 44">72 for the year ended September 30, 1944, will be adjusted in accordance with the stipulation of the parties which is set out in the last paragraph of our findings of fact.Decision will be entered under Rule 50. Footnotes1. SEC. 165. EMPLOYEES' TRUSTS.(a) Exemption From Tax. -- A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall not be taxable under this supplement and no other provision of this supplement shall apply with respect to such trust or to its beneficiary -- (1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees or their beneficiaries the corpus and income of the fund accumulated by the trust in accordance with such plan;(2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees or their beneficiaries;↩2. Hearings before the Committee on Finance, United States Senate on H. R. 7378, 77th Congress, Second Session, Statement of Richard D. Sturtevant, pp. 455, 465↩.3. H. R. 7378, sec. 165↩.4. See IT: PS No. 47, February 20, 1945, for payments prior to March 2, 1945, conditioned on respondent's approval or stockholder ratification.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623308/	YAKOV AND MARINA LYUBAROV, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentLyubarov v. CommissionerDocket No. 3619-91United States Tax CourtT.C. Memo 1992-283; 1992 Tax Ct. Memo LEXIS 311; 63 T.C.M. 3025; May 18, 1992, Filed 1992 Tax Ct. Memo LEXIS 311">311 An order will be entered dismissing this case for lack of jurisdiction on the ground that the petition was not timely filed. Yakov and Marina Lyubarov, pro se. William J. Gregg, for respondent. PAJAKPAJAKMEMORANDUM OPINION PAJAK, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. All section numbers refer to the Internal Revenue Code for the taxable year in issue. All Rule numbers refer to the Tax Court Rules of Practice and Procedure. This case is before the Court on respondent's motion to dismiss for lack of jurisdiction. Petitioners filed an objection. Respondent filed a reply to petitioners' objection. The sole issue for decision is whether the notice of deficiency was mailed to petitioners' "last known address" within the meaning of section 6212(b). Respondent determined a deficiency and additions to tax in petitioners' 1986 Federal income tax as follows: Additions to TaxDeficiencySec. 6653(a)(1)(A)Sec. 6653(a)(1)(B)$ 3,363 $ 16850 percent of theinterest due on theunderpaymentattributable tonegligence of $3,363.For convenience, we have combined the1992 Tax Ct. Memo LEXIS 311">312 findings of fact and opinion. Petitioners resided in Brooklyn, New York, at the time they filed their petition in this case. On March 19, 1990, respondent sent a notice of deficiency to petitioners at the following address: 222 East 8th Street Brooklyn, N.Y. 11218 This was also the address on petitioners' timely filed 1988 Federal income tax return. Petitioners' 1989 Federal income tax return was filed with the Brookhaven Service Center in Holtsville, New York, no earlier then March 5, 1990, the date petitioners signed that return. The address on petitioners' 1989 return was: 1530 East 8th Street Brooklyn, N.Y. 11230 It is well settled that to maintain an action in this Court there must be a valid notice of deficiency and a timely filed petition. ; . The Commissioner is authorized to send a notice of deficiency by certified or registered mail if she determines there is a deficiency in tax. Sec. 6212(a). Mailing the notice of deficiency to the taxpayers' last known address shall constitute sufficient notice. Sec. 6212(b)(1). Once1992 Tax Ct. Memo LEXIS 311">313 the notice of deficiency has been mailed, the taxpayers have 90 days (150 days if addressed to a person outside the United States) in which to file a petition with this Court. Sec. 6213(a). It is well settled that a notice of deficiency is valid even if it is not received. , affg. an unpublished Order of this Court; ; , affd. without published opinion . Due to the administrative burdens of the Internal Revenue Service (IRS), Congress did not intend to require actual notice. Rather, it permitted the use of a method that would ordinarily result in such notice. . The statute is satisfied as long as the notice of deficiency is mailed to the taxpayers' "last known address". The notice of deficiency in the instant case was returned to respondent on March 28, 1990, as unclaimed 1992 Tax Ct. Memo LEXIS 311">314 and moved, not forwardable. Nothing in section 6212(b) requires the IRS to take additional steps to deliver the notice if it is returned. Respondent sent a notice of deficiency to petitioners on March 19, 1990. The petition would have been timely if filed on or before June 18, 1990. Petitioners did not file their petition with this Court until February 25, 1991, in an envelope bearing a United States postmark dated February 20, 1991. The petition is untimely because it was filed after the expiration of the 90-day period after the issuance of the notice of deficiency. Accordingly, this case must be dismissed. If respondent issued a valid notice of deficiency, the petition must be dismissed for lack of jurisdiction as untimely. However, if jurisdiction is lacking because of respondent's failure to issue a valid notice of deficiency, we will dismiss the case on that ground. , affd. without published opinion . The taxpayers' "last known address" is the address to which, in light of all surrounding circumstances, 1992 Tax Ct. Memo LEXIS 311">315 respondent reasonably believed the taxpayers wished the notice of deficiency to be sent. . The taxpayers' last known address is that address which appears on the taxpayers' most recently filed return, unless respondent has been given clear and concise notification of a different address. . Petitioners argue that the notice of deficiency was not sent to their "last known address" because it was mailed to 222 East 8th Street (as reflected on the notice of deficiency dated March 19, 1990) instead of 1530 East 8th Street (as reflected on their 1989 return, filed no earlier than March 5, 1990). The taxpayers' most recently filed return is that return which has been properly processed by an IRS Service Center such that the address appearing on the return was available to respondent's agent when she sent the notice of deficiency to petitioners. . The address from a recently filed return is available to the agent issuing the notice of deficiency, if such address could be obtained by an IRS computer transcript. 1992 Tax Ct. Memo LEXIS 311">316 Ms. Lilian Cohen is a manager in the Brookhaven Service Center in Holtzville, New York. Ms. Cohen detailed the manner in which returns were processed during the relevant time period and how they were coded into the IRS computer system. Between January and April, the Brookhaven Service Center processes several million returns. She testified that the new address as reflected on petitioners' 1989 Federal income tax return would not have been accessible by computer by any of respondent's agents until April 9, 1990. We found Ms. Cohen to be a credible witness. Because the notice of deficiency was issued before respondent's agent could have accessed, by an IRS computer transcript, petitioners' new address as reflected on their 1989 return, we find the notice of deficiency was properly mailed to petitioners' last known address within the meaning of section 6212(b). ; , affd. . Petitioners contend that respondent should be required to exercise greater diligence1992 Tax Ct. Memo LEXIS 311">317 to discover the taxpayers whereabouts, prior to mailing the notice of deficiency, citing cases where respondent was aware that the taxpayers had moved before mailing the notice of deficiency. , revg. and remanding ; , revg. and remanding ; , revg. and remanding . These cases are distinguishable. In , also cited by petitioners, this Court stated: We agree that after respondent becomes aware of a taxpayer's change of address, she must exercise reasonable care and diligence in ascertaining and mailing the notice of deficiency to the correct address. ; Alta Sierra Vista v. Commissioner, 62 T.C. 374. However, this obligation arises only if respondent becomes aware of an address change prior to mailing1992 Tax Ct. Memo LEXIS 311">318 the deficiency notice to the taxpayer's last known address. [Emphasis in original.]There is no such evidence in this record that respondent became aware of an address change prior to mailing the notice of deficiency to petitioners at their last known address. We reject petitioners' contention. Rule 142(a); . We hold that petitioners' petition was not timely filed within the meaning of section 6213(a). Accordingly, respondent's motion to dismiss for lack of jurisdiction will be granted. Petitioners are not without a remedy. They may pay the tax, file a claim for refund, and, if the claim is disallowed, file a refund suit in the United States District Court or the United States Claims Court. Sec. 7422; . An order will be entered dismissing this case for lack of jurisdiction on the ground that the petition was not timely filed.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623309/	Estate of John H. Engwall, Deceased, Stina Carlson and Oscar Jacobson, Co-Administrators v. Commissioner.Estate of Engwall v. CommissionerDocket No. 45018.United States Tax CourtT.C. Memo 1956-6; 1956 Tax Ct. Memo LEXIS 290; 15 T.C.M. 29; T.C.M. (RIA) 56006; January 16, 19561956 Tax Ct. Memo LEXIS 290">290 Increase in net worth. - Decedent had an estate of some $166,000 at time of his death in 1949. He had not filed returns since 1937. Opening net worth determined and the increase in net worth in the intervening years held to be income for such years and properly to be allocated ratably over such years. Penalties. - Delinquency penalties sustained. Recoupment. - Claimed offset of barred overpayment of estate tax against income tax deficiencies in these proceedings is not within the jurisdiction of this Court. R. C. Pierce, Esq., 10 LaSalle Street, Chicago, Ill., for the petitioners. J. Bruce Donaldson, Esq., for the respondent. ATKINSMemorandum Findings of Fact and Opinion The respondent determined deficiencies in income taxes1956 Tax Ct. Memo LEXIS 290">291 of petitioner's decedent, and delinquency penalties for the years and in the amounts as follows: Penalty UnderYearIncome TaxSection 291(a)1939$ 459.99$ 115.001940530.50132.6319411,128.03282.0119421,875.32468.8219432,597.96649.4919441,927.24481.8119451,801.84450.4619461,444.04361.0119471,444.04361.0119481,291.24322.81Period 1-1-49 to8-13-49775.76193.94Total$15,275.96$3,818.99In the absence of any records of the income of the decedent for the above period, the respondent reconstructed income by determining the amount of the increase in the decedent's net worth in that period and spreading the increase evenly over the period. The petitioner alleges error in the respondent's determination that the decedent had any income in excess of interest and dividends, in failing to consider available records, in the determination of net worth at the beginning of the period, and in determining the deficiencies in an arbitrary and capricious manner. A claim is also made for the offset of overpaid estate tax against the income tax deficiencies. Findings of Fact Some of the facts have been stipulated1956 Tax Ct. Memo LEXIS 290">292 and by this reference are found as stipulated. The petitioner is the estate of John H. Engwall who died intestate on August 13, 1949. The decedent residedt at 1912 Lincoln Park West, Chicago, Illinois, at the time of his death. The decedent was born August 27, 1879. He was an only child. He never married. He lived with his father and mother until the death of his father, Andrew W. Engwall, in 1915. Thereafter he lived with his mother and supported her until her death in 1943. After his mother's death and until his death, he continued to reside in the same three-room apartment in which he had lived with his mother. His death was sudden, and occurred while he was in another city attending a convention of a fraternal organization. The decedent's father was believed to have been successful in his business operations. He loaned money to immigrants from Sweden, which was his native country, and for a number of years operated a well patronized tavern which was situated in a good location, across the street from a harvester manufacturing plant. He sold that tavern about 1910 and retired for a while, but in order to have something to do he acquired another tavern which he operated for1956 Tax Ct. Memo LEXIS 290">293 a few years. It was not a profitable enterprise. The decedent was the administrator of his father's estate. The assets in that estate amounted to $4,015.33, which, after expenses was distributed as follows: $1,883.89 to John H. Engwall (the decedent herein) and $1,941.89 to the widow, Charlotte Engwall. No estate was probated on the death of the decedent's mother. Agents of the respondent searched the probate records from 1915 to 1949 and also searched the gift tax records but found no record of the decedent's having received any other inheritance or gift. The agents of the respondent also made a reasonable investigation in an attempt to find any business or source of income of decedent during the years in controversy, but, except as pointed out herein, found none. The investigation included examination of records of the collector of internal revenue for the period 1913 to 1949, a Chicago newspaper morgue, personal and business directories, probate court records, bank records, some 50 volumes of county real estate records, title company records, and bond purchase and sale records of the Treasury Department. In 1901 the decedent was admitted to the practice of law in Illinois. He1956 Tax Ct. Memo LEXIS 290">294 engaged in the practice of law some time thereafter and prior to the year 1919. Along with his law practice he carried on an advertising business in which he advertised the products of others in various rural publications. Neither of these ventures was profitable. Also at some time prior to 1919 he operated a small book store in Chicago which was not a profitable venture, and his father was required to furnish him with cash to carry on the project. On October 4, 1919, the decedent became a full-time employee of the Chicago Title & Trust Company, at a starting salary of $25 per week. He remained in that employment until March 15, 1938. During that period of employment with the Chicago Title & Trust Company (including his retirement pay) the decedent was paid a total of $69,778.50. These payments, by years, were as follows: Salary Received FromChicago Title & Trust1919$ 325.0019202,400.0019212,585.0019222,600.0019232,845.0019243,105.0019253,630.0019264,080.0019274,160.0019284,160.0019294,640.0019304,680.0019314,680.0019324,374.0019333,793.5019344,032.0019354,212.0019364,212.0019374,212.0019381,053.00Total$69,778.501956 Tax Ct. Memo LEXIS 290">295 There is no record of the decedent's having filed income tax returns for any years prior to the year 1920. For each of the years 1920 to 1937, inclusive, the decedent filed income tax returns on which he showed amounts of income tax as set out below. The returns are no longer in existence. Based on the tax reported at the prevailing rates, the decedent's net taxable income for each of those years was the amount shown in the following tabulation: TaxableTax ShownNet TaxableYearon ReturnIncome1920$36.40$2,910.00192136.073,401.75192252.903,822.50192373.684,956.00192429.444,462.50192524.455,505.33192624.455,505.33192716.814,994.00192813.174,670.6719294.134,602.00193011.064,483.33193112.564,616.67193269.994,249.75193346.563,664.00193485.475,039.95193560.164.425.20193642.823,967.22193740.973,915.83Total$79,192.03The respondent's records disclose that no income tax returns were filed by the decedent for the years 1938 to 1948, inclusive. In 1951 the administrators of his estate filed an income tax return for him for the period January 1, 1949 to1956 Tax Ct. Memo LEXIS 290">296 August 13, 1949, in which they reported gross income of $535 and no tax due. In 1945 or 1946 the decedent rented a small office in the Consumer's Building in Chicago. The rental was $20 or $25 per month which he paid by check. He occupied the office for a period of two or three years. The furniture that he moved into the office consisted of a desk and a chair. He had no employees in the office. His name appeared on the office door and also the name Acme Advertising Service. The only papers that were seen in his office were out-of-town country newspapers. A bank account maintained in the name of Acme Advertising Service at The First National Bank of Chicago was an account solely owned by the decedent. The account was opened on January 23, 1939, with a deposit of $582.96. The year-end balances in the account from the date of opening to the date of the decedent's death were as follows: 1939$ 577.891940515.891941790.321942900.151943866.2719442,296.2719452,041.5019463,129.8519474,291.0419482,098.8519492,311.11The decedent at all times in his adult life was shabby in appearance, wore patched and frayed clothing, and apparently1956 Tax Ct. Memo LEXIS 290">297 spent very little. When he had an office in the Consumer's Building he carried with him daily a shopping bag and shopped for food. The furniture in his apartment was very poor, and the whole lot was sold by his administrators for $9. He never owned an automobile. His only known extravagance was his annual attendance at a fraternal convention. On the appointment of the administrators of the decedent's estate they inspected the decedent's apartment. It was in a very disorderly condition, and contained a lot of old soiled clothing and old umbrellas. No books or records pertaining to the decedent's business affairs were found in the apartment. Cash in the amount of $168 was found in a tobacco can, and various smaller sums of cash were found in old books. The key to the decedent's apartment and a safe deposit key were on the decedent's person and turned over to the administrators. The safe deposit box was located in the First National Bank of Chicago. It was found to contain a few small pieces of jewelry and foreign coins, several bank books, some $23,000 in cash, and municipal and Federal government bonds. The bank books found in the sale deposit box disclosed that the decedent then1956 Tax Ct. Memo LEXIS 290">298 had deposit accounts in nine banks in Chicago in addition to the account carried in the name of Acme Advertising Service. He had also previously had two other bank accounts which had been closed out in 1931. The year-end totals in all of the accounts, including that of Acme Advertising Services were as follows: YearYear End Totals1925$ 200.0019263,032.0019271,232.001928904.0319292,222.0019304,846.7319312,532.0019322,406.001933120.0119341,522.0019352,650.00193612,920.00193716,386.10193819,860.14193927,465.51194028,075.89194129,434.32194230,484.15194330,870.27194432,252.77194532,373.55194633,792.14194735,400.37194833,645.10194934,511.11At the date of decedent's death he owned municipal bonds which had a face value of $79,000. These had been acquired in the years 1921 to 1949, inclusive, in an aggregate face amount of $86,500, and in the years 1923 to 1935 he had sold some in the face amount of $7,500. The net cumulative totals are as follows: YearCumulative Totals1921$ 1,00019233,50019282,50019357,500194016,500194117,500194232,500194342,500194547,500194652,500194757,500194883,500194986,500Sold at various dates$ 7,500On hand at date of death$79,0001956 Tax Ct. Memo LEXIS 290">299 At the date of death the decedent owned United States Government bonds Series E and G as follows: YearAcquiredSeriesFace Amount1941E$ 3,0001942G5,0001943G2,000Total$10,000At the date of death the decedent owned United States Treasury bonds in the face amount of $18,400. Of these, $15,400 were 1955-60 series, 2 7/8 per cent interest, and $3,000 were 1951-55 series, 3 per cent interest. The date of acquisition of these bonds is not known. At the date of death the decedent owned 100 shares of stock in Illinois Brick Company which he had acquired in 1930. The cost of the shares is not known. These were sold by the decedent's estate for a net amount of $1,258.09. In 1933 the decedent acquired a parcel of land from a Chicago bank, as trustee, under a deed on which documentary stamp tax was 50 cents, tending to indicate a consideration or value of from $100 to $500 (Section 725, Revenue Act of 1932). The decedent conveyed that parcel to others on June 24, 1942, by warranty deed. The documentary tax stamps attached to the deed would tend to indicate a consideration in the amount of $7,000. In 1935 a parcel of land was conveyed to the1956 Tax Ct. Memo LEXIS 290">300 decedent by warranty deed. The tax stamps attached to the deed amounted to 50 cents, tending to indicate a consideration or value of from $100 to $500. That parcel was conveyed to others by the decedent by warranty deed recorded on November 12, 1941. The tax stamps attached would tend to indicate a consideration in the amount of $10,800. The decedent acquired either one or two pieces of rental property some time in the 1930's. He sold one about 1946. The record does not show the amounts of rental received, but the decedent had told his cousin that the rental was not profitable. The decedent's administrators converted his properties to cash. The total cash received by the administrators, including cash on hand and the bank deposits, amounted to $169,777.54. Of this total, $166,240.65 represented assets owned by the decedent at the date of his death, and the remaining $3,536.89 represented earnings on the principal during the period of probate. Of the principal of $166,240.65 representing assets owned by the decedent at the date of death, the sum of $28,618.23 represents assets (cash of $19,860.14 on deposit, municipal bonds of $7,500, and the 100 shares of Illinois Brick Company, 1956 Tax Ct. Memo LEXIS 290">301 cost unknown, but included at $1,258.09, the amount at which they were sold by the estate) that are known to have been acquired by the decedent prior to January 1, 1939. Assets on which the administrators received $96,150.97 (exclusive of interest) are represented by bank deposits made after December 31, 1938, and securities acquired after that date. Of the total assets of $166,240.65 held at time of death, an amount of $41,461.45 represents assets, the acquisition dates of which are unknown. These consisted of cash on hand and in safe deposit box, and the U.S. Treasury bonds, hereinabove referred to, in the amount of $18,400. The figures in this paragraph do not include any amounts on account of real estate. The decedent was not known to have owned any real estate at the date of his death. Disbursements by the administrators during the period of administration amounted to $43,444.69 which included $5,000 set up as a reserve for possible income tax deficiency and for possible adjustment of Federal estate tax. The balance of $126,332.85 ($169,777.54 minus $43,444.69) was distributed to 31 first cousins of the decedent in the amount of $4,075.25 to each of some and $4,075.26 to each1956 Tax Ct. Memo LEXIS 290">302 of others. The administrators filed a Federal estate tax return on April 11, 1950. It was examined and recommendation was made for acceptance as filed. The estate tax shown thereon in the amount of $19,024.74 was paid. The period of limitation for the adjustment of the estate tax liability expired on August 11, 1953. No liability for Federal income tax of the decedent was used in the computation of the estate tax liability. If the income tax liability of the decedent existing at the date of his death (as finally determined in this proceeding) had been used as a deduction in computing the liability for estate tax, it would have reduced the amount of estate tax determined and paid. The respondent determined that in the period from January 1, 1939 to August 13, 1949, there was an increase in the decedent's net worth of $99,973.15, and treated that amount as his net income for the period. The respondent took $66,267.50, the total earnings of decedent as an employee of the Chicago Title & Trust Company up to his retirement in 1938, as decedent's net worth at January 1, 1939, and subtracted that figure from the value of decedent's estate at date of death, $166,240.65, and thus arrived1956 Tax Ct. Memo LEXIS 290">303 at the net increase of $99,973.15. This amount he spread ratably over the period, treating $9,287.22 as being income in each of the years 1939 to 1948, inclusive, and $5,347.20 as income for the period January 1 to August 13, 1949. 1 In computing the deficiencies the respondent reduced the income that was so determined by amounts of tax-exempt interest from municipal bonds and for personal exemptions. He allowed standard deductions from gross income for the years in which such deductions are allowable. No income tax returns were filed by the decedent for any of the years 1939 to 1948, inclusive. An income tax return for the decedent for the period January 1, 1949 to August 13, 1949, was filed by the coadministrators in 1951. Opinion ATKINS, Judge: The respondent has determined deficiencies in income tax based on an amount that he determined to represent an increase in the decedent's net worth over the period that began with January 1, 1939, and ended with the date of death of the decedent, August 13, 1949. The respondent's1956 Tax Ct. Memo LEXIS 290">304 starting point was the amount of $66,267.50 which he determined had been received by the decedent from the title company in the 20-year period of employment there. The terminal point of the respondent's determination was the figure of $166,240.65 which is set forth in the notice of deficiency as the value of the decedent's estate comprised of the following major categories: Cash$ 57,732.60U.S. Treasury bonds18,400.00U.S. Savings bonds10,000.00Municipal bonds79,000.00Stock1,050.00Miscellaneous58.05Total$166,240.65Counsel for the petitioner argues that the reasonable inferences to be drawn from the evidence are against the decedent's having had substantial income in the taxable period; that while not much is known about the decedent's early business and professional activities, his known frugality makes it reasonable to assume that he saved a substantial portion of whatever earnings he realized. Also, it is pointed out, that in the prime years of the decedent's life when he was employed by the title company his earnings did not reach an annual average of $4,000. In the later period of the decedent's life it is pointed out that his only known1956 Tax Ct. Memo LEXIS 290">305 activity was the operation of a small advertising business which produced little or no income, and that he could not have had much interest income based on the meager yield of his bonds. Counsel also refers to the opinion of one witness that in the years in question the decedent's mind was not clear and that he could not have engaged in business successfully. After fully considering the record and the contentions of both parties, we have concluded that this is a case where resort to a net worth method of determination of income is amply justified. In reaching our conclusion we have been appreciative of the difficulties that confront the petitioner in contesting the respondent's determination. It was said in Holland v. United States, 348 U.S. 121">348 U.S. 121, that where the basic assumption that most assets derive from a taxable source is not true, "the taxpayer is in a position to explain the discrepancy." Here the taxpayer who might give an explanation of the increase in net worth is dead. He left no records that are helpful to his administrators. It also appears that he was secretive by nature and did not confide in others as to his business affairs. His administrators are his1956 Tax Ct. Memo LEXIS 290">306 first cousins, one of whom saw the decedent fairly frequently but never learned anything about the decedent's affairs. One witness expressed his opinion that the decedent may have acquired property from his father by gift or inheritance, but nothing was known by his relatives or other acquaintances that gave substance to this and the respondent's investigation failed to disclose any such gift or inheritance. At death and during the taxable period the decedent was possessed of substantial property. As far as is known, he had nowhere near that quantity of property at the beginning of the period. The rather constant increase over the years in controversy of the bank accounts and the bond holdings, strongly indicate that the decedent had a substantial source of income in those years, over and above any income from his bank accounts and security holdings. We must assume, under the basic rule referred to in the Holland case, that the increase in net worth derived from taxable sources. Apparently the decedent kept no record of his income; at least none has been found by his administrators other than bank books. In contesting the deficiencies, the petitioner points out that of the two1956 Tax Ct. Memo LEXIS 290">307 factors used in the respondent's net worth calculation, only one, namely, the net worth at the time of death, is known. It says that there is no evidentiary basis to support the respondent's treatment of the decedent's earnings while employed by the title company as the decedent's net worth at the beginning of the taxable period. It is, of course, an essential condition to the validity of a net worth calculation that an opening net worth be established with reasonable certainty to serve as a starting point. 348 U.S. 121">Holland v. United States, supra, see also Thomas v. Commissioner, 223 Fed. (2d) 83, in which the Court said: "Despite the essential difference between the burden of proof in a criminal case and that in a Tax Court deficiency determination, we see no reason why the determination of opening net worth should be any less vital to the validity of the method of computation invoked in the one type of case than in the other." In this case the respondent has not rested on the presumption of correctness that attaches to his determination, but has actively endeavored to establish the amount of beginning net worth. His representatives have made investigations1956 Tax Ct. Memo LEXIS 290">308 that indicate what seems to us to be an unusual degree of diligence. The results of much of this investigative work were negative. The pertinent facts that it did produce are set out in our findings of fact. The assets owned by the decedent at death amounted to a total of $166,240.65. Of the money and property making up that figure, the respondent was able to ascertain the bank deposit date or acquisition date of $124,769.20, of which only $28,618.23 was ascertained to have been acquired prior to January 1, 1939. However, instead of using this latter figure, the respondent used the amount of $66,267.50, stated by him to be the amount of the decedent's earnings through 1938 (on which he paid income tax) based on information obtained from the title company by which decedent had been employed from 1919 until early 1938. The respondent did not reduce this figure by any amount on account of living expenses over those years. Thus, the figure used by the respondent was generous in amount compared with the value of assets now known to have been acquired before 1939. It now develops that decedent's actual earnings from the title company amounted to $69,778.50. Based upon the whole record, 1956 Tax Ct. Memo LEXIS 290">309 we approve the use by the Commissioner of the net worth method of computing the decedent's income for the years in question. Furthermore, for lack of any evidence upon which a better allocation of income over the years can be made, we think that it was not error for the respondent to spread the increase in net worth evenly over the years in the taxable period. 2 There is no reason to believe that this method of allocation is inequitable from the standpoint of the taxpayer. However, it is our opinion that a more realistic figure representing net worth at January 1, 1939, would be $70,089.68, which consists of the value of the assets held at time of death which were known to have been held at January 1, 1939 ($28,618.23), plus the value at date of death of the assets as to which the date of acquisition was unknown ($41,471.35). We consider it fair to assume that the latter assets were owned at January 1, 1939. Furthermore, since these assets consisted almost entirely of cash and bonds, we may assume that the value substantially represents cost. This figure of $70,089.68 closely approximates the actual earnings which the decedent received over the years from the title company. It is1956 Tax Ct. Memo LEXIS 290">310 about $10,000 less than the total income which the returns of the decedent for the years 1920 to 1937 would indicate was received, but over that span of years the taxpayer must have expended at least the difference for living expenses. Upon recomputation the figure of $70,089.68 will be used as net worth at January 1, 1939, instead of the figure of $66,267.50 used by the Commissioner in the notice of deficiency. The petitioner urges us to reject the respondent's determination as being without rational foundation, citing Helvering v. Taylor, 293 U.S. 507">293 U.S. 507. However, for the reasons indicated above we do not consider the respondent's determination as being without rational foundation. On the other hand, we do not rest our decision upon the ground that petitioner has failed to meet its burden of proof, but, rather, have reached our conclusion upon the stipulated facts, plus all the evidence presented at the hearing. The assertion of delinquency penalties, reduced in amounts based on the reduced taxes that will follow from increasing the beginning net worth, must be approved. No returns were filed for the years 1939 to 1948, inclusive, and the return for the period January1956 Tax Ct. Memo LEXIS 290">311 1 to August 13, 1949, was not filed until some time in 1951. No reasonable cause has been shown for the delinquency. See section 291(a), Internal Revenue Code of 1939. The petitioner claims that if deficiencies are found in this proceeding they should be offset by an overpayment of Federal estate tax. As has been stipulated, any outstanding income tax liability of the decedent would reduce the amount of estate tax. Petitioner's counsel, while claiming this right of recoupment, with commendable frankness concedes that there is doubt as to our power to grant it. The offsetting of a barred overpayment against a deficiency is not within our jurisdiction. Section 272(g), Internal Revenue Code of 1939; Commissioner v. Gooch Milling & Elevator Co., 320 U.S. 418">320 U.S. 418. Decision will be entered under Rule 50. Footnotes1. These figures add up to a total of $98,219.40. The difference between that sum and the determined increase in net worth of $99,973.15 is not explained.↩2. Cf. United States v. Ridley, 120 Fed. Supp. 530 [54-1 USTC ¶ 9299↩].	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623310/	Portland Copper & Tank Works, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentPortland Copper & Tank Works, Inc.Docket No. 90564United States Tax Court43 T.C. 182; 1964 U.S. Tax Ct. LEXIS 18; November 17, 1964, Filed November 17, 1964, Filed 1964 U.S. Tax Ct. LEXIS 18">18 Decision will be entered for respondent. Petitioner, an accrual basis taxpayer, entered into renegotiable contracts with another company which had a contract to supply items to the Federal Government. Petitioner's contracts with the other company provided for price redetermination with increased payments to be made to petitioner or refunds made to the other company depending on the renegotiated price. Petitioner set up a reserve for its estimate of amounts refundable with respect to its billings for its fiscal year ended January 31, 1959, and reduced its gross sales by the amount of this reserve in computing its taxable income on its Federal income tax return. Held, petitioner's reduction of its taxable income by the amount of its reserve for refund on its contracts is improper since sections 1341 and 1482, I.R.C. 1954, provide the method of adjustment for such refunds and also because petitioner's liability for refunds was contingent and not properly accruable. John M. Doukas, for the petitioner.Albert Doyle and Harold Arcaro, for the respondent. Scott, Judge. SCOTT 43 T.C. 182">183 Respondent determined a deficiency of $ 449,413.94 in petitioner's income tax for its fiscal year ended January 31, 1959. The issue for decision is whether in computing its taxable income, petitioner properly reduced its gross sales for its fiscal year 1959 by the sum of an amount which it had proposed as a refund to its principal customer under price redeterminable contracts1964 U.S. Tax Ct. LEXIS 18">20 and an amount which it had estimated as the refund applicable to other such contracts.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Portland Copper & Tank Works, Inc., hereinafter referred to as petitioner, is a corporation organized under the laws of the State of Maine with its principal office at 80 Second Street, South Portland, Maine.Petitioner filed its Federal income tax return for its fiscal year ended January 31, 1959, with the district director of internal revenue for the district of Maine.At all times material hereto, petitioner kept its books and accounts and filed its Federal income tax returns on an accrual basis of accounting.Petitioner is a manufacturing company which engages in subcontract work for other contractors who furnish military and defense products to agencies of the U.S. Government. During the year here involved, petitioner's principal activity was the manufacture of jet engine components as a subcontractor for the General Electric Co., hereinafter referred to as General Electric.General Electric contracted with petitioner for production of specific items by means of purchase orders stating fixed prices, arrived 1964 U.S. Tax Ct. LEXIS 18">21 at by negotiation of the parties. The purchase orders were subject to a General Electric "Price Redetermination Supplement Applicable to United States Government Contracts and Subcontracts."Under the price redetermination supplement, the fixed prices shown on the purchase order were subject to change through negotiation at a future time. This redetermination supplement provided in part:43 T.C. 182">184 (3) Times for Negotiation.(a) At the time indicated or upon completion of delivery of the per-cent of the items to be furnished under this contract as stated on the face of the order, the parties shall negotiate to revise the prices of all items theretofore and thereafter to be delivered. Not more than thirty days after the time indicated or the completion of delivery of the percent, as stated on the face of the order, the Seller shall furnish to the Buyer the statements and data referred to in Clause (5) of this Supplement. * (b) For the purposes of the first negotiation contemplated by this Clause, the date of execution of this contract shall be deemed to be the effective date of the price revision. * ** * * (5) Submission of Data. -- At the time or each of the times1964 U.S. Tax Ct. LEXIS 18">22 specified or provided for in Clause (3) of this Supplement the Seller shall submit (i) a new estimate breakdown of the unit cost and proposed prices of items remaining under this contract after the effective date of the price revision, itemized so far as is practicable in the manner prescribed by Form DD 784 or the equivalent Government form; (ii) an explanation of the difference between the original (or last preceding) estimate and the new estimate; (iii) such relevant shop and engineering data, cost records, overhead absorption reports and accounting statements as may be of assistance in determining the accuracy and reliability of the new estimate; (iv) a statement of experienced costs of production hereunder to the extent that they are available at the time or times of the negotiation of the revision of prices hereunder; and (v) any other relevant data usually furnished in the case of negotiation of prices under a contract. The Government may make such examination of the Seller's accounts, records and books as the Contracting Officer may require and may make such audit thereof as the Contracting Officer may deem necessary.(6) Negotiations.(a) Upon the filing of the statements1964 U.S. Tax Ct. LEXIS 18">23 and data required by Clause (5) of this Supplement, the Seller and the Buyer will negotiate promptly in good faith to agree upon prices for items to be delivered on and after the effective date of the price revision. Negotiation for price revisions under this Supplement shall be conducted on the same bases, employing the same types of data (including, without limitation, comparative prices, comparative costs, and trends thereof) as in the negotiations of prices under a new contract.(b) After each negotiation the agreement reached will be evidenced by a supplemental agreement stating the revised prices to be effective with respect to deliveries on and after the effective date of the price revision (or such other later date as the parties may fix in such supplemental agreement).(7) Disagreements. -- If within 120 days after the date on which the statements and data are required pursuant to Clause (3) of this Supplement to be filed (or such further period as may be fixed by written agreement) the Buyer and the Seller fail to agree to revised prices, the failure to agree shall be deemed to be a disagreement as to a question of fact and shall be submitted for decision of the Contracting1964 U.S. Tax Ct. LEXIS 18">24 Officer having cognizance of the prime contract. He shall reduce his decision to writing and mail or otherwise furnish a copy thereof to the Buyer and the Seller. Within 30 days from the date of receipt of such copy, both the Buyer and the Seller shall have the right of appeal by mailing or otherwise furnishing to the Contracting Officer a written appeal addressed to the Secretary of the service involved, and the decision of the Secretary or his duly authorized representative for the hearing of such appeals shall, unless determined by a court of competent jurisdiction to have been fraudulent or capricious 43 T.C. 182">185 or arbitrary or so grossly erroneous as necessarily to imply bad faith, or not supported by substantial evidence, be final and conclusive; provided that, if no such appeal is taken, the decision of the Contracting Officer shall be final and conclusive and the prices so fixed shall remain in effect for the balance of the contract or until any subsequent effective date of price revision authorized by this Supplement. In connection with any appeal proceeding under this Supplement, the Buyer and the Seller shall both be afforded an opportunity to be heard and to offer evidence1964 U.S. Tax Ct. LEXIS 18">25 in support of their positions. Pending final decision of a disagreement hereunder, the Seller shall proceed deligently with the performance of the contract and in accordance with the Contracting Officer's decision.(8) Payments. -- Until new prices shall become effective in accordance with this Supplement the prices in force at the effective date of the price revision shall be paid upon all deliveries, subject to appropriate later revision made pursuant to Clause (6) or (7) or (9), 2., (B), of this Supplement.(9) Termination Provisions. -- For any of the purposes of the Termination Clause of this contract (including, without limitation, the computation of the "total contract price" and "the contract price of work not terminated"), the contract price of delivered articles shall be deemed to be: 1. For all items delivered prior to the effective date of the price revision, the contract price (giving effect to any prior revisions under this Supplement) applicable to each such item;2. For all items delivered on or after the effective date of the price revision: (A) The contract price as revised in accordance with this Supplement, if such revision shall have [been] agreed1964 U.S. Tax Ct. LEXIS 18">26 upon; and(B) If such revision shall not have been agreed upon then such estimated prices as the Seller and the Buyer with the approval of the Contracting Officer may agree upon as reasonable under all the circumstances and in the absence of such agreement and approval, such reasonable prices as may be determined in accordance with the Clause herein entitles [sic] "Disagreements".As a result of any redetermination petitioner might be required to refund amounts received under the purchase orders or General Electric might be required to pay additional sums to petitioner. When price redetermination negotiations were completed, new purchase orders would be executed, reflecting the corrected price of the items.Under its accounting practice, petitioner set up an account receivable due from General Electric when each item was billed at the current purchase order price. The sales account was credited with the full amount so billed at the time of the billing.The following entries were made on petitioner's books as of January 31, 1959, the last day of its fiscal year:Provision for contract readjustment$ 55,649.02Reserve for contract readjustment$ 55,649.02To provide for contract priceadjustments per H.H. & M.worksheet.Provision for contract readjustment811,134.24Reserve for contract readjustment811,134.24To provide a reserve for estimatedrefunds on price redeterminablejobs not yet completed.1964 U.S. Tax Ct. LEXIS 18">27 43 T.C. 182">186 Petitioner reported gross sales on its income tax return for the taxable year ended January 31, 1959, in the amount of $ 10,513,239.40, which represents gross sales reduced by the amount of $ 866,783.26, the balance of the "Provision for contract readjustment." Thus, gross sales prior to the adjustment were $ 11,380,022.66.Petitioner reduced the accounts receivable on its books by $ 866,783.26, the amount of its "Reserve for contract readjustment."The $ 55,649.02 item entered on petitioner's books represents initial proposals made by petitioner to General Electric for refunds under price redeterminable contracts. The amount was calculated by petitioner's cost accountant, whose primary functions were the preparation and submission of the price redetermination proposals on price redeterminable contracts and the preparation and submission of claims pertaining to canceled Government contracts. In reaching his determination, the cost accountant made an analysis of the total cost, including profit, that had been incurred on specific jobs. He took into consideration the cost of direct labor, direct material, outside purchases, outside services, charges for overhead, and profit. 1964 U.S. Tax Ct. LEXIS 18">28 The $ 811,134.24 item entered on petitioner's books is an amount which petitioner estimated would have to be refunded to General Electric under price redeterminable contracts. None of this amount had been proposed by petitioner to General Electric as refundable as of January 31, 1959.The amounts entered on its books represented petitioner's unilateral proposals and estimates of refunds which it would have to make under its price redeterminable contracts with General Electric.Fixed price redeterminable contracts, such as petitioner had with General Electric, are used with respect to new items where the Government or a prime contractor is uncertain at the time of the making of the contract as to the production costs of the item and is unable to make a reasonable estimate of such costs. No negotiations took place between petitioner and General Electric and no refunds were made in regard to any of the reserve in issue here during petitioner's fiscal year ended January 31, 1959.Refund proposals submitted by petitioner to General Electric in price redetermination negotiations subsequent to January 31, 1959, with respect to contracts to which the reductions here involved related were1964 U.S. Tax Ct. LEXIS 18">29 larger than the amount of the reserve established by petitioner as of January 31, 1959.The $ 866,783.26 here involved related to 64 original purchase orders of which 34 were dated subsequent to January 1, 1958, and 30 were dated prior to January 1, 1958.Petitioner entered amounts in a "Reserve for contract readjustment" account on its ledger for years prior to and subsequent to its fiscal year here in issue.43 T.C. 182">187 The balance in petitioner's "Reserve for contract readjustment" account on February 1, 1958, was $ 14,003.20. On August 15, 1960, petitioner filed a claim for refund of taxes paid in the amount of $ 157,842.36 for its fiscal year ended January 31, 1958, based upon its agreement to refund $ 303,543 to General Electric "on selling prices changed in the fiscal year ended January 31, 1958."Petitioner made refunds of undisclosed amounts with respect to its billings to General Electric during its fiscal year ended January 31, 1959, on undisclosed dates subsequent to January 31, 1959.Respondent in his notice of deficiency increased petitioner's income as reported on its return for its fiscal year ended January 31, 1959, by the amount of $ 866,783.26 with the following 1964 U.S. Tax Ct. LEXIS 18">30 explanation:Reserve for contract readjustment on completed contracts that are subject to price redetermination, where no fixed or determinable amount has been agreed upon, held not deductible. No deduction would be allowed under Section 1482 of the Internal Revenue Code, without repayment.OPINIONPetitioner contends that the "Reserve for contract readjustment" account set up on its books was a proper method of accounting in accord with accepted accounting principles and clearly reflected its net income. Petitioner concludes from this premise that under sections 446 and 451 of the Internal Revenue Code of 1954, 1 it properly reduced its gross sales by the amount of this reserve in computing its taxable income.1964 U.S. Tax Ct. LEXIS 18">31 Respondent argues that sections 1341 and 14822 set forth an exclusive 43 T.C. 182">188 congressional scheme for handling price redeterminable contracts involving Government procurement and that petitioner is therefore required to report the full amount of the contract prices. Respondent states that the Internal Revenue Code contains no provision for a reserve for repayments being considered in determining taxable income.1964 U.S. Tax Ct. LEXIS 18">32 We agree with respondent that the enactment of sections 1482 and 1341 was a congressional expression that price redeterminable subcontracts should be handled in the manner outlined therein. It is apparent from the congressional reports accompanying the Technical Amendments Act of 1958 3 that the new sections were designed to give "relief" to subcontractors, which relief would not have been necessary had Congress contemplated that subcontractors could set up reserves for refunds estimated to be due another under price redeterminable contracts and adjust income thereby for Federal income tax purposes. 41964 U.S. Tax Ct. LEXIS 18">33 Sections 1341 and 1482 are the only provisions of the Internal Revenue Code relating directly to the treatment of price redeterminable subcontracts where the refund is to someone other than a governmental agency.In Overlakes Corporation, 41 T.C. 503">41 T.C. 503 (1964), we held that a contractor under a renegotiable Government contract was not entitled to deduct a similar reserve for amounts refundable to the U.S. Government under such contract. In that case we stated (p. 515):43 T.C. 182">189 we have before us a situation where petitioner was attempting to anticipate a price adjustment under a Government contract which was subject to a price redetermination under the Armed Services Procurement Act. That Act, in conjunction with the provisions in the 1939 Code as will be discussed hereinafter, provides for a specific method of relief for handling refunds under Government contracts such as we have here and we do not believe that petitioner is entitled to depart from that scheme and attempt to handle the adjustments by claiming a deduction for a reserve for the recapture of excessive profits on Government contracts. 51964 U.S. Tax Ct. LEXIS 18">34 As to contracts entered into after January 1, 1958, petitioner contends that, since section 1482 was enacted to provide substantially the same benefit to subcontractors making repayments to a party other than a governmental agency as section 1481 provides for contractors and subcontractors who make refunds directly to the United States or one of its agencies, section 1481(a)(4) 6 should be considered applicable to section 1482. Since section 1482 which was enacted after section 1481 contains no provision similar to section 1481(a)(4), petitioner's contention is without foundation. In any event in the instant case, petitioner has not established "to the satisfaction of the Secretary or his delegate that a different method of accounting * * clearly reflects income." Also, petitioner has failed to show how much of the "reserve" in issue is attributable to contracts entered into after January 1, 1958.1964 U.S. Tax Ct. LEXIS 18">35 The fact that petitioner is an accrual basis taxpayer does not remove it from the provisions of sections 1341 and 1482 or justify its deduction of a reserve for an amount which had not become a fixed liability. 41 T.C. 503">Overlakes Corporation, supra. In Holmes Projector Co. v. United States, 105 F. Supp. 690">105 F. Supp. 690 (Ct. Cl. 1952), certiorari denied 344 U.S. 912">344 U.S. 912, rehearing denied 345 U.S. 914">345 U.S. 914, the court, in discussing that taxpayer's contention that the amounts due under renegotiable contracts did not accrue until the renegotiation was completed, stated (p. 693):We think there can be no question as to the authority of Congress to tax the full amount of earnings from contracts subject to renegotiation as income for the year in which such amounts were paid or payable under the terms of such contracts, subject to proper adjustments for such year in the event of renegotiation and the reduction in a subsequent year of the total receipts or profits. * 43 T.C. 182">190 Section 1482(a)(1) specifically refers to the amount "received or accrued."Petitioner accrued the amounts due under the 1964 U.S. Tax Ct. LEXIS 18">36 terms of the contracts as gross sales on its books when it billed General Electric and it does not specifically contend that this was not proper. Rather, it claims not to have "earned" the amounts it placed in reserve. Petitioner had established a legally enforceable right to receive the amounts as fixed payments for sales under the contracts. Commissioner v. Hansen, 360 U.S. 446">360 U.S. 446 (1959). In fact, insofar as the evidence in this case shows, petitioner may have actually received the payments. But see 360 U.S. 446">Commissioner v. Hansen, supra.While petitioner had made a unilateral determination that amounts would have to be refunded, the claim was contingent and unenforceable. 41 T.C. 503">Overlakes Corporation, supra.By far the largest part of the reserve was at best an estimate arrived at by applying "cost factors." Until negotiations or the other procedures provided for under the contracts were completed, and the amounts refundable definitely fixed, the amount of refunds was uncertain.The fact that petitioner's establishment of a reserve for contract refund may have been in accord with generally accepted1964 U.S. Tax Ct. LEXIS 18">37 accounting principles is not necessarily determinative in accounting for income for Federal income tax purposes where the statutory scheme requires a different method. American Automobile Association v. United States, 367 U.S. 687">367 U.S. 687 (1961), and Schlude v. Commissioner, 372 U.S. 128">372 U.S. 128 (1963).Decision will be entered for respondent. Footnotes1. All references are to the Internal Revenue Code of 1954 unless otherwise indicated.SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.(a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.SEC. 451. GENERAL RULE FOR TAXABLE YEAR OF INCLUSION.(a) General Rule. -- The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.↩2. SEC. 1341. COMPUTATION OF TAX WHERE TAXPAYER RESTORES SUBSTANTIAL AMOUNT HELD UNDER CLAIM OF RIGHT.(a) General Rule. -- If -- (1) an item was included in gross income for a prior taxable year * * (2) a deduction is allowable for the taxable year * (3) the amount of such deduction exceeds $ 3,000,then the tax imposed by this chapter for the taxable year shall be the lesser of the following: (4) the tax for the taxable year computed with such deduction; or(5) an amount equal to -- (A) the tax for the taxable year computed without such deduction, minus(B) the decrease in tax under this chapter * * for the prior taxable year * * * which would result solely from the exclusion of such item * * * from gross income for such prior taxable year * * ** * * (b) Special Rules. -- * * * (2) Subsection (a) does not apply to any deduction allowable with respect to an item which was * * * stock in trade * * * or property held by the taxpayer primarily for sale to customers * * . This paragraph shall not apply if the deduction arises out of payments or repayments made pursuant to a price redetermination provision in a subcontract entered into before January 1, 1958 * SEC. 1482. READJUSTMENT FOR REPAYMENTS MADE PURSUANT TO PRICE REDETERMINATIONS.(a) General Rule. -- If, pursuant to a price redetermination provision in a subcontract to which this section applies, a repayment with respect to an amount paid under the subcontract is made by one party to the subcontract (hereinafter referred to as the "payor") to another party to the subcontract (hereinafter referred to as the "payee"), then -- (1) the tax of the payor for prior taxable years shall be recomputed as if the amount received or accrued by him with respect to which the repayment is made did not include an amount equal to the amount of the repayment, and(2) the tax of the payee for prior taxable years shall be recomputed as if the amount paid or incurred by him with respect to which the repayment is made did not include an amount equal to the amount of the repayment.(b) Subcontracts to Which Section Applies. -- Subsection (a) shall apply only to a subcontract which is subject to renegotiation under the applicable Federal renegotiation act.(c) Limitation. -- Subsection (a) shall not apply to any repayment to the extent that section 1481 applies to the amount repaid.(d) Treatment in Year of Repayment. -- The amount of any repayment to which subsection (a) applies shall not be taken into account by the payor or payee for the taxable year in which the repayment is made; but any overpayment or underpayment of tax resulting from the application of subsection (a) shall be treated as if it were an overpayment or underpayment for the taxable year in which the repayment is made.↩3. S. Rept. No. 1983, 85th Cong., 2d Sess. (1958), General Explanation, pp. 83-84, 85-86, 1958-3 C.B. 922, 1004-1005, 1006-1007, and Technical Explanation, sec. 66, pp. 214-215, 1958-3 C.B. 1135-1136. Conference Rept. No. 2632, 85th Cong., 2d Sess., 1958-3 C.B. 1188↩, 1222.4. Petitioner does not contend that its contracts were not renegotiable contracts within the meaning of secs. 1482 and 1341↩.5. The section of the 1939 Code to which reference is made contained provisions similar to those of sec. 1481 of the 1954 Code permitting a reduction in income tax for a prior taxable year where a refund has actually been made to the United States or to one of its agencies under a price redeterminable contract.↩6. SEC. 1481. MITIGATION OF EFFECT OF RENEGOTIATION OF GOVERNMENT CONTRACTS.(a) Reduction for Prior Taxable Year. -- * * * (4) Exception. -- The foregoing provisions of this subsection shall not apply in respect of any contract if the taxpayer shows to the satisfaction of the Secretary or his delegate that a different method of accounting for the amount of the payment, repayment, or disallowance clearly reflects income, and in such case the payment, repayment, or disallowance shall be accounted for with respect to the taxable year provided for under such method, which for the purposes of subsection (b) and (c) shall be considered a prior taxable year.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623311/	LEONARD and EVELYN PARKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Parker v. CommissionerDocket No. 6452-73.United States Tax CourtT.C. Memo 1976-225; 1976 Tax Ct. Memo LEXIS 177; 35 T.C.M. 986; T.C.M. (RIA) 760225; July 20, 1976, Filed Solomon Fisher and Peter J. Picotte, II, for the petitioners. Alan E. Cobb, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined the following deficiencies and additions to tax in petitioners' Federal income tax: Section 6653(a) 1 Tax YearDeficiencyAddition to Tax1967$20,424.20$1,021.2119686,748.95337.4519693,473.33173.67The issues presented for decision are: (1) Whether petitioners had unreported income in each of the years in issue; (2) Whether petitioner, Leonard Parker, obtained credit in the form of playing chips1976 Tax Ct. Memo LEXIS 177">178 and cash at various gambling casinos by fraud and with no intention to repay such credit, and whether such funds less repayments constitute taxable income to petitioners in the years in issue; (3) Whether results of a polygraph examination of petitioner, Leonard Parker, are admissible into evidence; (4) Whether any part of any underpayment of taxes was due to negligence or intentional disregard of the rules and regulations within the meaning of section 6653(a); (5) If the Court holds that petitioners omitted income, whether petitioners are entitled to use income averaging; and (6) Whether petitioner, Evelyn Parker, is an innocent spouse within the meaning of section 6013(e). Issues (3), (4), (5), and (6) become moot if we hold for petitioners on issues (1) and (2). FINDINGS OF FACT Some of the facts have been stipulated and are so found. At the time petitioners filed their petition, they resided in Philadelphia, Pennsylvania. Petitioners filed joint returns for 1967, 1968 and 1969, using the cash receipts and disbursements method of accounting. Petitioner Evelyn Parker is a party only by virtue of having filed a joint income tax return with her husband, and petitioner1976 Tax Ct. Memo LEXIS 177">179 Leonard Parker will be referred to herein as "petitioner." Petitioner was born in 1929 and left school after completing the tenth grade. After leaving school he worked at various jobs until 1946 when he enlisted in the Army and served for approximately two years. Upon his discharge from the service in late 1947, he worked in Macon, Georgia as a candid photographer and Miami, Florida as a car attendant. Subsequently he returned to Philadelphia and enrolled in the Line-O-Type Institute of Philadelphia under the GI Bill of Rights program. Failing to find employment in the Line-O-Type field, he went to work selling shoes in various retail shoe stores. In 1950 he married Evelyn, and took a position with Abbott's Dairy as a milk truck driver. He later became a brakeman for Reading Railroad, but he sustained an injury and was forced to leave that position. He then took a position driving a taxicab for the Yellow Cab Company in Philadelphia. He eventually returned to selling shoes and in approximately 1962 he became an independent contractor selling shoes, on a commission basis, for Barclay Shoe Company. He worked continually for Barclay Shoe Company from 1962 to late 1969, when1976 Tax Ct. Memo LEXIS 177">180 the company went out of business. After Barclay discontinued operations, petitioner was employed by the Stern Shoe Company of Philadelphia as a salaried shoe salesman. As a commissioned salesman for Barclay Shoe Company, petitioner had approximately 150 accounts in a geographic area which covered the states of Pennsylvania, southern New Jersey, Delaware, Maryland, parts of Virginia and West Virginia, and the District of Columbia. Petitioner worked full time during the years 1967 through 1969 for Barclay Shoe Company and devoted at least 40 hours per week to contacting his various accounts.In addition, he attended at least 12 shoe shows per year in an attempt to increase his sales. Since the shoe shows took place on weekends, he occasionally had his wife accompany him. At the end of each month, petitioner received a statement from the Barclay Shoe Company indicating the sales transacted during the month and the commissions earned thereon, together with a check in the amount of the commissions. At the end of each year, the company issued petitioner a Form 1099 showing the total commissions paid by the company to him during the year. In each of the years in issue, petitioner1976 Tax Ct. Memo LEXIS 177">181 reported the income shown on the Form 1099 on his tax return. Similarly, he received a wage and tax statement, Form W-2, from the Stern Shoe Company for the period in 1969 during which he was employed by that company, and he reported that income on his tax return for 1969. During the years 1967, 1968 and 1969 petitioner engaged in no trade or business other than the shoe business. Other than interest and dividends reported on his income tax returns for the years in issue and the small amount of wages reported in the 1967 return, petitioners did not have any income other than that earned from the shoe business. Petitioner reported gross income from all sources during the years in issue as follows: 196719681969Salaries and Wages$ 443.62$ 3,900.00Dividends and Interest560.05$ 654.94761.40Schedule C (Gross)5,982.849,074.186,975.00$6,986.51$9,729.12$11,636.40During each of the years 1967, 1968 and 1969, petitioners were insolvent. At the time of trial their liabilities exceeded their assets by about $20,000. During each of the years at issue petitioners supplied over half the total cost of supporting their family. 1976 Tax Ct. Memo LEXIS 177">182 They expended a modest amount on their family's personal living expenses. Each week petitioner gave his wife about $30 to purchase food and other necessities. Additional assistance came from Evelyn's parents who gave her spending money and food. The Parker family frequently ate at Evelyn's parents' house, sometimes as often as three times a week. Petitioners maintained a modest lifestyle. They did not entertain at home or go out for amusement and, except for occasions when Evelyn's parents took her and the children to Atlantic City, they did not travel for pleasure or go on vacations other than trips to gambling casinos described hereinafter. Evelyn's clothes and those of her children were made by her father who was a tailor. Petitioner did not provide his wife any luxuries, such as furs and jewelry, during this period. Petitioner has gambled all his life. He played the horses, bet on ball games, and played cards. He used to play poker every Saturday night with friends. One night the police raided the poker game and arrested all the players. One of the poker players was a known bookmaker named Larry Geller who had with him wagering information from his day's business. 1976 Tax Ct. Memo LEXIS 177">183 Geller denied the information belonged to him. After the players, including petitioner, were discharged from jail the next day, Geller asked petitioner if he could use petitioner's telephone temporarily. Geller was afraid to use his own because the police knew he was a bookmaker. Petitioner agreed to let Geller use the telephone in his basement for a week in return for $50 (which Geller never paid him).One night while petitioner was having dinner with his family in the kitchen and Geller was using the basement telephone, the police came and arrested both petitioner and Geller. On May 10, 1966, petitioner was convicted of being a proprietor of a gambling house, pool selling, bookmaking and conspiracy, and fined $100. During the years 1967 through 1969, various gambling casinos in Las Vegas, Nevada, and elsewhere offered free transportation, lodging and meals to persons interested in gambling. In early 1967, petitioner was invited to participate in such a gambling junket to Caeser's Palace in Las Vegas. He looked upon the junket as a vacation which he and his wife could not otherwise afford. Every customer who participated in a gambling junket was given a specific line of1976 Tax Ct. Memo LEXIS 177">184 credit by the casino sponsoring the junket which he could draw against by executing markers. Generally, a casino customer deciding to obtain credit from a casino merely filed a credit application listing his name, residence address, firm name and address, and his bank. No other information was required, and the customer was not asked to represent the manner in which he would use the credit extended to him or the extent to which he would gamble. If the application were approved, the customer could obtain credit in the form of playing chips either at the gaming table or at the cashier's cage. When credit was obtained, the customer was required to sign a marker which was, in essence, a blank check enabling the casino to draw against the customer's bank account in the event the customer did not pay his debts to the casino. Prior to petitioner's first junket, friends told him that if he played heavily and appeared to lose, Caesar's Palace would invite him back, provided he paid his debts. Petitioner was also told of several ways in which he could convert the casino's credit into the cash needed to repay the casino, while, at the same time, appearing to lose money. Petitioner's first1976 Tax Ct. Memo LEXIS 177">185 gambling junket was to Caeser's Palace in Las Vegas on or about May 14, 1967. During the years 1967, 1968 and 1969, petitioner returned to Las Vegas and traveled to other places on gambling junkets approximately 15 to 20 times. On most of these trips his wife accompanied him.Eveyln did not gamble. She amused herself during the trips by window shopping, going to see the various night club shows and watching the gambling. During the day she enjoyed the sun by the pool. She considered the trips to Las Vegas to be vacations. On each junket petitioner followed the procedures outlined by his friends. He applied for credit, had it approved, and then played at the various gaming tables of the casino issuing him credit. Petitioner generally broke even or suffered small losses from his gambling activities. From time to time, either he or his wife would go to the cashier's cage to cash in small amounts of chips, ranging from $100 to $300. He restricted himself to converting small amounts to avoid inquiry into his credit status with the casino. During the years in issue the casinos in Las Vegas honored each other's chips. Additionally, a casino did not require its credit customer to1976 Tax Ct. Memo LEXIS 177">186 gamble on such credit only on its premises. These policies enabled petitioner to travel from the casino issuing him credit to a second casino and convert the chips from the first casino into the chips of the second casino. Furthermore, when petitioner presented these converted chips for cash, the second casino would not check on his credit standing with the first casino. Thus petitioner could convert far more chips during a single visit to a cashier's cage at other casinos than at the credit-issuing casino without causing inquiry into his credit status. By the time a trip was over, petitioner had accumulated cash generally equal to the amount of credit that had been extended to him. He brought the money back to Philadelphia in a money belt. He kept the money in his house or in his safety deposit box until about a week or ten days later, when he purchased a cashier's check or money order in the amount of his debt to the casino and mailed it to the casino. This repayment completed the cycle of borrowing and achieved petitioner's goal of obtaining a free vacation. In addition to the trips to Las Vegas, petitioners also went on junkets to Puerto Rico and England during the years1976 Tax Ct. Memo LEXIS 177">187 in issue. During the years in issue, petitioner received credit from the following casinos on the dates and in the amounts indicated: 1967 CasinoDateAmount(1) Caesar's PalaceMay 14$ 2,000July 116,000July 132,000August 111,500August 128,000August 251,000August 263,000August 273,500September 121,500September 131,500September 141,000September 154,000October 53,000October 619,000$57,000(2) Flamingo HiltonAugust 15$ 4,000August 241,000August 251,000August 261,500August 275,000September 188,000October 910,875$31,375(3) Dunes Hotel andJuly 11$ 2,000Country ClubSeptember 142,000$ 4,000Total$92,3751968(1) Sahara HotelJune 21$ 500(2) Circus-CircusNo date$ 4,000Hotelindicated(3) Aladdin Hotel andNo date$ 2,000Casinoindicated(4) Frontier HotelNo date$10,250indicated(5) El ConquistadorNo date$ 6,000Hotel and Casino,indicatedPuerto Rico(6) Victoria SportingNo date$ 5,000Club, LondonindicatedTotal$27,750During the years 1967, 1976 Tax Ct. Memo LEXIS 177">188 1968 and 1969, petitioner made the following repayments to the aforementioned casinos: CAESAR'S PALACE DateAmount1967May 22$ 2,000July 212,000August 116,000August 249,200August 27300September 92,500September 125,000September 133,000September 145,000November 141,000$ 36,0001968February 3500March 16500May 91,500June 19500October 241,000November 291,000$ 5,000Total$41,000FLAMINGO HILTON1967August 28$ 4,000September 138,500September 233,000October 45,000November 201,000$21,5001968February 1$ 500March 20500May 7500June 20500$ 2,0001972December$ 200$ 200Total$23,700DUNES HOTEL AND COUNTRY CLUB1967August 21$ 2,000September 282,000Total$ 4,000SAHARA HOTEL1969January 16$ 500ALADDIN HOTEL AND CASINO1968$ 200As of December 31, 1969, petitioner had outstanding balances due to the following casinos: CasinoBalance dueCaesar's Palace$16,000Flamingo Hilton7,875Circus Circus Casino4,000Aladdin Hotel and Casino1,800Frontier Hotel10,250El Conquistador Hotel & Cas.6,000Victoria Sporting Club5,000Total$50,9251976 Tax Ct. Memo LEXIS 177">189 Petitioner intended to repay all of the money he borrowed from the various casinos. As time progressed, however, he realized that his credit transactions with the various casinos amounted to interest-free loans, and he began to lengthen the period of time between his borrowings and his repayments. Eventually he began to use portions of the casino funds to pay other personal obligations. As a result, by late 1968 he was unable to currently repay the money he had borrowed from the casinos. Petitioner is presently a partner in a travel agency which arranges gambling junkets to casinos throughout the world. His outstanding obligations to Las Vegas casinos prevent him from holding a work card there, which is a prerequisite to conducting Las Vegas junkets.One of the reasons for his continued intention to repay his outstanding debts to the casinos is his desire to be able to work in Las Vegas. The special agent and the revenue agent who investigated and examined the returns of petitioners for the years 1967, 1968 and 1969 determined that the petitioners' books and records adequately supported the income and deductions claimed by them on their returns for those years. After a thorough1976 Tax Ct. Memo LEXIS 177">190 investigation they could find no evidence that petitioner was engaged in any trade or business other than that of a full-time commissioned shoe salesman, or that he was engaged in any gambling activities other than his trips to legal gambling casinos. Respondent's statutory notice of deficiency recomputes petitioners' taxable income on the basis of the application and source of funds method. In computing petitioners' source of funds, no credit was given for monies borrowed from various gambling casinos in Las Vegas. If the money obtained by petitioner on credit in the form of playing chips at the various casinos were converted to cash, petitioners' source of cash available would exceed their expenditures for each of the years in issue. OPINION Respondent determined that petitioners failed to report income in the calendar years 1967, 1968 and 1969 in the respective amounts of $57,983.97, $27,178.50 and $15,832.86. This determination was made by using the source and application of funds method of reconstructing income, an indirect method of proving unreported income. The method is based on the assumption that the amount by which a taxpayer's expenditure of funds exceeds his1976 Tax Ct. Memo LEXIS 177">191 reported source of funds during a given taxable period constitutes taxable income, absent a reasonable explanation for the excess. Edward A. Troncelliti,30 T.C.M. 297, 40 P-H Memo. T.C. par. 71,072 (1971). The use of this method was premised upon respondent's determination that petitioners' books and records did not adequately reflect their income. Respondent's determination is presumptively correct and petitioners have the burden of proving otherwise. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1930); Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioners can sustain their burden either by establishing the adequacy of their records, (see David Courtney,28 T.C. 658">28 T.C. 658, 28 T.C. 658">664 (1957)), or by showing that the difference between the total application of funds and the total reported sources of funds is attributable to non-taxable sources such as loans. Edward A. Troncelliti,supra.Petitioners rely solely on the explanation that the increase in expenditures over reported sources of funds came from the non-taxable source of credit obtained at gambling casinos. We hold for petitioners on the basis that they1976 Tax Ct. Memo LEXIS 177">192 have carried their burden of proof. We conclude initially that petitioners' books and records were inadequate in that they contained no record of any of petitioners' borrowings and repayments. Respondent discovered petitioner's Las Vegas casino borrowings by chance. Petitioner testified that he also borrowed sums from $50 to $10,000 for short periods without interest, security or the execution of a note, from his friends, and that neither he nor his friends kept any records of these transactions. We find petitioner's testimony vague and that of his friends incredible in this regard. In view of the state of petitioners' books and records, respondent was justified in using the source and application of funds method. See John Harper,54 T.C. 1121">54 T.C. 1121, 54 T.C. 1121">1129 (1970). 1. Sources of Funds.Respondent's position is based upon the supposition that all credit extended to petitioner by various gambling casinos was lost at the gaming tables, and that therefore all repayment of credit must have come from an unreported source of income. Respondent has no evidence to back up his theory and relies entirely on the presumption of correctness of his determination. 1976 Tax Ct. Memo LEXIS 177">193 Petitioner has the burden of proof and has, by a preponderance of the evidence (see Valetti v. Commissioner,260 F.2d 185, 187 (3rd Cir. 1958), reversing on other grounds 28 T.C. 692">28 T.C. 692 (1957)) overcome respondent's presumption of correctness. We do not find, as respondent urges, that petitioners and their witnesses are wholly incredible. While petitioner's story is a very unusual one, his explanation, if believed, that he brought home the money he borrowed and paid back his debts with that borrowed money, is a complete answer to respondent's determination. We found petitioner and his wife to be credible witnesses. There is no question that petitioner obtained credit from the various casinos. The only question is whether he lost the borrowed money at the gaming tables, as respondent claims, or whether he converted the chips obtained on credit to cash with which he subsequently repaid the casinos, as he claims. Against respondent's bare assertion that petitioner lost all the borrowed funds gambling, we have petitioner's rather detailed account of the conversion. He has drawn a fairly clear picture of casino credit practices during the years in1976 Tax Ct. Memo LEXIS 177">194 issue, their inadequacies, and his behavior in relation to them. The credit situation in Las Vegas at the time and petitioner's credit and repayment records with Caesar's Palace were corroborated by the credit manager of Caesar's Palace. That petitioner was a full-time shoe salesman during the years in issue with limited time to pursue a "second career" was confirmed by the former sales manager of the Barclay Shoe Company. Petitioner's activities on the various gambling junkets were attested to by his wife. We found both petitioner and his wife worthy of belief in this regard. Respondent has offered no evidence to rebut petitioner's story. The fact that petitioner was fond of gambling and apparently kept company with people of like inclination is insufficient evidence to overcome his specific testimony as to his behavior on the gambling junkets taken during the years in issue. The evidence does not contradict petitioners' assertions that they maintained a modest life style. After careful scrutiny of the evidence we conclude that petitioners have met their burden of persuasion as to the source of funds. Since such source of funds exceeds their expenditures for each year1976 Tax Ct. Memo LEXIS 177">195 in issue, we need not go into the parties' various estimates of petitioner's personal and family living expenses. 2.Fraud Upon The Casinos.The second issue is whether petitioner obtained credit in the form of playing chips and cash at the various casinos by fraud and with no intention to repay such credit, and whether such funds less repayments constitute taxable income to petitioners in the years in issue. 2Respondent raised this issue for the first time after trial. Accordingly, respondent has the burden of proof with respect to this issue. Rule 142(a), Tax Court Rules of Practice and Procedure. Consequently, respondent must prove1976 Tax Ct. Memo LEXIS 177">196 by a preponderance of the evidence that petitioner had no intention of repaying the casinos, and this respondent has failed to do. Petitioner testified that he fully intended to repay his obligations to the casinos. His last payment, according to our record here, was $200 paid to the Flamingo Hotel in 1972. Moreover, petitioner has a good business reason to repay his casino debts as soon as he is financially able, namely, to obtain a work permit in Las Vegas. Petitioner is presently a partner in a travel firm and arranges gambling junkets throughout the world, and he cannot accompany a junket to Las Vegas until he has a Las Vegas work permit. Respondent's argument that petitioner repaid $69,400 of his loans by the end of 1969 solely to increase the amount of credit the casinos would lend him, rather than because he intended to repay his loans as he was able, is unsupported by the record. Respondent, on whom the burden of persuasion rests, has failed to carry that burden. 3. Remaining Issues.Since we have held for petitioners on the primary issues involving omission of gross income, the remaining issues--whether our ruling at trial rejecting petitioner's offer of1976 Tax Ct. Memo LEXIS 177">197 polygraph evidence in support of his credibility was correct, whether petitioners are liable for additions to tax for negligence, whether petitioners may use income averaging and whether petitioner Evelyn Parker is an innocent spouse--are moot and we need not reach them. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩2. See United States v. Rochelle,384 F.2d 748, 751 (5th Cir. 1967), cert. denied 390 U.S. 946">390 U.S. 946 (1968), where the Court stated, citing James v. United States,366 U.S. 213">366 U.S. 213, 366 U.S. 213">219 (1961): "Where the loans are obtained by fraud, and where it is apparent that the recipient recognizes no obligation to repay, the transaction becomes a 'wrongful appropriation [and comes] within the broad sweep of 'gross income'.'" Cf. Rozelle v. McSpadden,50 T.C. 478">50 T.C. 478↩ (1968).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623312/	Richard B. Bennett and Luanne Bennett, Petitioners v. Commissioner of Internal Revenue, RespondentBennett v. CommissionerDocket No. 6790-70United States Tax Court58 T.C. 381; 1972 U.S. Tax Ct. LEXIS 113; May 30, 1972, Filed 1972 U.S. Tax Ct. LEXIS 113">113 Decision will be entered for the petitioners. Held, an integrated transaction whereby the stock interest of a majority shareholder in a closely held corporation was terminated did not result in a distribution essentially equivalent to a dividend to the minority shareholder within the meaning of sec. 302(b)(1), I.R.C. 1954. James P. Brody, Benjamin F. Garmer III, and Joseph R. Barnett, for the petitioners.Matthew W. Stanley, Jr., for the respondent. Featherston, Judge. FEATHERSTON58 T.C. 381">381 Respondent determined a deficiency in petitioners' Federal income tax for 1965 in the amount of $ 47,850.40. The sole issue for decision is whether petitioner Richard B. Bennett, owner of a minority of the shares of a corporation, realized income, taxable under section 301, 1 as the result of a transaction in which the stock ownership of the majority shareholder was terminated.1972 U.S. Tax Ct. LEXIS 113">115 58 T.C. 381">382 FINDINGS OF FACTRichard B. Bennett (hereinafter referred to as petitioner) and Luanne Bennett, husband and wife, were legal residents of Eau Claire, Wis., at the time they filed their petition. They filed a joint Federal income tax return for 1965 with the district director of internal revenue, Milwaukee, Wis.Petitioner was graduated from the University of Wisconsin at Madison, Wis., in 1948. Thereafter, for about 2 years, he worked for the Coca-Cola Bottling Co. of Bay City, Mich. In 1950, he took a job with the Coca-Cola Bottling Co. of Eau Claire, Inc. (hereinafter the corporation), as a warehouse manager at Menomonee, Wis. About a year later, he moved to Eau Claire and became sales manager of the corporation. Sometime between 1951 and 1956, he was made vice president and general manager of the corporation, and in 1956, he became its president.Between 1941 and 1946, Robert T. Jones, Jr. (hereinafter Jones), acquired 1,000 of the 1,500 outstanding shares of the voting common stock of the corporation. Prior to September 1, 1965, he had transferred 999 of these shares to various members of his family or to the First National Bank of Atlanta (hereinafter the1972 U.S. Tax Ct. LEXIS 113">116 Atlanta bank) to hold in trust for them; the 1 remaining share was retained by Jones. These 1,000 shares of stock will be hereinafter referred to as the Jones stock or the Jones interest. The remaining 500 shares were, by September 1, 1965, owned by petitioner (275), his wife (5), his mother (104), and his father (116). The directors of the corporation at this time were Jones, Mary Malone Jones, and petitioner.During 1964, Jones expressed a desire to sell a portion of the stock held by the trusts for members of his family. Initial consideration was given to the immediate purchase by petitioner of 133 1/2 shares of stock and the subsequent redemption of other stock so that petitioner's family would control the corporation. However, Jones was not willing to assume a minority position, and petitioner did not want merely to increase his minority interest in the corporation. The negotiations, therefore, turned to a procedure which would terminate the entire Jones interest.As early as April 22, 1965, Jones suggested to petitioner that an arrangement whereby the corporation would redeem at least part of the Jones stock would be to petitioner's tax advantage. Through consultations1972 U.S. Tax Ct. LEXIS 113">117 with the corporation's legal counsel and accountant, petitioner learned that the corporation could legally redeem the Jones stock. A price for the Jones interest, based on an objective appraisal, was negotiated, and petitioner contacted two banks and an insurance company in efforts to arrange financing for a corporate redemption. 58 T.C. 381">383 Petitioner never contemplated purchasing the entire Jones interest for himself, and he did not have enough money or borrowing capacity to enable him to do so.During the summer of 1965, petitioner received oral assurances from each of the two banks that they would loan the corporation the amount needed to redeem the Jones stock. Thereafter, in late July, petitioner and Jones agreed in principle to the termination of the entire Jones interest at a price of $ 226,700. During the ensuing discussions as to the details of the transfer, Jones insisted that the transaction take the form of a sale of the stock to petitioner rather than directly to the corporation. He stated that he was concerned that a debt incurred by the corporation to redeem the stock while he was a director might involve him and his wife in an impairment of capital of the corporation1972 U.S. Tax Ct. LEXIS 113">118 for their own benefit and, thereby, cause them to be liable to creditors of the corporation. The transaction took the form which Jones requested; however, Jones was informed in advance that the corporation was to borrow the money required to purchase the Jones interest and immediately redeem the Jones stock.On August 10, 1965, the First Wisconsin National Bank of Eau Claire, Wis. (hereinafter the Eau Clair bank), formally agreed to loan the corporation $ 227,000 in order to redeem the Jones stock. This loan was to be secured by mortgages on the real estate, equipment, and machinery of the corporation; personal guaranties by petitioner, his wife, and his father; and an insurance policy on petitioner's life. The Eau Claire bank would not have made this loan to petitioner individually.By letter dated August 18, 1965, the Jones stock, accompanied by appropriate stock powers, was sent to the Eau Claire bank to be held in escrow until the purchase price of $ 226,700, less any applicable transfer taxes, had been paid.On September 1, 1965, meetings of the corporation's board of directors and stockholders were held at the Eau Claire bank. These meetings did not last more than a total1972 U.S. Tax Ct. LEXIS 113">119 of one-half hour. While the directors, the corporation's attorney, Jones' representative, and the Eau Claire bank's representatives were present, petitioner executed on behalf of the corporation a note in the amount of $ 226,700, together with the agreed mortgage on the real estate and chattel security agreement. The Eau Claire bank deposited $ 226,700 in the corporation's checking account. The corporation drew a check in the same amount to petitioner. He deposited the check in his checking account and drew a certified check payable to the Atlanta bank in the amount of $ 226,609.32, the net purchase price of the stock after stock-transfer taxes.Immediately following these meetings, stock transfers were made 58 T.C. 381">384 on the books of the corporation to reflect the above-described series of transactions, i.e., the transfer of the Jones shares to petitioner and the retirement of those shares. The certificates for the 1,000 shares of Jones stock were canceled and put in the stock-record book, and one certificate representing those shares was issued to petitioner and immediately canceled and redeemed by the corporation. Stock-transfer stamps were affixed to each certificate.1972 U.S. Tax Ct. LEXIS 113">120 The minutes of these meetings reflect that they were held for the purpose of considering the purchase and retirement of 1,000 shares of stock, the borrowing of $ 226,700 from the Eau Claire bank to finance such purchase, and the execution of required security agreements. The minutes of the board of directors meeting reflect that there was presented a "Waiver of Notice and Consent to the transaction of any business that might come before the meeting," signed by Jones and Mary Malone Jones. The minutes of the stockholders meeting reflect that all 1,500 outstanding shares of stock were represented and that petitioner voted the Jones stock. Such minutes also reflect that the officers and board of directors of the corporation were authorized to "retire 1,000 shares of stock in * * [the corporation], now held in the name of * * * [petitioner] upon the books of this corporation," and in order to finance the redemption the officers and directors were authorized to borrow the necessary funds from the Eau Claire bank.Upon the completion of this series of events, petitioner, his wife, his mother, and his father continued to own their 500 shares of stock in the same proportions as they1972 U.S. Tax Ct. LEXIS 113">121 had before the redemption. A new board of directors was elected, composed of petitioner, his wife, his mother, and his father. The 1,000 shares of stock previously owned by the Jones group were held as treasury stock.Respondent determined that petitioner "realized a taxable dividend in the amount of $ 92,649.66 during the calendar year 1965 with regard to the redemption by the Coca-Cola Bottling Company of Eau Claire, Inc. of one-thousand shares of its capital stock from * * [him] on September 1, 1965."OPINIONRespondent has taken the position that petitioner received a distribution "essentially equivalent to a dividend" within the meaning of section 301(a)21972 U.S. Tax Ct. LEXIS 113">122 or section 302(b)(1)3 in the transaction in which the 58 T.C. 381">385 Jones stock was redeemed. Petitioner contends that he was a mere conduit or agent through which the corporation redeemed the stock owned by the Jones interest and that he did not, therefore, realize taxable income from the transaction. The issue is basically factual, and we hold for petitioner.Respondent seeks to support his determination on two theories. First, he argues that petitioner initially obligated himself personally to buy the Jones stock, and that he realized income when the corporation distributed to him the money required to discharge that obligation. See, e.g., Sullivan v. United States, 363 F.2d 724 (C.A. 8, 1966), certiorari denied 387 U.S. 905">387 U.S. 905 (1967); Wall v. United States, 164 F.2d 462 (C.A. 4, 1947); 1972 U.S. Tax Ct. LEXIS 113">123 Louis H. Zipp, 28 T.C. 314">28 T.C. 314 (1957), affirmed per curiam 259 F.2d 119 (C.A. 6, 1958), certiorari denied 359 U.S. 934">359 U.S. 934 (1959), acq. 1957-2 C.B. 7. Second, respondent contends that, since section 318 (a) (1)4 attributes to petitioner the ownership of all the Bennett family stock, petitioner is to be treated as the sole shareholder of the corporation during the moment when the stock certificate covering the Jones stock stood in his name and the corporation issued its $ 226,700 check to him; on this factual premise, respondent invokes the rule that as a matter of law any distribution by a corporation to its sole shareholder is essentially equivalent to a dividend. See, e.g., United States v. Davis, 397 U.S. 301">397 U.S. 301 (1970), rehearing denied 397 U.S. 1071">397 U.S. 1071 (1970); Estate of William F. Runnels, 54 T.C. 762">54 T.C. 762 (1970).1972 U.S. Tax Ct. LEXIS 113">124 As we view the evidence, however, the facts do not support either of respondent's positions. We do not think petitioner, in his individual capacity, ever became obligated to pay for the Jones stock or ever acquired ownership of such stock. The delivery of corporate funds to petitioner to pay Jones for the stock did not involve a discharge of petitioner's personal obligation or a distribution to him with respect to his stock. Rather, the corporation's disbursement involved a payment pursuant to a prearranged plan for the redemption of the Jones stock.The evidence shows that Jones, after about July 23, 1965, insisted that the transaction take the form of a transfer of the Jones stock to petitioner. He was concerned that he might become involved in claims by creditors of the corporation based on an impairment of its capital in a transaction in which he was beneficially interested. He wanted the paper record to reflect that petitioner, rather than the corporation, 58 T.C. 381">386 had bought the stock; otherwise, it appears that he did not care how the transaction was handled.Though insisting that the transaction take the form of a purchase by petitioner, Jones was aware that petitioner1972 U.S. Tax Ct. LEXIS 113">125 did not intend to acquire the stock for himself but rather the corporation was to redeem it. As early as April 22, 1965, in a letter to petitioner, Jones suggested the tax advantages of having the corporation acquire part of the stock. In telephone conversations between petitioner, his attorney, and Jones, the details of the transaction were prearranged. Indeed, under date of September 2, 1965, Jones transmitted, on behalf of himself and Mary Malone Jones, a waiver to the holding of the board of directors meeting at which the transaction was consummated, expressing the hope, nevertheless, that the waiver would not be needed lest he be subjected to possible liability for impairing the corporation's capital.That petitioner was acting on behalf of the corporation in arranging to acquire the stock is further demonstrated by his lack of both the funds and the borrowing capacity personally to pay a sum equal to the value of the stock. The Eau Claire bank made the $ 226,700 loan to the corporation, secured by mortgages on its property, for the specific purpose of providing the funds needed to redeem the 1,000 shares of Jones stock. The escrow agent for the Jones stock was not authorized1972 U.S. Tax Ct. LEXIS 113">126 to deliver it until the $ 226,700 had been paid, and the payment could not have been made until the bank advanced the funds. Jones had been associated with petitioner for several years in the ownership and management of the corporation, and the negotiations preceding the retirement of the Jones stock spanned a period of several months. Jones knew, at least generally, petitioner's financial situation. In one of the stipulated letters addressed to petitioner, Jones offered to arrange an appointment for petitioner to meet with officials of a bank in Atlanta for the purpose of attempting to arrange a loan to finance the stock purchase. The only reasonable inference is that Jones was aware that petitioner could not have personally financed the purchase of the stock.Had petitioner declined at the last minute to go through with the transaction, we do not think Jones would have had any enforceable personal claim against petitioner for the agreed redemption price. Petitioner neither signed any agreement nor made any oral commitment personally to pay for the stock. At the 30-minute meeting when the prearranged transaction was consummated, petitioner merely served as a conduit through1972 U.S. Tax Ct. LEXIS 113">127 which the stock passed from the Jones group to the corporation and the payment therefor passed from the corporation to Jones.Petitioner realized no financial or economic gain from the redemption of the stock. The redemption price, negotiated in the light of an 58 T.C. 381">387 appraisal by an expert satisfactory to both parties, represented the fair market value of the stock. Prior to the transaction, petitioner (and other members of his family) owned only one-third of the corporation's stock. After the redemption, petitioner (and his family) owned all the stock, but the value of their stock interest had not increased. While petitioner and his family gained control of the corporation and may ultimately realize greater income, such did not occur in the tax year. See, e.g., Niederkrome v. Commissioner, 266 F.2d 238, 243 (C.A. 9, 1958); Holsey v. Commissioner, 258 F.2d 865 (C.A. 3, 1958); Milton F. Priester, 38 T.C. 316">38 T.C. 316, 38 T.C. 316">326 (1962).The words of this Court in Frank Ciaio, 47 T.C. 447">47 T.C. 447, 47 T.C. 447">458 (1967), acq. 1972 U.S. Tax Ct. LEXIS 113">128 1967-2 C.B. 2 -- a case involving similar facts -- are apposite:The real substance of the transaction is, in our opinion, perfectly clear. The transaction was simply and purely a purchase by the corporation of the stock of * * * [the retiring shareholders], using the petitioner as its instrument. * * * [The retiring shareholders] got the cash. Petitioner received nothing from the transaction except a proportionate increase in the reduced assets of the corporation. He started out, in effect, with 33 1/3 percent of 100 percent and ended up with 100 percent of 33 1/3 percent.Also analogous is Fox v. Harrison, 145 F.2d 521 (C.A. 7, 1944), where the taxpayer owned one-third and Cross owned two-thirds of a corporation's stock. The taxpayer obtained a loan and paid Cross for his stock. The corporation then paid the taxpayer for the stock, and he applied such payment on the loan. Holding the payment of the loan was not essentially equivalent to a dividend, the court said (pp. 522-523):In reality, the involved stock was purchased by the corporation from Cross. That the purchase was not made directly from him was due to the inability of the1972 U.S. Tax Ct. LEXIS 113">129 corporation readily to finance such purchase. Appellee merely supplied the security by which the finances were obtained. The very checks which he received for the stock when it was turned over to the corporation were used in payment of the loan which he had obtained from the bank. He realized no gain or profit on the transaction. His relation to the transaction is very aptly described by the District Court:" * * that Fox was acquiring said stock on behalf of the corporation and as a temporary expedient, and that when the corporation should accumulate a sufficient surplus and should have available funds, it would take the stock off of Fox's hands. He had no desire or purpose to make a permanent personal investment in the Cross stock."Since petitioner personally did not incur a primary obligation to pay for the Jones stock and personally did not acquire beneficial ownership of it, we do not think either of respondent's theories has merit. In supplying the funds to redeem the Jones stock, the corporation did not discharge an obligation of petitioner because he never obligated himself personally to purchase the stock. 1972 U.S. Tax Ct. LEXIS 113">130 And although the certificate for the 1,000 shares of Jones stock stood momentarily in 58 T.C. 381">388 petitioner's name, petitioner did not beneficially own the stock even during that fleeting moment, and it was not redeemed from him in his individual capacity. Thus, under neither of respondent's theories was there a distribution essentially equivalent to a dividend. 51972 U.S. Tax Ct. LEXIS 113">131 See John A. Decker, 32 T.C. 326">32 T.C. 326, 32 T.C. 326">333 (1959), affirmed per curiam 286 F.2d 427 (C.A. 6, 1960); Arthur J. Kobacker, 37 T.C. 882">37 T.C. 882, 37 T.C. 882">895 (1962), acq. 1964-2 C.B. 6; Ray Edenfield, 19 T.C. 13">19 T.C. 13, 19 T.C. 13">20-21 (1952), acq. 1953-1 C.B. 4; Hargleroad v. United States, 202 F. Supp. 92">202 F. Supp. 92, 202 F. Supp. 92">95 (D. Neb. 1962); Erickson v. United States, 189 F. Supp. 521">189 F. Supp. 521, 189 F. Supp. 521">524 (S.D. Ill. 1960). 6Respondent relies heavily upon Wall v. United States, supra. In that case, the taxpayer gave cash and notes for another shareholder's 50-percent interest in a dairy company. The taxpayer made the payment on the first note. The dairy company subsequently agreed, in return for the purchased stock, to pay the remaining notes as they matured, and did so. The court reasoned that (p. 464):if a corporation, instead of paying a dividend to a stockholder, pays a debt for him out of its surplus, it is the same for tax purposes as if the corporation pays a dividend to a stockholder, and the stockholder then utilizes it to pay his debt.Respondent argues that the facts are the same in the present case as in Wall except that the events in the latter case occurred in "slow motion." We do not agree. The1972 U.S. Tax Ct. LEXIS 113">132 differences are much more fundamental, and the cases are clearly distinguishable. In Wall, the taxpayer in one transaction acquired stock, paid an amount of cash, and obligated himself personally to pay additional amounts; in a subsequent, separate transaction the corporation paid the notes. In contrast, petitioner never intended to acquire personal ownership of the Jones stock and never incurred any personal obligation to do so; at all times, he was serving as a conduit or agent for the corporation in a single, integrated transaction in which it acquired the stock. The court, in Wall, distinguished Fox v. Harrison, supra, stating at page 466, "Wall deliberately elected to attain his objective by two distinct transactions and there is no evidence that he was merely acting as an agent for * * * [the dairy 58 T.C. 381">389 company] when he made the purchase." The same observation serves to distinguish Wall from the instant case.Respondent also urges that Jones would not have assented to the transaction if petitioner had not agreed to allow it to take the form of a purchase of the stock from him and, on this ground, insists that we are precluded from holding1972 U.S. Tax Ct. LEXIS 113">133 that the arrangement was a redemption from Jones. However, in any transaction where the form differs from the substance, such difference is presumably dictated by someone who has the power to change the natural form of the transaction. The fact that the one causing such a change has the power to prevent the transaction from occurring in any other way is not sufficient, in itself, to show that the form chosen reflects the substance of the transaction. Indeed, we do not understand respondent to seriously advocate such a rule. See, e.g., Gregory v. Helvering, 293 U.S. 465">293 U.S. 465 (1935). We are unable to give controlling weight to Jones' request that the transaction not be handled as a redemption from him. See 202 F. Supp. 92">Hargleroad v. United States, supra at 95.We hold on the facts here presented that petitioner did not receive a distribution from the corporation which was essentially equivalent to a dividend.Decision will be entered for the petitioners. Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the tax year in issue.↩2. SEC. 301. DISTRIBUTIONS OF PROPERTY.(a) In General. -- * * * a distribution of property * * * made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c). [I.e., as a dividend to the extent of earnings and profits.]↩3. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.(a) General Rule. -- If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.(b) Redemptions Treated as Exchanges. -- (1) Redemptions not equivalent to dividends. -- Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.↩4. SEC. 318. CONSTRUCTIVE OWNERSHIP OF STOCK.(a) General Rule. -- For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable -- (1) Members of family. -- (A) In general. -- An individual shall be considered as owning the stock owned, directly or indirectly, by or for --(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and(ii) his children, grandchildren, and parents.↩5. The general issue here presented has been frequently litigated, and respondent has prevailed in many of these cases. See, e.g., Sullivan v. United States, 363 F.2d 724 (C.A. 8, 1966); Woodworth v. Commissioner, 218 F.2d 719 (C.A. 6, 1955), affirming a Memorandum Opinion of this Court; Lowenthal v. Commissioner, 169 F.2d 694 (C.A. 7, 1948), affirming a Memorandum Opinion of this Court; William K. Edmister, 46 T.C. 651">46 T.C. 651 (1966), affirmed per curiam 391 F.2d 584 (C.A. 6, 1968); Aloysius J. McGinty, 38 T.C. 882">38 T.C. 882 (1962), affd. 325 F.2d 820 (C.A. 2, 1963); Frank P. Holloway, a Memorandum Opinion of this Court dated Dec. 12, 1951, 10 T.C.M. 1257, affirmed per curiam 203 F.2d 566↩ (C.A. 6, 1953). All of these cases are distinguishable on their facts.6. See also Herbert Enoch, 57 T.C. 781">57 T.C. 781 (1972); W. P. Bunton, Sr., T.C. Memo. 1968-3, 27 T.C.M. 9; Robert N. Peterson, T.C. Memo. 1964-15, 23 T.C.M. 63; William A. Green, T.C. Memo. 1963-248, 22 T.C.M. 1241↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623313/	John M. Carson and Jean Carson, Petitioners v. Commissioner of Internal Revenue, RespondentCarson v. CommissionerDocket No. 45191-85United States Tax Court92 T.C. 1134; 1989 U.S. Tax Ct. LEXIS 69; 92 T.C. No. 72; May 24, 1989. May 24, 1989, Filed 1989 U.S. Tax Ct. LEXIS 69">69 Decision will be entered under Rule 155. Husband, a self-employed dentist, incorporated his dental practice as a professional corporation. Ps, husband and wife, executed a trust agreement, as grantors, with wife as sole trustee, for the benefit of their two sons. Ps, as co-owners, transferred the real property, equipment, and furnishings used in husband's dental practice to the trust. Thereafter, the corporation leased the real property comprising the dental practice from the trust. The trust's rental income from the corporation was then distributed to the beneficiaries pursuant to the trust agreement in unequal amounts on an annual basis. Held: Wife, as grantor, is treated as the owner of the trust since the beneficial enjoyment of the income is subject to a power of disposition exercisable by the wife without the approval or consent of any adverse party. Sec. 674(a), I.R.C. 1954. Thus, all of the trust income is taxable to Ps. Bennett v. Commissioner, 79 T.C. 470">79 T.C. 470 (1982), distinguished. Richard S. Calone, for the petitioners.Debra A. Bowe, for the respondent. Nims, Chief Judge. NIMS92 T.C. 1134">1134 Respondent determined the following1989 U.S. Tax Ct. LEXIS 69">70 deficiencies and additions to tax:Additions to taxYearDeficiencySec. 6653(a) 1Sec. 66611981$ 10,317.45$ 51619826,151.04308$ 61519836,533.60327653Before trial, petitioners conceded the 1981 deficiency and respondent conceded all of the determined additions to tax under sections 6653(a) and 6661. Respondent filed a motion to amend the pleadings after trial, wherein he moved, pursuant to section 6214(a), that the deficiency for the taxable year 1983 be increased from $ 6,533.60 to $ 6,962. Petitioners filed no objection and we granted respondent's motion on October 14, 1988.92 T.C. 1134">1135 The primary issue for decision is whether Jean Carson, as a grantor, retained the power to sprinkle any portion or all of the trust income between the beneficiaries, 1989 U.S. Tax Ct. LEXIS 69">71 so as to cause her to be treated as the owner of the trust under section 674(a), and thereby making the trust income taxable to petitioners.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.Petitioners timely filed joint returns as husband and wife for the taxable years at issue. Petitioners filed an amended return for the taxable year 1982 on April 16, 1984. At the time they filed their petition, petitioners resided in Stockton, California, and had two sons, Jon and Derrick, who were born on May 23, 1960, and June 18, 1964, respectively.Petitioner, Dr. John M. Carson, was a self-employed dentist during the taxable years at issue. On April 28, 1981, Dr. Carson incorporated his dental practice under the laws of California as John M. Carson, D.D.S., Inc., a California professional corporation. On June 22, 1981, petitioners, as grantors, executed a trust agreement with Jean Carson, as sole trustee, for the benefit of their sons, Jon and Derrick, as beneficiaries. Jean Carson had previously opened a checking account in the name of the trust with the Bank of America 1989 U.S. Tax Ct. LEXIS 69">72 in May 1981. The trust was irrevocable for a term of 10 years plus 1 month, and the trust agreement provided that the trust would be "governed by the laws of the State of California."On June 30, 1981, petitioners, as co-owners, transferred the real property, furnishings, and equipment used in Dr. Carson's dental practice to the trustee. On June 30, 1981, Jean Carson as trustee and Dr. Carson as President of John M. Carson, D.D.S., Inc., executed a lease agreement whereby John M. Carson, D.D.S., Inc., leased the real property from the trust.The following lease payments were made by John M. Carson, D.D.S., Inc., to the trust: 92 T.C. 1134">1136 EquipmentYearBuilding rentlease rentTotal1982$ 10,710.00$ 3,650$ 14,360.00198315,328.784,42519,753.78The trustee received the lease payments and deposited them in the trust's checking account. After depositing the lease payments, the trustee disbursed the trust's net income under the terms of the trust agreement, which stated in part:NET INCOME OF TRUST1. During the term of this Trust, the TRUSTEE shall pay to or apply for the benefit of JON CARSON and DERRICK CARSON, here called "BENEFICIARIES," children1989 U.S. Tax Ct. LEXIS 69">73 of the TRUSTOR, all of the net income of the Trust Estate, in monthly or other convenient installments, in no event less than annually, until they die or this Trust shall terminate, as hereinafter set forth, whichever shall first occur.In the event that one of the beneficiaries herein shall die during the term of this Trust, then the TRUSTEE shall pay to or apply for the benefit of the issue, if any, of the deceased beneficiary in the same manner and in the same proportion of the net income of the Trust Estate, as would have been done for the benefit of the beneficiary, if he had survived.In the event that one of the beneficiaries herein shall die during the term of this Trust, leaving no issue, then the TRUSTEE shall pay to or apply for the benefit of the surviving beneficiary all of the net income of the Trust Estate, in monthly or other convenient installments, until said surviving beneficiary shall die or this Trust shall terminate, whichever shall first occur.TERMINATION OF TRUST2. On the death of both of the beneficiaries, if there are no issue of the beneficiaries, or on the expiration of ten (10) years and one (1) month after the date of this declaration, whichever first1989 U.S. Tax Ct. LEXIS 69">74 occurs, this Trust shall terminate and all the Trust Estate then in the hands of the TRUSTEE shall go and be, by the TRUSTEE, transferred, conveyed, and delivered in fee to the TRUSTOR.The trustee made the following distributions to or on behalf of the beneficiaries pursuant to the trust agreement:Trust'sFYE March 31Jon CarsonDerrick CarsonTotal1982$ 6,414$ 6,413$ 12,82719839,0656,64015,70519844,5649,37013,93492 T.C. 1134">1137 Jean Carson, as trustee, filed the trust's fiduciary income tax returns (Form 1041) for the trust's fiscal years ending in 1982, 1983, and 1984. Petitioners did not report any of the trust income as taxable income on their joint returns for the taxable years at issue. In the statutory notice of deficiency respondent determined that all of the trust income was taxable to petitioners.OPINIONSection 674(a) provides the following general rule:SEC. 674(a). General Rule. -- The grantor shall be treated as the owner of any portion of a trust in respect of which the beneficial enjoyment of the corpus or the income therefrom is subject to a power of disposition, exercisable by the grantor or a nonadverse party, 1989 U.S. Tax Ct. LEXIS 69">75 or both, without the approval or consent of any adverse party.Section 674(a) codifies a line of cases arising out of the Supreme Court's decision in Helvering v. Clifford, 309 U.S. 331">309 U.S. 331 (1940). H. Rept. 1337, 83d Cong., 2d Sess., 63-64 (1954); S. Rept. 1622, 83d Cong., 2d Sess., 86-87 (1954). These cases establish, among other things, that if a grantor retains the power to "spray" or "sprinkle" income unevenly between members of a class of beneficiaries he then has the power to dispose of the beneficial enjoyment of the trust income. Stockstrom v. Commissioner, 148 F.2d 491">148 F.2d 491, 148 F.2d 491">493-495 (8th Cir. 1945), revg. and affg. in part 3 T.C. 255">3 T.C. 255 (1944). Commissioner v. Buck, 120 F.2d 775">120 F.2d 775 (2d Cir. 1941), revg. and affg. in part 41 B.T.A. 99">41 B.T.A. 99 (1940); Corning v. Commissioner, 24 T.C. 907">24 T.C. 907 (1955), affd. per curiam 239 F.2d 646">239 F.2d 646 (6th Cir. 1956). The power to sprinkle income allows the grantor to control the beneficial enjoyment of trust income so that under section 674(a) he then is treated as1989 U.S. Tax Ct. LEXIS 69">76 owning that portion of trust income over which he retained the sprinkling power. Such income thereby becomes taxable to the grantor. 120 F.2d 775">Commissioner v. Buck, supra at 777-778; 24 T.C. 907">Corning v. Commissioner, supra at 913; see also sec. 1.674(a)-1(b)(3), Income Tax Regs.The issue here is whether Jean Carson, as grantor, retained the power to sprinkle trust income between the beneficiaries. (If we find that she retained a sprinkling power, then her co-grantor and spouse, Dr. Carson, will also 92 T.C. 1134">1138 be deemed to have retained such a power under section 672(e).)Petitioners do not argue that any of the statutory exceptions to the general rule of section 674(a) apply here. See secs. 674(b), (c), and (d); see also secs. 1.674(b)-1, 1.674(c)-1, and 1.674(d)-1, Income Tax Regs. Instead, petitioners assert that Jean Carson did not retain a sprinkling power because petitioners as grantors did not intend for her, as trustee, necessarily to equalize income distributions annually, but did so intend for her to do so cumulatively over the entire term of the trust. Alternatively, petitioners assert that the trustee was legally obligated1989 U.S. Tax Ct. LEXIS 69">77 to equalize distributions so any unequal distributions merely constituted misadministration of the trust. See Bennett v. Commissioner, 79 T.C. 470">79 T.C. 470 (1982).In his brief, respondent contends that the unequal distributions in the trust's fiscal years 1983 and 1984 indicate "that Mrs. Carson as grantor and a nonadverse party with respect to Carson, retained the power to sprinkle income among the beneficiaries of [the] trust and that the retention of such power is violative of section 674(a)." We agree with respondent.Jean Carson testified that "the boys [i.e., her sons] would always tell [her] what amount they needed," and she would then distribute income on the basis of need. The record supports her testimony. As trustee, she made the following income distributions to or on behalf of the beneficiaries:Trust'sFYE March 31Jon CarsonDerrick Carson1982$ 6,414$ 6,41319839,0656,64019844,5649,370While she made roughly equal distributions to or on behalf of her sons in 1982, she distributed income unequally in 1983 and 1984. The unequal distributions indicate that as a grantor she believed that she had retained1989 U.S. Tax Ct. LEXIS 69">78 the power to sprinkle income in those fiscal years.Petitioners testified that although distributions were unequal in 1983 and 1984, it was their intent as grantors to equalize distributions over the 10-year and 1-month term of the trust. We find their intent, which we note was not 92 T.C. 1134">1139 expressed in the trust agreement, to be irrelevant here. Section 674(a) requires the taxation of trust income to grantors when they retain the power to sprinkle income -- regardless of whether they choose to exercise such power. 148 F.2d 491">Stockstrom v. Commissioner, supra at 493-495. To determine the proper period for analyzing whether a grantor retained a sprinkling power, we look to the terms of the trust agreement. These specifically require that all net trust income would be distributed "in no event less than annually."Petitioners argue in the alternative that although one of the grantors may have exercised a sprinkling power as trustee, she did not legally possess such a power under the trust agreement and therefore she misadministered the trust by making unequal distributions in 1983 and 1984. See 79 T.C. 470">Bennett v. Commissioner, supra at 486-488.1989 U.S. Tax Ct. LEXIS 69">79 To determine whether the trustee breached her fiduciary duty, we look to the relevant trust provision (paragraph 1, NET INCOME OF TRUST, supra at 1136). Petitioners assert that the language "in the same proportion * * as would have been done for the benefit of the beneficiary" creates an implied duty to equalize distributions. We do not agree. The trust agreement does not specify the beneficiaries' income proportions.We note that in the critical dispositive language of section 1 of the trust agreement, there is conspicuously absent the word "equal" as a modifier of the "monthly or other convenient installments" of income distribution requirement. Thus, the language in the trust agreement does not limit the trustee's discretion in dividing distributions between the two beneficiaries. Although not expressly granting the trustee full discretionary powers, the only restriction imposed on her by the trust provision is that all net trust income has to be paid to or applied for the benefit of both beneficiaries at least annually.In 79 T.C. 470">Bennett v. Commissioner, supra at 487, we held that "The grantor-trustees' misadministration of the trust is not 1989 U.S. Tax Ct. LEXIS 69">80 the equivalent of the authority to dispose of the beneficial enjoyment of the trust income [under section 674(a)]." But here, as we have held, the administration of the trust (as regards unequal income distributions) by a grantor-trustee 92 T.C. 1134">1140 was consistent with the terms of the trust, so there could have been no misadministration on that score.Next, we must decide over what "portion" the sprinkling power was retained. Petitioners assert that, if Jean Carson did retain a sprinkling power, she did not retain a sprinkling power over all of the trust income but only over the excess portion of trust income which was actually sprinkled. Petitioners note that the beneficiaries both received $ 6,640 during 1983, with an excess of $ 2,425 being paid to Jon. Petitioners further note that during 1984 both beneficiaries received $ 4,564 with an excess of $ 4,806 being paid to Derrick. Thus, petitioners contend that because the trustee exceeded making equal distributions by $ 2,425 and $ 4,806 in 1983 and 1984, respectively, the trustee retained the power to sprinkle only the $ 2,425 and $ 4,806 portions of trust income. Respondent asserts that the trustee retained a sprinkling power1989 U.S. Tax Ct. LEXIS 69">81 over all of the trust income and, as such, all of the trust income should be taxable to petitioners as grantors under section 674(a). We agree with respondent. As we have held, petitioners retained the power to sprinkle all of the trust income, not just the $ 2,425 and $ 4,806 excess portions.There is one final point which we must address. Although we agree with respondent that all of the trust income should be taxable to petitioners, the record does not sustain the amounts of trust income which he asserts were received by the trust. Respondent argues on brief that the trust received $ 15,458 and $ 17,305 of rental income during the taxable years 1982 and 1983, respectively.Respondent arrived at the $ 15,458 and $ 17,305 income figures determined in the statutory notice of deficiency as follows:19821983Gross building rent$ 14,280$ 14,280Less: Depreciation1,5061,355Interest expense1,696Net building rent11,07812,925Equipment lease rent4,3804,380Total income15,45817,305However, the parties stipulated for trial that the following amounts were the total amounts of building and equipment rent paid to the trust by John M. 1989 U.S. Tax Ct. LEXIS 69">82 Carson, D.D.S., Inc.: 92 T.C. 1134">*1141 EquipmentYearBuilding rentlease rentTotal1982$ 10,710.00$ 3,650$ 14,360.00198315,328.784,42519,753.78We accept the stipulated figures. However, we note that the stipulated income totals must be reduced by depreciation and interest expenses, which the parties can calculate pursuant to Rule 155.Because we find that all of the trust income is taxable to petitioners under section 674(a), we do not reach the issue of whether the trustee used trust funds to satisfy the grantors' liabilities so as to cause some portion or all of the trust income to be taxed to them under section 677(b).To reflect the foregoing,Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years in question. All Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623315/	H. S. JAUDON ENGINEERING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.H. S. Jaudon Eng'g Co. v. CommissionerDocket No. 14060.United States Board of Tax Appeals15 B.T.A. 161; 1929 BTA LEXIS 2906; January 31, 1929, Promulgated 1929 BTA LEXIS 2906">2906 PERSONAL SERVICE CORPORATION. - Upon the facts, held that the petitioner was a personal service corporation in 1921. George F. Adams, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. TRUSSELL 15 B.T.A. 161">161 This proceeding results from the determination of a deficiency in income and profits taxes for 1921 amounting to $2,695.84. The petitioner alleges error in the failure to consider the petitioner to be a personal service corporation. FINDINGS OF FACT. The petitioner is a Georgia corporation with its principal office at Elberton. 15 B.T.A. 161">162 The petitioner was organized in 1910 for the purpose of taking over and continuing the engineering business of H. S. Jaudon previously conducted in his individual capacity. Capital stock of a par value of $10,000 was issued to Jaudon in consideration of equipment valued at about $2,000 and of four or five contracts for jobs then under way which were valued on a basis of the expected profits from them. Three thousand dollars par value capital stock was subsequently issued to a man named Camp. Jaudon afterwards purchased this stock from Camp. The remainder of the capital stock, 1929 BTA LEXIS 2906">2907 par value $2,000, was issued as a stock dividend of surplus which had been accumulated. Five shares of the stock were given to the wife of Jaudon at incorporation for the purpose of qualifying her as a director of the petitioner. Mrs. Jaudon is not an engineer and took practically no part in the affairs of the petitioner. During 1921, 150 shares of capital stock were outstanding, of which H. S. Jaudon held 145 shares and his wife 5 shares. The charter of the petitioner authorizes a general engineering business in all its branches including construction work, general contracting, manufacturing and the buying and selling of real estate and personal property. The petitioner is actually engaged in the business of providing engineering services to municipalities and counties, acting as supervising engineers in construction projects, incidentally furnishing resident engineers for superintendence where they are desired. The services of the petitioner are offered to its clients in competition with others at proposed rates per centum of the cost of the work. The rates are higher where resident supervisors are furnished. The petitioner prepares the necessary plans and specifications, 1929 BTA LEXIS 2906">2908 advertises for bids in the name and at the expense of the clients, opens and considers the bids, makes recommendations to the clients, and after the letting of the contract, the job is given general engineering supervision until completed. The compensation to the petitioner is payable in installments usually at an agreed percentage of the expected cost when the plans and specifications are finished, and thereafter in monthly payments based upon the estimated amount of work completed on the contract. Ordinarily the payments upon completion of the plans and specifications are sufficient in amount to finance the expenses of the petitioner incident to the further operations. The petitioner does not undertake to supply materials or supplies and did not sell any commodities during 1921. In carrying on the business of the petitioner it is necessary to provide surveying instruments, drafting tools and automobiles for the use of the employee engineers and inspectors. Three automobiles were in use in 1921. It is the practice of the petitioner to employ a few engineers regularly and to 15 B.T.A. 161">163 employ temporarily other engineers and/or inspectors if necessary. No solicitors of work1929 BTA LEXIS 2906">2909 or salesmen are employed. Where resident engineers were employed on the work, they were expected to prepare the monthly estimates of work completed, and these estimates were gone over by Jaudon in conference with the resident engineers. For final estimates Jaudon checked the results in detail. In connection with contracts involving improvement of streets the petitioner assumed, by agreement, the task of preparing an assessment list showing the portion of the cost chargeable to each owner of abutting property to the end that assessment certificates might be issued. The contracts between the clients of the petitioner and the parties who undertook to do the work specified a time in which the work should be completed, provided for liquidated damages in event of delay, including the cost of engineering and inspection, and the clients of the petitioner agreed to endeavor to collect the damages and turn them over to the petitioner in addition to the fees agreed upon, it being understood that any expenses involved in the collection of the damages would be borne by the petitioner. H. S. Jaudon was of good reputation as an engineer. He was the president and general manager of the1929 BTA LEXIS 2906">2910 petitioner. He devoted all of his time to the affairs of the petitioner. He was charged with the duty of obtaining all of the work secured by the petitioner. He personally closed all of the contracts for the work. He had personal supervision over the preparation of the plans and specifications for the work, the actual drafting being done by employees, usually by the men who also acted as resident superintendents. He visited the various jobs as often as necessary to keep in close touch with the work and he personally authorized any changes from the routine carrying on of any contract. It was understood with the clients of the petitioner that all of the work would be under the personal supervision of Jaudon. Jaudon had never been particular about the amount of his salary because of his interest through his stockholdings, and his compensation for 1921 was reported as $6,000, a figure which he would have been unwilling to accept from outside sources. During 1921 the petitioner had under way eight jobs, from which income was derived, and, in addition, collections of income were made and reported in the return from three jobs which were completed prior to 1921. Four men were permanently1929 BTA LEXIS 2906">2911 employed by names of Cobb, Brotchie, Gilbert, and Stringfellow. Of these, three were graduate engineers and the other was a "self-made" engineer. These men had no part in the soliciting of work, but, in addition to acting as resident engineering supervisors on contracts, they were called into headquarters when necessary to assist in the preparation 15 B.T.A. 161">164 of plans and specifications, including doing the drafting work involved. Cobb was employed for a compensation of a fixed salary of $250 per month and in addition 10 per cent of the profits on all jobs in which he participated. In 1921 Cobb did not participate in any share of the collections which were made for work done in prior years. Stringfellow was a resident of Polk County, Florida. In that vicinity Jaudon and Stringfellow were well and favorably known, due to their personal services in 1915 and 1916 in supervising work which had cost the clients about $1,500,000, and on which they had derived fees at a rate of 3 3/4 per cent of the cost. Work was done for the same clients in 1921 on several contracts. Stringfellow was unable to secure the work on his individual responsibility and reputation, but agreements were1929 BTA LEXIS 2906">2912 negotiated with the clients upon the assurance that Jaudon would give the work his personal general supervision. Stringfellow was a party to these agreements, as were either Jaudon, acting in his individual capacity, or the petitioner. In addition to his salary Stringfellow participated in the profits derived from this work. During 1921 the petitioner derived no income from (1) trading as a principal or (2) from a Government contract made between April 6, 1917, and November 11, 1918, inclusive. Details relative to the several jobs in 1921 follow: JobServicesServices Amount of resident income engineer inderived 1921in 1921Brunswick Co., N.CRendered in rpior yearNone$ 3,052.00Bartow, FlaConsulting advice onlydo500.00Chester, S.CRendered in prior yeardo350.00 Cook Co., GaRendered in 1921Dentham, 1 month5,500.00Elberton, GaConsulting advice onlyNone3,967.22Perry, FlaRendered in 1921Gilbert, part time;8,684.94St. John, part time Polk Co., Fla. Partly in a prior year andStringfellow11,821.61(several jobs).partly from August to December, 1921 Seneca, S.CJuly to December, 1921Gilbert5,050.00Springstein MillsJanuary to April, 1921do1,113.41Washington, GaRendered in prior yearNone461.02Wilkes Co., GaYesBrotchie6,142.05Total46,615.251929 BTA LEXIS 2906">2913 For 1921 the petitioner filed a return as a personal service corporation computing net income as follows: Gross income from services$ 46,615.25Deductions:Expenses$ 26,259.79Compensation of stockholder6,000.00Interest332.48Taxes237.60Exhaustion, wear and tear514.501 34,344.37Net income12,270.8815 B.T.A. 161">165 The expenses included salaries to employees as follows: Permanent employees:Cobb, engineer$ 3,119.66Stringfellow, engineer2,917.72Brotchie, engineer2,400.00Gilbert, engineer2,100.00Tate, bookkeeper and stenographer60.00Haslett, bookkeeper and stenographer715.00Williams, porter in office36.00Seigling, colored messenger12.00Temporary employees:Wells, inspector900.00Coburn, inspector775.00St. John, inspector1,260.03Sledge, inspector682.75Denton, inspector175.0015,153.16Interest was paid on money borrowed from the bank. All of the borrowed money was turned over to H. S. Jaudon for his personal use in operations incident to a farm he owned. The taxes were state taxes for carrying on business and taxes1929 BTA LEXIS 2906">2914 on the automobiles owned by the petitioner. The following balance sheets were filed with the return: December 31, 1920December 31, 1921ASSETSCash in bank$1,295.77$1,527.95Bills receivable90.0050.00Accounts receivable18,611.0128,274.79Equipment4,171.502,727.00Totals shown24,169.1832,579.74LIABILITIES AND CAPITALNotes payable (proceeds to Jaudon)5,107.152,000.00Accounts payable566.77Capital stock15,000.0015,000.00Profit and loss account3,495.2615,579.74Totals shown24,169.1832,579.74DETAIL OF ACCOUNTS RECEIVABLEH. S. Jaudon, withdrawals17,636.9327,806.68Mrs. Jaudon, loan495.5499.97Brotchie, loan444.95Cobb, loan33.595.34Stringfellow, loan362.80Totals18,611.0128,274.79In determining the deficiency the respondent has based his computation of the tax upon the amount of $12,270.88 of net income reported in the return, and the excess-profits tax has been computed under the limitation provided in section 302 of the Revenue Act of 1921. 15 B.T.A. 161">166 OPINION. TRUSSELL: The petitioner contends that it is a personal service corporation subject to the provisions of section1929 BTA LEXIS 2906">2915 218(d) of the Revenue Act of 1921, taxing the individual stockholders thereof after the manner of members of partnerships. Personal service corporations are defined in section 200(5) of the Revenue Act of 1921. Three of the statutory requirements are material here: (1) the income of the corporation must be ascribed primarily to the activities of the principal owners or stockholders; (2) such principal owners or stockholders must be themselves regularly engaged in the active conduct of the affairs of the corporation; and (3) capital, whether invested or borrowed, must not be a material income-producing factor. During the taxable year the petitioner was engaged in the business of furnishing engineering service to its clients. This service was purely personal and professional; materials and supplies were not furnished or traded in; financial obligations were not incurred for the accounts of clients; the petitioner was not a contractor for construction work. The amount of capital employed in the business was trifling, being the cost of surveying instruments and drafting tools together with a few automobiles. The balance sheets reported with the return reflected no large amount1929 BTA LEXIS 2906">2916 of capital. Accounts receivable, the largest item, were made up entirely of charges for cash withdrawals by H. S. Jaudon and his wife, and of a few small loans to employees for their personal needs. The item of notes payable was entirely for money borrowed from the bank for the sole purpose of turning it over to Jaudon so that he might conveniently finance operations in connection with a farm which he owned and operated in his individual capacity. All of the outstanding capital stock, save five shares, was owned by the president and general manager, H. S. Jaudon. The five shares were owned by his wife and were given her in order to qualify her as a director of the petitioner. She is not an engineer and took no active part in the affairs of the petitioner. Jaudon was the sole representative of the petitioner in the transactions with its clients. He gave all of his time to the affairs of the petitioner. He secured all of the work handled by the petitioner and he had full direction and control of the technical details of the work from inception to accomplishment. A few technical assistants were permanently employed. They did not solicit work and were at all times subordinate1929 BTA LEXIS 2906">2917 to Jaudon. Additional employees were temporarily utilized when needed, mainly as inspectors. In the headquarters' office were employed a stenographer-bookkeeper and a porter. A colored messenger 15 B.T.A. 161">167 was hired for a small amount of part-time service in connection with the handling of the mail. Upon consideration of these facts we do not see that there is the slightest basis for ascribing any income whatever to the use of capital, and it is apparent that the statutory condition is met that the principal stockholders must be themselves regularly engaged in the active conduct of the affairs of the petitioner. The real question for decision is whether the income is ascribable primarily to the activities of the principal stockholders. The respondent contends that certain of the employees rendered services which were primarily productive of income. This could not be in their responsibilities for they were strictly subordinates. Jaudon's was the responsibility and ability relied upon by the clients. His was the initiative. The employees performed their duties under his constant supervision and direction. 1929 BTA LEXIS 2906">2918 We do not attach significance to the possibility of a small amount of income probably reflected in the fees of the petitioner where the subordinates were availed of upon request of the client and the additional expense was paid for by the client. In the case of , a personal service status was allowed even though there were a number of employees, where, as in the instant case, we were of the opinion that the services of such employees were of a subordinate character not productive of income primarily. See also ; ; ; ; . The instant case is distinguishable from , where the labor employed by that petitioner in manufacturing operations was directly productive of income. See also 1929 BTA LEXIS 2906">2919 , where one-half of the income was ascribable to the activities of subagents. In the case of , we had under consideration the factor of employment of others, and we said: We do not mean to hold that personal service classification must be denied in all cases where there are employees under the supervision of stockholders, but where, as here, employees so greatly outnumber the stockholders and there is no evidence of the character of the service performed by most of them * * we can not find that the income is to be ascribed primarily to the activities of the stockholders. We are under no disability of lack of evidence in the instant case. Two of the employees participated in the profits derived from the work on which they were engaged. The respondent contends that this is evidence of their productive capacities to produce income. In 15 B.T.A. 161">168 any case in which the amount of total compensation derived was relatively large it might have that significance, but we do not find it material in the instant case, where not one of the employees drew an amount of compensation1929 BTA LEXIS 2906">2920 which we could designate as of the slightest consequence. One of the employees of the petitioner was a party to the agreements with the clients for the work in Florida and he shared in the profits, but it appears that he lacked the personal qualifications and standing to acquire this work individually and we believe that the income derived by the petitioner from this work was none the less primarily attributable to the personal influence, reputation, and activity of Jaudon, petitioner's principal stockholder. We conclude that the petitioner's action in filing a personal service return was correct. Judgment of no deficiency will be entered for the petitioner.Footnotes1. Discrepancy of $ 1,000 not explained. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623316/	Ernestine M. Carmichael Trust No. 21-35, Marshall County Bank & Trust Company, Trustee, and Irrevocable Living Trust Created by Ella L. Morris for Ernestine M. Carmichael No. 21-32, Bremen State Bank, Trustee, Petitioners v. Commissioner of Internal Revenue, RespondentErnestine M. Carmichael Trust No. 21-35 v. CommissionerDocket No. 6171-76United States Tax Court73 T.C. 118; 1979 U.S. Tax Ct. LEXIS 35; October 18, 1979, Filed 1979 U.S. Tax Ct. LEXIS 35">35 Decision will be entered under Rule 155. In 1968, two trusts sold shares of common stock for 5 1/2-percent convertible subordinate debentures of the purchaser-corporation. The trusts properly elected to report the resulting gains on the installment method under sec. 453(b), I.R.C. 1954. In 1972, the trusts sold some of the debentures on the open market and reported the gain therefrom pursuant to sec. 453(d), I.R.C. 1954. Held, the long-term capital gain reported by the two trusts following the 1972 sales of corporate debentures received in the 1968 stock sales qualifies as "subsection (d) gain" as defined in sec. 1201(d)(1), I.R.C. 1954, for purposes of computing the alternative tax under sec. 1201(b), I.R.C. 1954. 1979 U.S. Tax Ct. LEXIS 35">38 William A. Cromartie, Burton H. Litwin, and Francis O. McDermott, for the petitioners.Harmon B. Dow, for the respondent. Wilbur, Judge. WILBUR73 T.C. 118">119 Respondent determined the following deficiencies in the Federal income tax of two trusts:2Ernestine M. Carmichael Trust No. 21-351972$ 54,388.831973329.972Irrevocable Living Trust Created by Ella L. Morris2for Ernestine M. Carmichael No. 21-321972$ 1,041.36The sole issue for decision is whether the long-term capital gain reported by each trust on its tax return for taxable year 1972 qualifies as "subsection (d) gain" within the meaning of section 1201(d)11979 U.S. Tax Ct. LEXIS 35">39 for purposes of computing the alternative tax imposed by section 1201(b). 2FINDINGS OF FACTThe facts have been fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation of facts and attached exhibits are incorporated herein by this reference.Petitioners are Marshall County Bank & Trust Co., the trustee of the Ernestine M. Carmichael Trust No. 21-35, and Bremen State Bank, the trustee of the Irrevocable Living Trust created by Ella L. Morris for Ernestine M. Carmichael No. 21-32. At the time the petitioners filed their joint petition in this case, Marshall County Bank & Trust Co. and Bremen State Bank had their principal offices at 315 North Michigan Street, Plymouth, Ind., and 104 West Plymouth, Bremen, Ind., respectively. Petitioners timely filed separate Federal fiduciary income tax returns (Forms 1041) for each trust for calendar year 1972 with 73 T.C. 118">120 the District Director, Internal Revenue Service, in Memphis, Tenn.In July 1968, the Ernestine M. Carmichael Trust No. 1979 U.S. Tax Ct. LEXIS 35">40 21-35 (hereinafter Trust No. 35) and the Irrevocable Living Trust created by Ella L. Morris for Ernestine M. Carmichael No. 21-32 (hereinafter Trust No. 32) transferred shares of Associated Investment Co. common stock owned by them in exchange for Gulf & Western Industries, Inc., 5 1/2-percent convertible subordinate debentures. Such exchanges were taxable transactions from which Trust No. 35 realized long-term capital gains of $ 8,020,870.79 and Trust No. 32 realized long-term capital gains of $ 692,476.02. Each trust properly elected to report its gain under the installment method pursuant to section 453. Since the parties have stipulated that these exchanges met the requirements for installment method reporting of gain, we will hereafter refer to the Gulf & Western Industries, Inc., debentures as "the Gulf & Western installment obligations" for purposes of clarity.In 1972, each trust sold some of its Gulf & Western installment obligations on the open market. As a result of these sales, petitioners reported a $ 727,673.83 long-term capital gain for Trust No. 35 and a $ 150,648.29 long-term capital gain for Trust No. 32 on the Forms 1041 filed for taxable year 1972. Petitioners1979 U.S. Tax Ct. LEXIS 35">41 calculated the alternative tax under section 1201(b) for each trust by treating the gain reported from the sales of the Gulf & Western installment obligations as "subsection (d) gain." Respondent determined that the gain reported by each trust upon the sales of the Gulf & Western installment obligations did not qualify as "subsection (d) gain" and therefore recomputed the tax of each trust for the taxable year 1972 in accordance with such determination.OPINIONThe issue presented for our decision is whether long-term capital gain reported by two trusts following sales in 1972 of corporate debentures they had received in a 1968 "installment sale" of stock qualifies as "subsection (d) gain," as defined by section 1201(d), for purposes of computing the alternative tax imposed by section 1201(b) on capital gains of noncorporate taxpayers.Prior to modification by the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, 635, the alternative tax, where applicable, 73 T.C. 118">121 taxed all long-term capital gains of noncorporate taxpayers at the rate of 25 percent. In order to remedy the perceived dilution of the progressive tax rate structure caused by the flat-rate alternative tax, 3Congress1979 U.S. Tax Ct. LEXIS 35">42 enacted section 511(b) of the Tax Reform Act of 1969, 83 Stat. 635, which increased the rates at which some capital gains were to be taxed. Applicable to taxable years beginning after December 31, 1969 (sec. 511(c), 83 Stat. 638), the new provisions basically retained the 25-percent rate only with respect to the first $ 50,000 of a noncorporate taxpayer's long-term capital gain. However, Congress specifically provided that certain long-term capital gains which arose from pre-October 9, 1969, transactions would continue to be taxed at the 25-percent rate, even if they exceeded $ 50,000. This tax regime was effected, in general, by the retention of the 25-percent rate of tax on "subsection (d) gain," statutorily defined by subsection 1201(d) 4 as follows:SEC. 1201. ALTERNATIVE TAX.(d) Subsection (D) Gain Defined. -- For purposes of this section, the term "subsection (d) gain" means the sum of long-term capital gains for the taxable year arising -- (1) in the case of amounts received before January 1, 1975, from sales or other dispositions pursuant to binding contracts (other than any gain from a transaction described in section 631 or 1235) entered into on or before October1979 U.S. Tax Ct. LEXIS 35">43 9, 1969, including sales or other dispositions the income from which is returned on the basis and in the manner prescribed in section 453(a)(1),(2) in respect of distributions from a corporation made prior to October 10, 1970, which are pursuant to a plan of complete liquidation adopted on or before October 9, 1969, and(3) in the case of a taxpayer other than a corporation, from any other source, but the amount taken into account from such other sources for the purpose of this paragraph shall be limited to an amount equal to the excess (if any) of $ 50,000 ($ 25,000 in the case of a married individual filing a separate return) over the sum of the gains to which paragraphs (1) and (2) apply.1979 U.S. Tax Ct. LEXIS 35">44 Trust No. 35 and Trust No. 32 reported as components of their long-term capital gains for taxable year 1972, gains of $ 727,673.83 and $ 150,648.29, respectively, from sales during 1972 of Gulf & Western installment obligations they received as part of the consideration in a 1968 sale of stock. Since these gains 73 T.C. 118">122 were properly reported after 1969, the gain in excess of $ 50,000 per trust 5 is subject to the higher rate of tax unless it qualifies as "subsection (d) gain."Petitioners contend that the gain reported for taxable year 1972 from the disposition of the Gulf & Western installment obligations satisfies the requirements for "subsection (d) gain" status because, by virtue of section 453(d), it "relates back" to the underlying stock sales which were completed in 1968 and therefore "arises from" pre-October 9, 1969, sales. 6 Respondent, on the other1979 U.S. Tax Ct. LEXIS 35">45 hand, argues that the "relation back" rule of section 453(d) is not as expansive as petitioners contend and further argues that the amounts received upon the sales of the Gulf & Western installment obligations do not qualify as "subsection (d) gain" because they were neither reported in the manner prescribed under section 453(a)(1) nor were they received "pursuant to" the original installment sales.This appears to be a case of first impression. The parties have presented both cogent technical arguments and arguments founded on congressional intent in support of their respective positions. While the matter is not completely free from doubt, we believe that petitioners properly calculated the alternative tax for 1972 by treating the entire1979 U.S. Tax Ct. LEXIS 35">46 gain from the sales of the Gulf & Western installment obligations as "subsection (d) gain."Respondent contends that the gain reported by the trusts from the 1972 sales of the Gulf & Western installment obligations does not qualify as "subsection (d) gain" as that term is defined in section 1201(d)(1). Respondent interprets section 1201(d)(1) as defining "subsection (d) gain" as "amounts received 'pursuant to' binding contracts entered into on or before October 9, 1969" and argues that the amounts constituting the gain in this case were not received "pursuant to" such a contract. Respondent argues that the only amounts which would qualify for "subsection (d) gain" treatment under the facts of this case are amounts received in accordance with the terms of the contract of sale of the Associated Investment Co. stock.Respondent's contention appears to be based on an erroneous 73 T.C. 118">123 construction of section 1201(d)(1). The relevant portion of section 1201(d)(1) tersely defines "subsection (d) gain" as: * * long-term capital gains for the taxable year arising:(1) in the case of amounts received before January 1, 1975, from sales or other dispositions pursuant to binding contracts1979 U.S. Tax Ct. LEXIS 35">47 * * entered into on or before October 9, 1969. * * The phrase "pursuant to binding contracts" modifies the words "sales or other dispositions," not, as respondent posits, the words "amounts received." Consequently, the fact that the trusts did not receive the contested amounts "pursuant to" pre-October 10, 1969, binding contracts is immaterial so long as the gain arose from a sale completed prior to that date.Respondent also contends that the gain does not qualify as "subsection (d) gain" because it was not returned "on the basis and in the manner" prescribed by section 453(a)(1) but rather in the manner prescribed by section 453(d)(1). 7 Respondent states that section 1201(d) defines "subsection (d) gain" as "amounts received pursuant to pre-October 10, 1969 contracts, including sales or other dispositions the income from which is returned on the basis and in the manner prescribed in section 453(a)(1)," which definition limits qualifying installment sale gain to gain reported under section 453(a)(1), and by negative inference, excludes gain reported under section 453(d)(1).1979 U.S. Tax Ct. LEXIS 35">48 Petitioners, on the other hand, argue that section 1201(d) does not require that "subsection (d) gain" itself be computed under section 453(a)(1). Petitioners argue that the reference in section 1201(d) to section 453(a)(1) "merely serves to identify or define what kind of sales or other dispositions, i.e., installment transactions, which, if consummated before October 10, 1969, are to qualify for subsection (d) gain treatment." Petitioners also note 73 T.C. 118">124 that section 453(d), under which the trusts computed their gain in 1972, can only apply with respect to "sales the income from which is returned in the manner set forth in section 453(a)(1)."We agree with petitioners that the language of section 1201(d)(1) does not limit the applicability of section 1201(d) to section 453(a)(1) transactions to the exclusion of section 453(d) transactions. From our reading of section 1201(d), the fundamental language defining "subsection (d) gain" is "gain * * arising * * * from sales * * * including sales * * * the income from which is returned on the basis and in the manner prescribed in section 453(a)(1)." Respondent's construction of the "including" phrase as a strict limitation1979 U.S. Tax Ct. LEXIS 35">49 on sales, the gain from which will qualify as "subsection (d) gain," appears unwarranted in light of the rule of statutory construction that the use of the word "including" in a statutory definition conveys the conclusion that there are other kindred items includable within the defined term although not specifically enumerated. See Argosy Limited v. Hennigan, 404 F.2d 14">404 F.2d 14 (5th Cir. 1968); Federal Land Bank of St. Paul v. Bismarck Lumber Co., 314 U.S. 95">314 U.S. 95, 314 U.S. 95">100 (1941); 2A Sutherland, Statutes and Statutory Construction, sec. 47.07, p. 82 (4th ed. 1973). Rather, the phrase is illustrative only of one type of sale which, if the other conditions of section 1201(d) are met, would produce "subsection (d) gain."Both parties speculate about the absence of any reference to section 453(d) in the legislative history accompanying section 1201(d). According to respondent, "the failure of Congress to suggest that premature sales of installment obligations to third parties would qualify as subsection (d) gain must be construed to mean that the Congress did not intend it to qualify."Respondent points out that in 1969, Congress enacted1979 U.S. Tax Ct. LEXIS 35">50 section 453(b)(3)8 to preclude taxpayers from deferring tax under 73 T.C. 118">125 section 453 in certain cases and argues that "Congress was aware of the different treatment of installment obligations under section 453 at the very time it was considering the question of subsection (d) gain." Respondent seems to argue that the Congress' failure to mention section 453(d) in section 1201(d) was intentional rather than inadvertent. Petitioners seem to view the absence from section 1201(d) of a specific reference to section 453(d) as an oversight which occurred during the legislative process of revising the alternative tax. Petitioners argue that no adverse conclusions concerning congressional intent with respect to the disposition of installment obligations can be attributed to the absence of any reference to such dispositions in the legislative history relevant to section 1201.1979 U.S. Tax Ct. LEXIS 35">51 The most we can say about the absence of any mention of section 453(d) in the legislative history to section 1201(d) is that Congress never specifically considered the effect of the enactment of the latter section on dispositions of installment notes. The reference to section 453 sales was included by the Senate Committee on Finance. As originally reported by the House Ways and Means Committee, H.R. 13270 (which, after numerous amendments, was enacted as the Tax Reform Act of 1969) would have eliminated the alternative capital gains tax for noncorporate taxpayers effective with respect to sales and other dispositions after July 25, 1969. According to the conference report, the result of the originally-proposed provision would have been that "after [July 25, 1969] noncorporate taxpayers are to include one-half of their net long-term capital gains in income without regard to their tax rate bracket." H. Rept. 91-782 (1969), 1969-3 C.B. 667.The Senate Committee on Finance substantially modified the 73 T.C. 118">126 House provision. The Senate provision introduced the concept of "subsection (d) gain." 9The committee report accompanying the Senate proposals explains1979 U.S. Tax Ct. LEXIS 35">52 the concept in part as a transitional rule which exempts from the general repeal of the alternative tax "sales or dispositions under binding contracts that were in effect on October 9, 1969," even though the sales were consummated after that date and "installment sale payments received after the effective date of the change on sales on or before October 9, 1969, or pursuant to binding contracts in effect on that date." S. Rept. 91-552 (1969), 1969-3 C.B. 546. The only modification made to the Senate proposal by the Conference Committee that is relevant to this decision was to limit the continuation of the 25-percent tax rate in the case of "payments received pursuant to certain binding contracts and installment sales" to amounts received before 1975. H. Rept. 91-782 (1969), 1969-3 C.B. 668. Thus, the reference in section 1201(d) to section 453(a)(1) is explainable as an intended clarification of the status of installment payments received after 1969 but which relate to sales made before October 10, 1969. However, the fact that Congress specifically addressed the problem of section 453(a)(1) installment payments received after1979 U.S. Tax Ct. LEXIS 35">53 1969 without mentioning section 453(d) does not mean that payments reported under section 453(d) were not to be covered by the transitional rules. This seems particularly true in light of the ameliorative features of the transitional rule of 1201(d) and the philosophy underlying section 453.Section 453, in general, allows a taxpayer to elect to report gain realized on certain qualifying sales on1979 U.S. Tax Ct. LEXIS 35">54 an installment basis, thereby deferring a portion of the tax stemming from the gain on the sale. The installment method of reporting income for Federal tax purposes was first authorized by statute in section 212(d), Revenue Act of 1926, ch. 27, 44 Stat. (Part 2) 23, and was designed to avoid the hardships of income "bunching" in the 73 T.C. 118">127 year of sale when the seller received certain debt obligations but did not receive cash or the equivalent of cash which would provide him with funds to pay the tax due on the gain. S. Rept. 52, 69th Cong., 1st Sess. (1926), 1939-1 C.B. (Part 2) 332, 346; H. Rept. 356, 69th Cong., 1st Sess. (1926), 1939-1 C.B. (Part 2) 361, 363; H. Rept. 91-413 (1969), 1969-3 C.B. (Part 1) 200, 267. In 1928, Congress enacted section 44(d), Revenue Act of 1928, ch. 852, 45 Stat. (Part 1) 806, 10 to terminate the privilege of reporting gain on the installment method where a taxpayer who had elected installment method reporting subsequently disposed of unpaid installment obligations. The House and Senate Committee Reports, H. Rept. 2, 70th Cong., 1st Sess. (1927), 1939-1 C.B. (Part 2) 384, 394;1979 U.S. Tax Ct. LEXIS 35">55 S. Rept. 960, 70th Cong., 1st Sess. (1928), 1939-1 C.B. (Part 2) 409, 425, explained the objectives of the 1928 legislation in identical language:Subsection (d) contains new provisions of law to prevent evasion of taxes in connection with the transmission of installment obligations upon death, their distribution by way of liquidating or other dividends, or their disposition by way of gift, or in connection with similar transactions. The situations above specified ordinarily do not give rise to gain and yet at the same time it is urged that they permit the recipient to obtain a greatly increased basis in his hands for the property received, except in the case of gifts. It therefore seems desirable to clarify the matter. The installment basis accords the taxpayer the privilege of deferring the reporting at the time of sale of the gain realized, until such time as the deferred cash payments are made. To prevent the evasion the subsection terminates the privilege of longer deferring the profit if the seller at any time transmits, distributes, or disposes of the installment obligations and compels the seller at that time to report the deferred profits1979 U.S. Tax Ct. LEXIS 35">56 . The subsection also modifies the general rule provided in subsection (a) for the ascertainment of the percentage of profit in the deferred payments, in those cases in which the obligations are satisfied at other than their face value or are sold or exchanged. The modification permits a compensating reduction in the percentage of profit in case the obligations are satisfied at less than their face value, or are sold or exchanged at less than face value.Whether or not the gain or loss realized under the section is recognized for tax purposes, depends upon general principles of law embodied in the income 73 T.C. 118">128 tax provisions, the exchange of installment obligations in connection with tax-free exchanges, for instance, being cared for by section 112.[Emphasis added.]1979 U.S. Tax Ct. LEXIS 35">57 Section 44(d), Revenue Act of 1934, ch. 277, 48 Stat. (Part 1) 680, 695, 11 carried over substantially the same language as that of section 44(d) of the 1928 Act, with the following pertinent addition:1979 U.S. Tax Ct. LEXIS 35">58 Any gain or loss so resulting [from the disposition of an installment obligation] shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.This language has been preserved, unchanged, in the flush language of section 453(d)(1). 12 The purpose of the 1934 legislation was to ensure that any profit reported on the disposition of installment obligations would be characterized as long-term or short-term gain according to the period for which the original property sold had been held, rather than according to the period 73 T.C. 118">129 for which the installment obligations were held. S. Rept. 558, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 586, 608; H. Rept. 1385, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 627, 629.Although respondent states that "the purpose of section1979 U.S. Tax Ct. LEXIS 35">59 453(d) is to abort the operation of section 453(a)(1) and (b)(1)," we view the purpose as being to accelerate the reporting of gain already realized and technically recognized but not yet reported. 131979 U.S. Tax Ct. LEXIS 35">61 Except for establishing the time when profit is to be taxed, with the consequent possibility that a change in the tax laws in the interval between the initial installment sale and the disposition of the installment obligations may result in a differing rate of tax or the recharacterization of the asset and hence the nature of the gain (see Snell v. Commissioner, 97 F.2d 891">97 F.2d 891 (5th Cir. 1938), affg. a Memorandum Opinion of this Court), the disposition of installment obligations is given no effect independent from the original sale. Thus, under section 453(d)(2), the basis of obligations received in an installment sale is a direct function of the basis of the property originally sold. 14 In addition, there is no "tacking" of the holding periods of the installment obligations and the property originally sold. Rather, the character of any gain on disposition of the installment obligations is determined solely by the holding period of the underlying 1979 U.S. Tax Ct. LEXIS 35">60 asset. Estate of Rogers v. Commissioner, 1 T.C. 629">1 T.C. 629 (1943), affd. 143 F.2d 695">143 F.2d 695 (2d Cir. 1944), cert. denied 323 U.S. 780">323 U.S. 780 (1944). Furthermore, the nature of the gain on the disposition of an installment obligation is determined by whether the underlying property sold was a capital asset or an ordinary-income producing asset. There is no allocation of the gain reported on disposition of installment obligations between the underlying sale transaction and the subsequent disposition transaction. In sum, the gain "resulting" from the disposition of installment obligations is the gain that previously was realized on the sale of the underlying asset, but was not yet reported. Estate of Rogers 73 T.C. 118">130 , 1 T.C. 629">1 T.C. 639; H. Rept. 2, 70th Cong., 1st Sess. (1927), 1939-1 C.B. (Part 2) 384, 395, and S. Rept. 960, 70th Cong., 1st Sess. (1928), 1939-1 C.B. (Part 2) 409, 425, quoted above; cf. Smith v. Commissioner, 56 T.C. 263">56 T.C. 263, 56 T.C. 263">285 (1971).Applying these principles to the facts of this case, it is apparent that the gain "resulting" from the sales of the Gulf & Western installment obligations was the gain that had been realized upon the sales of the Associated Investment Co. stock. The stock sales occurred in 1968. Accordingly, the gain from the sales of the Gulf & Western installment obligations was gain "arising * * from sales * * * entered into on or before October 9, 1969," and, therefore, qualifies as "subsection (d) gain."Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year 1972. In 1969, subject to certain transitional rules, Congress eliminated the alternative tax on capital gains in excess of $ 50,000 in any tax year. The alternative tax imposed a flat rate of 25 percent on a long-term capital gain and was more advantageous to an individual in a tax bracket above 50 percent than the standard method of simply deducting one-half of the gain. However, "subsection (d) gain," provided for in sec. 1201(d), preserved the alternative tax for gains from sales prior to Oct. 9, 1969, including sales reported on the installment basis pursuant to sec. 453(a). See infra↩.2. Petitioners have not alleged any error with respect to the deficiency asserted against the Ernestine M. Carmichael Trust No. 21-35 for taxable year 1973.↩3. H. Rept. 91-413 (Part 1) (1969), 1969-3 C.B. 290-291; S. Rept. 91-552 (1969), 1969-3 C.B. 544↩-545.4. Sec. 1901(a)(135)(C)(i), Tax Reform Act of 1976, 90 Stat. 1787, amended sec. 1201(d), I.R.C. 1954↩, for the taxable years beginning after 1976, by striking out the definition of "subsection (d) gain" and redesignating subsec. (e) as subsec. (d).5. The notices of deficiency show that respondent has allowed $ 50,000 of each trust's gain to be treated as "subsection (d) gain" under sec. 1201(d)(3)↩.6. Sec. 453(d) provides that gain or loss resulting from the disposition of an installment obligation arising under sec. 453 "shall be considered as resulting from the sale or exchange of the property↩ in respect of which the installment obligation was received." (Emphasis added.)7. Sec. 453(d)(1) provides:(d) Gain or Loss on Disposition of Installment Obligations. -- (1) General rule. -- If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and -- (A) the amount realized, the case of satisfaction at other than face value or a sale or exchange, or(B) the fair market value of the obligation at the time of distribution, transmission, or disposition, in the case of the distribution, transmission, or disposition otherwise than by sale or exchange.Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.↩8. Sec. 453(b) provides:(b) Sales of Realty and Casual Sales of Personalty. -- (1) General rule. -- Income from -- (A) a sale or other disposition of real property, or(B) a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year) for a price exceeding $ 1,000,may (under regulations prescribed by the Secretary) be returned on the basis and in the manner prescribed in subsection (a).(2) Limitation. -- Paragraph (1) shall apply only if in the taxable year of the sale or other disposition -- (A) there are no payments, or(B) the payments (exclusive of evidences of indebtedness of the purchaser) do not exceed 30 percent of the selling price.(3) Purchaser evidences of indebtedness payable on demand or readily tradable. -- In applying this subsection, a bond or other evidence of indebtedness which is payable on demand, or which is issued by a corporation or a government or political subdivision thereof (A) with interest coupons attached or in registered form (other than one in registered form which the taxpayer establishes will not be readily tradable in an established securities market), or (B) in any other form designed to render such bond or other evidence of indebtedness readily tradable in an established securities market, shall not be treated as an evidence of indebtedness of the purchaser.It is not disputed that the Gulf & Western installment obligations were marketable securities. However, the rule of sec. 453(b)(3)↩ was made effective for transactions occurring after May 27, 1969. Sec. 412(b), Tax Reform Act of 1969, 83 Stat. 609.9. The Senate revision to H.R 13270, 91st Cong., 1st Sess. (1969), defined "subsection (d) gain" in pertinent part as follows:(d) Subsection (D) Gain Defined. -- For purposes of this section, the term "subsection (d) gain" means the sum of the long-term capital gains for the taxable year arising -- (1) from sales or other dispositions pursuant to binding contracts (other than any gain from a transaction described in section 631 or 1235) entered into on or before October 9, 1969, including sales or other dispositions the income from which is returned on the basis and in the manner prescribed in section 453(a)(1)↩ * * 10. Sec. 44(d), Revenue Act of 1928, provided:(d) Gain or Loss Upon Disposition of Installment Obligations. -- If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange -- the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange -- the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.↩11. Sec. 44(d), Revenue Act of 1934, provided:(d) Gain or Loss Upon Disposition of Installment Obligations. -- If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange -- the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange -- the fair market value of the obligation at the time of such distribution, transmission, or disposition. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full. This subsection shall not apply to the transmission at death of installment obligations if there is filed with the Commissioner, at such time as he may by regulation prescribe, a bond in such amount and with such sureties as he may deem necessary, conditioned upon the return as income, by the person receiving any payment on such obligations, of the same proportion of such payment as would be returnable as income by the decedent if he had lived and had received such payment.↩12. Sec. 453(d) provides, in part:(d) Gain or Loss on Disposition of Installment Obligations. -- (1) General rule. -- If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and -- (A) the amount realized, in the case of satisfaction at other than face value or a sale or exchange, or(B) the fair market value of the obligation at the time of distribution, transmission, or disposition, in the case of the distribution, transmission, or disposition otherwise than by sale or exchange.Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.(2) Basis of obligation. -- The basis of an installment obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.↩13. As one commentator has written:"The statute [sec. 453(d)] is careful not to say that gain or loss shall be "recognized" upon the disposition of an installment obligation. Since section 453 provides for income deferral and not for nonrecognition (the gain from a sale reported under section 453 having been both realized and recognized), it would be erroneous to describe the disposition of an installment obligation as a gain or loss recognizing event. The activation of section 453(d) simply triggers the inclusion of the previously deferred income or, if the obligation is disposed of in a loss context, allows the taxpayer a loss which may be deductible. * * [M. Emory, "Disposition of Installment Obligations: Income Deferral, 'Thou Art Lost and Gone Forever,'" 54 Iowa L. Rev. 945">54 Iowa L. Rev. 945, 54 Iowa L. Rev. 945">948↩ (1969). Emphasis in original; fn. ref. omitted.]"14. See sec. 1.453-9(b)(3), example (1)↩, Income Tax Regs.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623317/	FREDERICK M. EGAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEgan v. CommissionerDocket No. 6806-75.United States Tax CourtT.C. Memo 1976-351; 1976 Tax Ct. Memo LEXIS 52; 35 T.C.M. 1601; T.C.M. (RIA) 760351; November 18, 1976, Filed 1976 Tax Ct. Memo LEXIS 52">52 Frederick M. Egan, pro se. Willard J. Frank, for the respondent. RAUMMEMORANDUM OPINION RAUM, Judge: The Commissioner determined deficiencies in petitioner's 1972 and 1973 income taxes in the amounts of $806 and $1,784.44, respectively, portions of which appear to have already been paid through withholding. The deficiencies are based on the following adjustments: 19721973Salary & Wages$4,911.36Interest Income2,119.12$2,770.68 Petitioner does not challenge these adjustments. Petitioner is a carpenter. Since 1971 he has been engaged in a dispute with officers of his union. He quite plainly feels bitter about them, and states that he has been deprived of his livelihood as a result of expulsion from the union. The present litigation in this Court is largely an outgrowth of the injustice which he believes he has suffered in his litigation against the union officers in the United States District Court for the District of Massachusetts. Among his grievances is his complaint that the United States Marshall failed to make service upon at least one of the defendants. He believes with great sincerity that he has been "getting1976 Tax Ct. Memo LEXIS 52">53 a run around" in that litigation, and, as a consequence, he has taken the position that the Internal Revenue Service has "forfeited the right" to collect taxes from him that could be used to support other branches of the Government, notably the Federal District Court. He accordingly has written in red ink across the front page of his 1972 and 1973 returns the words "Forfeit the Right", which words also appear in his petition to this Court. While we have no doubt whatever as to the sincerity and moral fervor and intensity of petitioner's strongly held views, it must be remembered that we are a Court of limited jurisdiction and have no power whatever to inquire into the grievances about which petitioner complains in the District Court proceeding. To the extent that petitioner thinks that error has been committed against him in District Court, his proper course would seem to be an appeal to the United States Court of Appeals which has direct jurisdiction over decisions of the District Court. Our authority under law is confined strictly in cases of this character merely to a review of the Commissioner's determination of deficiency. We are without any power to act upon any broader1976 Tax Ct. Memo LEXIS 52">*54 basis. Cf. ; , affirmed (C.A. 7), certiorari denied ; , remanded on another ground, (C.A. 9). Accordingly, since no error has been shown in the adjustments underlying the Commissioner's determination, it must be approved, but in order that the decision herein may show the correct amount of credits to which petitioner is entitled as a result of taxes already paid by him, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623318/	DENNIS J. PRING, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPring v. CommissionerDocket No. 11452-85United States Tax CourtT.C. Memo 1989-340; 1989 Tax Ct. Memo LEXIS 336; 57 T.C.M. 958; T.C.M. (RIA) 89340; July 17, 1989Richard L. Carico and John M. Bekins, for the petitioner. Mary E. Jansing and Alison W. Lehr, for the respondent. SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION SWIFT, Judge: In a termination assessment under section 6851(a), 1 respondent determined petitioner's Federal income tax liabilities for 1977 through 1980. After the termination assessment, respondent issued a timely notice of deficiency and determined deficiencies in petitioner's Federal income tax liabilities as follows: Additions to Tax, Secs.YearDeficiency6651(a)(1)6653(a)6654(a)1977$ 21,104.00$ 5,276.00$ 1,055.00$ 751.0019786,582.001,646.00329.00210.00197914,970.003,743.00749.00627.001980312,528.0076,980.0015,626.0019,360.001989 Tax Ct. Memo LEXIS 336">338 Petitioner has conceded respondent's determinations for 1977 through 1979. The issues for decision for 1980 are: (1) Whether the value of property petitioner forfeited to the United States under 21 U.S.C. sec. 881 (1976) should be charged to petitioner as taxable income; (2) if so, whether petitioner is entitled to a business loss deduction under section 165 for the value of the forfeited property; (3) if petitioner is not entitled to the loss deduction, whether petitioner is entitled to the tax rate allowable under section 1348(a) for "personal service" income; and (4) whether the addition to tax under section 6654(a) can be waived by respondent. FINDINGS OF FACT Many of the facts have been stipulated and are so found. At the time the petition was filed, petitioner was incarcerated at the Federal Prison in Lompoc, California. On October 28, 1982, petitioner pled guilty to and was convicted of possession with intent to distribute cocaine in violation of Federal law. Petitioner did not file a Federal individual income tax return for the years 1974 through 1980. In 1980, petitioner lived with his wife, Robin Hale Pring, in a house he had purchased1989 Tax Ct. Memo LEXIS 336">339 with his father, John Pring. Petitioner made a $ 21,500 cash downpayment when the house was purchased. On February 10, 1980, Drug Enforcement Administration ("DEA") agents arrested petitioner. Within a few hours after petitioner's arrest, DEA agents conducted a legal search of the house petitioner and his father had purchased and in which petitioner lived. Petitioner was present during the search. While conducting the search, the agents discovered a locked closet. The agents opened the closet with a key from petitioner's key ring. Inside the closet was a locked combination floor safe and a file cabinet. Petitioner told the agents the combination of the safe. When the agents opened the safe and file cabinet, they discovered large amounts of cash and cocaine. The agents also searched the rest of petitioner's house. They found in the house approximately $ 242,000 in cash, and 3,679.50 grams of cocaine. Respondent determined the wholesale cost of the cocaine to be $ 176,616. The agents seized the cash and cocaine, and petitioner subsequently forfeited the property to the United States under 21 U.S.C. sec. 881 (1976). Using a combination of the cash on1989 Tax Ct. Memo LEXIS 336">340 hand and cash expenditures method of proof, respondent determined that petitioner had underreported income for 1980 of $ 473,205 and respondent determined the deficiency for 1980 of $ 312,528. Respondent charged the following items to petitioner as income: (1) The $ 241,982 in cash found in petitioner's house and on his person; (2) a $ 4,000 cashier's check found in the house; (3) $ 4,607.35 seized from petitioner's bank account; (4) the $ 176,616 estimated wholesale cost of the cocaine found in the house; and (5) the $ 46,000 cost to petitioner of real estate purchased. OPINION Ownership of Seized PropertyPetitioner first challenges respondent's determination that he owned the seized cash and cocaine. He argues that he did not own nor did he have sufficient control over the property prior to the forfeiture to be regarded as having derived economic value or income from the property. Petitioner argues that most of the cash and cocaine was owned by drug dealers who had paid him merely to store it in his house. Petitioner also argues that it was apparent from his life style that he did not own the majority of the cash and cocaine. Petitioner argues in the alternative1989 Tax Ct. Memo LEXIS 336">341 that because the seized property (i.e., the cash and cocaine) was subject to immediate forfeiture, for tax purposes, he should not be regarded as owning it. Respondent contends that petitioner failed to present any credible evidence to prove that he did not own the seized property. Respondent also argues that regardless of the forfeiture, the value of the property is includable in petitioner's gross income under the broad reach of section 61. We agree with respondent. Under section 61, gross income includes "all income from whatever source derived." The Supreme Court has held that whenever a taxpayer acquires wealth and has such control over the property "that, as a practical matter, he derives readily realizable economic value from it," the taxpayer is regarded generally as having received income and is liable for tax on the income. James v. United States,366 U.S. 213">366 U.S. 213, 366 U.S. 213">219 (1960), citing Rutkin v. United States,343 U.S. 130">343 U.S. 130, 343 U.S. 130">137 (1952); Wood v. United States,863 F.2d 417">863 F.2d 417, 863 F.2d 417">419 (5th Cir. 1989). Based on the evidence at trial, we1989 Tax Ct. Memo LEXIS 336">342 find that petitioner owned the seized property prior to forfeiture and further that the forfeited property is includable in petitioner's income. Gambina v. Commissioner,91 T.C. 826">91 T.C. 826 (1988). The property was seized in petitioner's house. Petitioner possessed a key that unlocked the door to the closet, and he knew the combination to the safe where most of the cash and cocaine was stored. Petitioner admitted to and was convicted of possession with intent to distribute cocaine. Petitioner failed to call witnesses (namely, his wife and father), who might have been able to corroborate his allegations regarding the drug traffickers. In explanation for his failure to call these witnesses, petitioner states that he and his family feared they would be harmed or killed if they testified and disclosed the identities of the drug traffickers. Petitioner's failure, however, to call the witnesses gives rise to an inference that their testimony would have been unfavorable to petitioner. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 6 T.C. 1158">1165 (1946), affd. 162 F.2d 523">162 F.2d 523 (10th Cir. 1947). We also reject petitioner's argument that his1989 Tax Ct. Memo LEXIS 336">343 life-style was inconsistent with the amount of taxable income determined by respondent. As stated in Lopez v. Internal Revenue Service, 614 F. Supp. 1332">614 F. Supp. 1332, 614 F. Supp. 1332">1335 (E.D. N.Y. 1985), a discrepancy between the amount of cash seized from a drug trafficker and his apparent life-style may simply imply that the drug trafficker is hiding the cash rather than displaying it. We conclude that petitioner owned the cash and cocaine and that respondent properly charged petitioner with taxable income with respect thereto. 91 T.C. 826">Gambina v. Commissioner, supra at 828-829; 863 F.2d 417">Wood v. United States, supra at 419. Loss DeductionThe second issue for decision is whether petitioner is entitled to a business loss deduction under section 165 with respect to the forfeited property. Under 21 U.S.C. sec. 881(a) (1976), controlled substances and money used or to be used to purchase controlled substances are subject to forfeiture in favor of1989 Tax Ct. Memo LEXIS 336">344 the United States. Under section 165(a), ordinary loss deductions are allowed for uncompensated losses incurred in transactions entered into for profit. Courts, however, uniformally have disallowed section 165 loss deductions where the deductions arise from transactions that violate strong public policy. Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30">356 U.S. 30, 356 U.S. 30">35 (1958); Holmes Enterprises, Inc. v. Commissioner, 69 T.C. 114">69 T.C. 114, 69 T.C. 114">117 (1977); Holt v. Commissioner, 69 T.C. 75">69 T.C. 75, 69 T.C. 75">79 (1977), affd. per curiam 611 F.2d 1160">611 F.2d 1160 (5th Cir. 1980). 2In 863 F.2d 417">Wood v. United States, supra at 421, 422, the Fifth Circuit concluded that because of the strong public policy underlying the Federal forfeiture penalty and against drug trafficking, drug dealers should not be allowed loss deductions for property forfeited to the United States under 21 U.S.C. sec. 881 (1976). Petitioner notes that before 1982 the Code was silent as1989 Tax Ct. Memo LEXIS 336">345 to whether loss deductions were allowable with respect to property forfeitures relating to illegal drug activities. See sec. 280E. Petitioner, therefore, argues that in 1980 there could not have been a "sharply defined National or State policy" against loss deductions relating to drug forfeitures. 69 T.C. 75">Holt v. Commissioner, supra at 79. Respondent correctly argues that notwithstanding the Code's failure, as of 1980, to address specifically losses arising from drug forfeitures, court decisions had done so and routinely had disallowed such deductions. 69 T.C. 75">Holt v. Commissioner, supra at 80; 69 T.C. 114">Holmes Enterprises, Inc. v. Commissioner, supra at 117. We conclude that petitioner is not entitled to a section 165 loss deduction with respect to the property forfeited to the United States under 21 U.S.C. sec. 881(a) (1976). Personal Service IncomeThe third issue is whether income charged to petitioner with respect to the forfeited property constituted personal service income, so as to qualify petitioner for the tax rates available on earned income under section 1348, as in effect in 1980. In general, 1989 Tax Ct. Memo LEXIS 336">346 section 1348 (and by reference section 911(b)) defines personal service income to be income from wages, salaries, personal services, and other sources with respect to which capital is not a material factor. In certain situations, income attributable to both personal services and capital also will qualify as personal service income. See sec. 1.1348-3(a)(3), Income Tax Regs.Petitioner maintains that he received personal service income (namely, payments drug suppliers allegedly made to him for storing drugs in his house and commissions for selling drugs on behalf of dealers). Respondent argues that the income petitioner received from the sale of large amounts of illegal drugs is attributable solely to capital and not to personal services. On the record before us, we conclude that only capital and not personal services was the material income-producing factor in petitioner's drug activities. Strauser v. United States, 535 F. Supp. 957">535 F. Supp. 957, 535 F. Supp. 957">961-962 (N.D. Ill. 1982). The only apparent assets used in petitioner's drug activities were his house, the1989 Tax Ct. Memo LEXIS 336">347 cocaine inventory, and cash. Petitioner is not entitled to the tax rates available under section 1348(a). Addition to TaxThe last issue is whether respondent's determination for 1980 of an addition to tax under section 6654(a) can be waived for reasonable cause. Petitioner argues that in 1980 it was impossible for him to make estimated tax payments on time, since the Government seized all of his cash before the payments were due. Petitioner, therefore, argues that the imposition of the section 6654(a) addition to tax is unfair and that respondent should waive this addition to tax due to reasonable cause. The addition to tax under section 6654(a) is to be determined by respondent where a taxpayer fails to make estimated tax payments. As in effect for 1980, no provision for a waiver of the addition to tax is made in the statute, and under section 1.6654-1(a), Income Tax Regs., the addition to tax is mandatory and cannot be waived due to reasonable cause. Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 75 T.C. 1">21 (1980); Estate of Reuben v. Commissioner, 33 T.C. 1071">33 T.C. 1071, 33 T.C. 1071">1072 (1960).1989 Tax Ct. Memo LEXIS 336">*348 In 33 T.C. 1071">Estate of Reuben v. Commissioner, supra at 1072, we held that an addition to tax under section 6654 for failure to make estimated tax payments is mandatory and that "extenuating circumstances are irrelevant." 75 T.C. 1">Grosshandler v. Commissioner, supra at 21. With respect to 1984 and subsequent years, respondent does have the authority in certain cases to waive the addition to tax for an individual's failure to pay estimated income tax. Section 6654(e)(3); Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 793. We sustain respondent's determination under section 6654(a). Respondent also has moved to strike petitioner's testimony on the grounds that on cross examination petitioner refused to answer many questions concerning his drug-related activities. On the facts of this case, and in light of our resolution of the other issues in respondent's favor, we deny respondent's motion. Decision will be entered for the respondent. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect during the years at issue.↩2. See also Gillan v. Commissioner, T.C. Memo. 1988-321↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623320/	ESTATE OF CELIA GOSCH, HARRY M. GOSCH, EXECUTOR, LAWRENCE S. GOSCH, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Gosch v. CommissionerDocket No. 7105-73.United States Tax CourtT.C. Memo 1976-82; 1976 Tax Ct. Memo LEXIS 326; 35 T.C.M. 353; T.C.M. (RIA) 760082; March 16, 1976, Filed Richard J. Mandell, for the petitioner. J. S. Hamelburg and Richard S. Kestenbaum, for the respondent. RAUMMEMORANDUM OPINION RAUM, Judge: The Commissioner determined an estate tax deficiency in the amount of $4,341.40. All other issues having been conceded, the only remaining1976 Tax Ct. Memo LEXIS 326">327 matter in controversy is whether a debt owed by the decedent at the time of her death based on a $10,000 demand note is deductible under section 2053(a)(3), I.R.C. 1954. All of the facts have been stipulated. Cellia Gosch ("decedent") died testate on August 12, 1970. At the time of her death she resided in Bal Harbour, Florida. Her sons, Harry M. Gosch and Lawrence S. Gosch, were duly appointed executors of her will. At the time the petition was filed herein, Harry M. Gosch resided in Portchester, New York, and Lawrence S. Gosch resided in New Rochelle, New York. The decedent was survived by three adult children, her sons, Harry and Lawrence, and her daughter, Barbara Laner. In her will, she bequeathed her entire estate to these children in equal shares. On or about November 13, 1968, nearly two years before her death, the decedent executed a promissory demand note in the amount of $10,000 payable to the order of Dorothy Reiskin in New Rochelle, New York. On July 31, 1970, the decedent forwarded two checks to Dorothy Reiskin, one, in the amount of $5,000, representing a principal payment on the note, and the other, in the amount of $160, representing interest to July 31, 1970. These1976 Tax Ct. Memo LEXIS 326">328 checks were deposited by Dorothy Reiskin but did not clear the decedent's bank, City National Bank of Miami Beach, Florida, because they were not presented to it until after the decedent had died. The executors of decedent's will were granted letters testamentary by the County Judge's Court, Dade County, Florida, on September 1, 1970. Later in that month, in response to written demands made by Dorothy Reiskin's attorneys, the executors remitted $10,242 in full payment of principal and interest that had accrued on the note. No claim was filed in the "Probate Court of Florida" in respect of the note. On the Federal estate tax return filed August 6, 1971, the executors reported a gross estate, valued at date of death, in the amount of $160,533.51, and claimed deductions from this amount totalling $22,162.78. Among the deductions thus claimed was an item of $10,242 in respect of the Dorothy Reiskin note, which was listed as a debt of the decedent. In his deficiency notice, the Commissioner determined that "the amount of $10,242.00 paid to Dorothy Reiskin is not allowable as a deduction from the gross estate because the debt was not an enforceable claim against the estate under the1976 Tax Ct. Memo LEXIS 326">329 applicable state law." Although petitioner's position would appear superficially to be unassailable, we find that we must reluctantly sustain the Commissioner's determination. Section 2053 of the Internal Revenue Code provides that for purposes of the Federal estate tax, "the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts -- * * (3) for claims against the estate * * * as are allowable by the laws of the jurisdiction * * * under which the estate is being administered." And it has been made clear that under these provisions deductions are allowable only in respect of those claims that are enforceable against the estate according to the law of the jurisdiction under which the estate is administered. Sec. 20.2053-4, Estate Tax Regs.; cf. Estate of Frank G. Hagmann,60 T.C. 465">60 T.C. 465, 60 T.C. 465">468-469, affirmed per curiam, 492 F.2d 796 (C.A. 5); Estate of Anna Lewis,49 T.C. 684">49 T.C. 684, 49 T.C. 684">687. It is not disputed that the debt here in issue was a valid debt owed by decedent at the time of her death, nor that the debt was subsequently paid by her executors. But those facts alone1976 Tax Ct. Memo LEXIS 326">330 do not necessarily establish that the debt was an enforceable claim against decedent's estate. Events occurring after a decedent's death may preclude the enforcement of an otherwise valid claim against his estate. In such circumstances the claim would not be deductible under section 2053. 60 T.C. 465">Estate of Frank G. Hagmann,supra; cf. Commissioner v. Shively's Estate,276 F.2d 372">276 F.2d 372 (C.A. 2).1Like other states, Florida imposes limitations on the enforceability of otherwise valid claims against a decedent's estate. For estates such as the decedent's, the administration of which began in September 1970, the pertinent Florida statute provides as follows: 733.16 Form and manner of presenting claims; limitation1976 Tax Ct. Memo LEXIS 326">331 (1) No claim or demand, whether due or not, direct or contingent, liquidated or unliquidated, or claim for personal property in the possession of the personal representative or for damages, including but not limited to actions founded upon fraud or other wrongful act or commission of the decedent, shall be valid or binding upon an estate, or upon the personal representative thereof, or upon any heir, legatee or devisee of the decedent unless the same shall be in writing and contain the place of residence and postoffice address of the claimant, and shall be sworn to by the claimant, his agent or attorney, and be filed in the office of the county judge granting letters. Any such claim or demand not so filed within six (6) months from the time of the first publication of the notice to creditors shall be void even though the personal representative has recognized such claim or demand by paying a portion thereof or interest thereon or otherwise; * * * (Emphasis supplied.) As these provisions plainly indicate, under Florida law no claim is enforceable against an estate unless timely filed in the office of the appropriate county judge. Moreover, the Florida Supreme Court has interpreted1976 Tax Ct. Memo LEXIS 326">332 these provisions as precluding the decedent's personal representative from being allowed credit in his final accounting for any unfiled but otherwise valid claims which he has in fact paid, even where such payment occurred prior to the expiration of the six month period 2 for filing claims. Twomey v. Clausohm,234 So. 2d 338">234 So. 2d 338 (Fla.). And in its opinion in Twomey v. Clausohm the court stated that "the Legislature clearly and pointedly tells us, as well as personal representatives, that the required filing of claims cannot be waived." 234 So. 2d 338">234 So. 2d at 341. Accordingly, since no claim, timely or otherwise, was filed in this case, the obligation on the Reiskin note became void under section 733.16, and, in accord with the Florida Court's holding in Twomey v. Clausohm, the fact that the executors made payment on the note is wholly irrelevant. 1976 Tax Ct. Memo LEXIS 326">333 Petitioner seeks escape from the unhappy consequences of the foregoing Florida statutory provisions by relying upon a 1973 amendment to section 733.16, which, interalia, added the following language to the statute: However, the personal representative may settle in full or in part any legal claim without the necessity of said claim being filed by the creditor, when the settlement has been approved by the heirs or beneficiaries adversely affected or accounted for in accountings to the court, and when the settlement is made within the statutory time for filing claims; * * * Unfortunately for petitioner, the Florida legislature explicitly stated that this and other amendments then made to section 733.16 "shall not be applicable to any estate the administration of which was commenced prior to October 1, 1973." Act of June 6, 1973, ch. 73-106, sec. 5, Fla. Laws 166. 3 The 1973 amendment is therefore of no help to petitioner. 41976 Tax Ct. Memo LEXIS 326">334 Petitioner has relied heavily upon Rev. Rul. 75-24, 1975-1 C.B. 306, where it was stated, in connection with a Mississippi statute that was similar to the Florida provisions herein, that informal presentation of a claim to the executor followed by payment within the statutory period was sufficient to qualify for the deduction under section 2053 of the Code. However, petitioner has ignored the companion ruling in Rev. Rul. 75-177, 1975-1 C.B. 307, involving the Florida statute itself. This second ruling pointed out the difference between Florida cases governed by the statutes of that state prior to the 1973 amendment and such cases arising under the amendatory provisions. Thus, it held that although an unprobated claim against a Florida decedent paid by the executors might qualify for deduction under section 2053 in cases of estates the administration of which began on or after October 1, 1973, no such deduction was allowable where administration of the estate began prior to that date. In so concluding, it properly relied upon the controlling criteria established by the highest court of Florida in Twomey v. Clausohm as it applied to cases governed1976 Tax Ct. Memo LEXIS 326">335 by Florida law prior to the 1973 amendment. Although the result may appear to be harsh in this case, we can find no escape from it in view of the Florida statute and the authoritative interpretation of it by the Supreme Court of that state. Our holding is, of course, limited to those estates the administration of which began prior to October 1, 1973. A different and more reasonable result could be reached in cases governed by the later statutory provisions. Decision will be entered for the respondent.Footnotes1. Petitioner has relied on Winer v. United States,153 F. Supp. 941">153 F. Supp. 941 (S.D. N.Y.), which holds otherwise. However, the Second Circuit has expressly disagreed with the reasoning of that case ( 276 F.2d 372">Commissioner v. Shively's Estate,supra, 276 F. 2d at 374-375), and the Winer rationale has also been rejected by this Court in Estate of Frank G. Hagmann,supra,60 T.C. 465">60 T.C. 469↩.2. The six-month period begins to run upon the "first publication of the notice to creditors". The record does not show when such notice was first published in this case. However, the burden of proof is upon petitioner, and we may fairly assume that such notice was published here no later than shortly after the beginning of the administration of the estate on September 1, 1970, as is generally the case in such situations.↩3. Section 733.16 was subsequently repealed in connection with the enactment of a new probate code effective July 1, 1975. Florida Stat. Ann. ch. 731-735↩ (West Special Pamphlet 1975). We do not understand petitioner to rely upon any provisions in this new legislation. 4. oreover, even if otherwise applicable, the record herein fails to establish that the conditions of the 1973 amendment were satisfied. While it may be assumed that the executors, who, as beneficiaries of the decedent's will, approved their payment of the Reiskin debt, there is no such evidence in the record as to approval by the third beneficiary, Barbara Laner. To be sure, petitioner has attached to its brief an "exhibit", in which Barbara Laner purports to confirm and consent to the executors' payment of the debt. However, not only is that "exhibit" not part of the record in this case (cf. Rule 143(b), Tax Court Rules of Practice and Procedure↩), but it in any event is dated January 21, 1972, long after the payment made by the executors and after the six month statutory period had expired.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623322/	Joseph S. Freeland v. Commissioner. Joseph S. Freeland and Murray M. Freeland v. Commissioner.Freeland v. CommissionerDocket Nos. 77836, 83317.United States Tax CourtT.C. Memo 1960-258; 1960 Tax Ct. Memo LEXIS 34; 19 T.C.M. 1460; T.C.M. (RIA) 60258; November 30, 19601960 Tax Ct. Memo LEXIS 34">34 Pursuant to paragraph 10 of their separation agreement, petitioner's former wife conveyed her interest in certain real property to petitioner in exchange for a promissory note under which petitioner promised to pay her the sum of $24,000 in 120 equal monthly installments of $200, "said monthly installments being inclusive of interest at the rate of six per cent per annum upon the unpaid principal balances of the indebtedness." Held, payments under the promissory note did not constitute periodic payments within the meaning of section 71(a), Internal Revenue Code of 1954, and are not deductible by petitioner under section 215. Held further, that amount of petitioner's payments which represents interest at the specified rate is properly deductible as interest on an indebtedness under section 163. Arthur Clark, Jr., Esq., for the respondent. BRUCE Memorandum Opinion BRUCE, Judge: These proceedings involve deficiencies in the Federal income tax of the petitioners as follows: PetitionerDkt. No.YearDeficiencyJoseph S. Freeland778361956 $352Joseph S. Freelandand Murray M.Freeland833171957528 The issues presented are: (1) whether certain monthly payments made by petitioner, Joseph S. Freeland, 1960 Tax Ct. Memo LEXIS 34">35 to his former wife, Cordelia Freeland, in 1956 and 1957, are deductible as periodic payments under the provisions of sections 215 and 71, Internal Revenue Code of 1954; 1 and (2) in the alternative, whether any portion of such payments is deductible as interest under section 163. These two proceedings have been submitted on common stipulations of facts and for purposes hereof shall be considered as having been consolidated for opinion. The stipulated facts are so found and the stipulations, together with exhibits attached thereto, are incorporated herein by this reference. Joseph S. Freeland and Murray M. Freeland, husband and wife, reside in Paducah, Kentucky. Joseph S. Freeland, hereinafter referred to as petitioner, filed an individual Federal income tax return for the year 1956 with the district director of internal revenue for the district of Kentucky. Petitioner and Murray M. Freeland filed a joint Federal income tax return for the year 1957 with the district director of internal revenue for the district of Kentucky. On April 20, 1956, the petitioner and his then wife, Cordelia 1960 Tax Ct. Memo LEXIS 34">36 Freeland, hereinafter referred to as Cordelia, executed a separation agreement wherein it was provided: * 1. Second party is to have the care, custody and control of Joseph C. Freeland, David S. Freeland and Mary Cordelia Freeland, the children of the parties, who are eighteen, fourteen and nine years of age, respectively, subject to the approval of any court of competent jurisdiction of the parties and subject matter in the event any action for divorce is hereafter brought by either of said parties and subject to and until the further orders of such court or of any other court of competent jurisdiction; and subject also to the right of first party to see and visit with said children and to have said children see and visit with him at reasonable intervals, times and places. 2. From and after the first day of May, 1956, first party shall pay to second party for the support and maintenance of the said three children and for her own support and maintenance the sum of Three Hundred Dollars ($300.00) per month, which shall be due and payable in advance on the first day of each month thereafter for the remainder of the lifetime of second party or until the death of first party, whichever 1960 Tax Ct. Memo LEXIS 34">37 first occurs, subject, however, to the provisions of this agreement hereinafter contained. 3. In the event of the remarriage of the party of the second part, the amount thus payable by first party shall be reduced by one-third (or One Hundred Dollars per month) as and when each of said children reaches his or her majority and is either self-supporting or has finished his or her college and/or professional education, whichever first occurs, or in the further event of the death of any of said children before the occurrence of any of said events. 4. Until the youngest of said children reaches the age of majority and is either self-supporting or has completed his or her college and/or professional education, whichever first occurs, one-half of all amounts received by second party in gainful employment (after deduction of required contributions for retirement benefits or social security benefits) or by way of pension, retirement benefits, social security benefits, unemployment compensation or similar income, but not to exceed in all One Thousand Eight Hundred Dollars ($1,800.00) per annum, shall be credited as received against the obligations herein undertaken by first party; and in the 1960 Tax Ct. Memo LEXIS 34">38 event of a reduction in the amount of such obligations under the provisions of Paragraph 3 hereof, the amount for which such credit shall be given first party shall be proportionately reduced. 5. After the youngest of said children shall have attained his or her majority, and is either self-supporting or has completed his or her college and/or professional education, whichever first occurs, all of such income received by second party shall be credited against first party's obligations hereunder. 6. Second party shall in no event be required to work, but agrees that from and after September 1, 1957, she will make reasonable efforts in good faith to obtain and retain such employment as shall be suitable to her talents, her education and the condition of her health, during such time as the obligations of first party hereunder shall continue. 7. First party further agrees, in addition to the undertakings hereinbefore recited, to: - a. Assume all unusual medical and hospital expense chargeable to any serious or extended illness suffered by any of the children during their minority or by second party prior to her remarriage. b. Maintain in force until their respective majorities the life 1960 Tax Ct. Memo LEXIS 34">39 insurance now in effect upon the lives of the three children and to transfer said policies, with cash values and other life benefits intact, to each insured as the latter becomes of age. c. Defray the reasonable expense of a college education, including one complete course of professional education, if desired, for each of the three children. First party reserves the right to have a voice in the selection of such course of study and such educational institution as any of the children may select. 8. To provide further for the support and education of said children in the event of the death of first party, first party agrees that he will cause all of his now existing life insurance (of which second party is now the beneficiary) in the total amount of Fourteen Thousand Five Hundred Dollars ($14,500.00) to be made payable to the said three children equally, and will maintain said insurance in force for the pro rata benefit of said three children until each of them respectively completes his or her education. 9. First party agrees that he will forthwith transfer to second party, free and clear of all encumbrances, the title to the 1955 model Plymouth automobile which is now in her possession; 1960 Tax Ct. Memo LEXIS 34">40 and that second party may retain as her own absolute property all of the household goods and furnishings and other contents of the home heretofore occupied by the parties, with the exception of the books and tools, which the parties shall divide by mutual agreement. 10. Second party agrees that she will forthwith convey to first party, free of all encumbrances, all of her right, title and interest in and to the real estate owned by the parties and heretofore occupied by them as their home, consisting of a residence and approximately two acres of ground located on the Blandville Road near Paducah, Kentucky. Simultaneously with said conveyance, first party agrees that he will execute and deliver to second party a good and sufficient promissory note, secured by a first and superior mortgage lien against said property, obligating himself to pay to the order of second party the sum of Two Hundred Dollars ($200.00) per month for the period of ten years from the date of May 1, 1956, inclusive of principal and interest. 1. In the event that first party fails to pay said note indebtedness in accordance with its terms, and as a result thereof second party through foreclosure proceedings or otherwise 1960 Tax Ct. Memo LEXIS 34">41 acquires title to said property, then during such time as second party continues to remain the owner of said property first party shall not be entitled to the credit mentioned in Paragraph 4 of this agreement. 12. In consideration of the foregoing undertakings on the part of first party, the second party hereby releases first party from any and all other or further obligations of support or maintenance for herself than those set forth in this instrument, and she does further release and relinquish unto first party, his heirs, executors, administrators and assigns, all rights or claims by way of dower, homestead, inheritance or descent, in and to any real property which first party now owns or may hereafter acquire, and any and all rights to a distributive share of his personal estate now owned or hereafter acquired, and any and all other rights and claims of every kind and nature arising or growing out of the marital relationship of said parties. She further agrees that she will not, in any manner, incur or contract any debts on the credit of first party and will not incur any liabilities in his name or on his behalf; and she waives, releases and relinquishes any and all claims by 1960 Tax Ct. Memo LEXIS 34">42 way of alimony (except for the provisions contained in this instrument) either temporary or permanent. During the continued marriage of the parties the second party agrees to sign any and all papers necessary to the economic transaction of first party's business. 13. First party, in consideration of said undertakings by second party, does hereby release and relinquish unto second party, her heirs, executors, administrators and assigns, all rights and claims of dower, curtesy, inheritance, descent, distribution, and any and all other rights or claims in any manner arising or growing out of the marital relationship of said parties, in and to the estate of second party, whether real or personal, now owned or hereafter acquired, and to any property given to second party by the terms of this agreement; but by these presents first party shall be forever barred therefrom. 14. It is further agreed by and between the parties hereto that the provisions of this instrument shall, by agreement of the parties, be made a part of any judgment rendered in any action for divorce hereafter brought by either of them against the other. * During the property settlement negotiations between the petitioner 1960 Tax Ct. Memo LEXIS 34">43 and Cordelia, which culminated in the execution of the separation agreement, the petitioner had proposed to convey to Cordelia his interest in the family home in Paducah. However, Cordelia refused to take the property and instead insisted upon being paid the $300 per month required under paragraph 2 of the separation agreement, and an additional $24,000 to be paid at $200 per month over a period of 10 years. She agreed that the petitioner could keep the property and give her a mortgage on it as security for the payment of the $24,000. This is what was finally agreed upon, resulting in the inclusion of paragraph 10 of the separation agreement. In compliance with the provisions of paragraph 10 of the separation agreement, Cordelia executed and delivered to the petitioner a deed wherein she conveyed to the petitioner all of her interest in said real property. 21960 Tax Ct. Memo LEXIS 34">45 Simultaneously with the execution of said deed on April 20, 1956, petitioner executed and delivered to Cordelia a promissory note in which it was provided: For value received, I promise to pay to the order of Cordelia Freeland the sum of Twenty-four Thousand Dollars ($24,000.00) in lawful currency of the United States of America, 1960 Tax Ct. Memo LEXIS 34">44 in 120 equal monthly installments of Two Hundred Dollars ($200.00) each, the first of said installments being due and payable on or before the first day of May, 1956, with a like installment falling due on or before the same day of each and every successive month thereafter until the said sum of Twenty-four Thousand Dollars ($24,000.00) shall have been fully paid, said monthly payments being inclusive of interest at the rate of six per cent per annum upon the unpaid principal balances of the indebtedness evidenced by this note. It is understood and agreed that in the event of failure on the part of the maker hereof to pay any installment hereof within ninety (90) days after the due date of same, the holder of this note may declare the entire indebtedness due and payable and proceed at law or in equity to collect the same. This note is secured by a mortgage of even date herewith, conveying in mortgage certain real property situated on the Blandville Road, near Paducah, McCracken County, Kentucky, and each and all of the terms, provisions and stipulations of said mortgage are made a part hereof as though set forth at length herein. Simultaneously with the execution of said deed and note, the petitioner also executed and delivered to Cordelia a mortgage on the said real estate securing the payment of said promissory note. On May 11, 1956, the Circuit Court of McCracken County, Kentucky, entered a judgment of divorce upon Cordelia's complaint against the petitioner. The terms of the separation agreement executed on April 20, 1956, were approved and made a part of said judgment. In addition to the amounts paid by petitioner pursuant to paragraph 2 of the separation agreement of April 20, 1956, petitioner paid to Cordelia in 1956 the aggregate sum of $1,600 in equal monthly installments of $200 commencing on May 1, 1956, as provided for by paragraph 10 of the said separation agreement and the promissory note. In addition to the amounts paid by petitioner in compliance with paragraph 2 of said separation agreement, petitioner paid to Cordelia in 1957 the aggregate amount 1960 Tax Ct. Memo LEXIS 34">46 of $2,400 in equal monthly installments of $200, as provided for by paragraph 10 of the said separation agreement and the promissory note. In his income tax return for the year 1956 petitioner deducted the sum of $1,600, which he paid to Cordelia in said year. In their income tax return for the year 1957 petitioner and Murray M. Freeland deducted the sum of $2,400, which sum petitioner paid to Cordelia in said year. The issues raised in this case concern the deductibility of certain monthly payments made by petitioner to his former wife under a promissory note which was executed pursuant to paragraph 10 of their separation agreement. Petitioner contends that the payments constitute "periodic payments * * in discharge of * * * a legal obligation which, because of the marital or family relationship, is * * * incurred by the husband * * * under a written instrument incident to * * * divorce or separation" within the meaning of section 71(a), 31960 Tax Ct. Memo LEXIS 34">48 Internal Revenue Code of 1954, and are therefore deductible in their entirety by the petitioners under section 215. 4 Alternatively, petitioner contends that even if the payments in question do not constitute periodic payments within the meaning 1960 Tax Ct. Memo LEXIS 34">47 of section 71(a), a portion thereof is deductible under section 163, 5 as interest on an indebtedness. The first issue presents the question of whether or not the payments were in discharge of a "legal obligation" which was incurred "because of the marital or family relationship" within the meaning of section 71(a)(1), or whether said payments were made as consideration for the property which his former wife conveyed to petitioner. The facts point to the latter conclusion. It is clear that the payments under the promissory note which was executed pursuant to paragraph 10 of the separation agreement are not for his former wife's support or in the nature of alimony or in lieu of alimony. Neither 1960 Tax Ct. Memo LEXIS 34">49 the note nor paragraph 10 of the separation agreement indicates in any way that payments under the note were for support or alimony. In fact, petitioner's obligation for the "support and maintenance of his wife and children" was separately stated under paragraphs 2 to 8, inclusive, of the separation agreement. That obligation is separate and distinct from the obligation established by paragraph 10 and the related promissory note and the payments thereunder are not here in issue. The circumstances which culminated in the inclusion of paragraph 10 in the separation agreement and the terms of the said paragraph and of the related promissory note and mortgage indicate that paragraph 10 involves the settlement of property rights and not the wife's right to alimony or support. Accordingly, we hold that payments under the promissory note did not constitute periodic payments within the meaning of section 71(a) and are not deductible by petitioner under section 215. Cf. John Sidney Thompson, 22 T.C. 275">22 T.C. 275. Even assuming arguendo that the payments could be considered as arising out of the marital or family relationship, they would not constitute deductible periodic payments under section 71, 1960 Tax Ct. Memo LEXIS 34">50 since under section 71(c), 61960 Tax Ct. Memo LEXIS 34">51 only installment payments discharging a principal sum over a period of more than 10 years are deductible. The payments involved in the instant case are payable over a period of less than 10 years from the dates of both the separation agreement and the divorce decree. The agreement and related instruments were all executed on April 20, 1956. The divorce decree was entered on May 11, 1956. The initial payment on the obligation was due to be made on or before May 1, 1956, and the 120th or final payment will be due on or before April 1, 1966, which is 20 days less than 10 years from the date of the agreement and 41 days less than 10 years from the entry of the decree of divorce. Alternatively, petitioner seeks to deduct a portion of the payments to his former wife as interest under section 163. We think he is entitled to such a deduction. As indicated in our holding above, the payments in question were in discharge of the promissory note. This was a genuine indebtedness payable at all events without regard to the death, remarriage, or change of economic status of either of the parties, and enforceable in the event of default by a foreclosure action on the note and mortgage. Both the promissory note and paragraph 1960 Tax Ct. Memo LEXIS 34">52 10 of the separation agreement, in compliance with which the note was executed, provided that the monthly payments of $200 should be inclusive of both principal and interest. The note provided that such interest should be "at the rate of six per cent per annum upon the unpaid principal balances of the indebtedness evidenced by this note." We hold that a part of each of said monthly payments, the amount of which may be computed under Rule 50, constitutes interest deductible under section 163. Decisions will be entered under Rule 50. Footnotes1. All statutory references herein are to the Internal Revenue Code of 1954, except as otherwise indicated.↩2. In this connection, it is noted from the derivation of title recited in the mortgage, hereinafter mentioned, that Cordelia had an undivided one-half interest in the real property by virtue of a deed, dated October 6, 1948, transferring such property to Joseph S. Freeland and Cordelia Freeland jointly.3. SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS. (a) General Rule. - (1) Decree of divorce or separate maintenance. - If a wife is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such decree in discharge of (or attributable to property transferred in trust or otherwise, in discharge of) a legal obligation which, because of the marital or family relationship, is imposed on or incurred by the husband under the decree or under a written instrument incident to such divorce or separation. (2) Written separation agreement. - If a wife is separated from her husband and there is a written separation agreement executed after the date of the enactment of this title, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such agreement is executed which are made under such agreement and because of the marital or family relationship (or which are attributable to property transferred, in trust or otherwise, under such agreement and because of such relationship). This paragraph shall not apply if the husband and wife make a single return jointly. * * ↩4. SEC. 215. ALIMONY, ETC., PAYMENTS. (a) General Rule. - In the case of a husband described in section 71, there shall be allowed as a deduction amounts includible under section 71 in the gross income of his wife, payment of which is made within the husband's taxable year. * ↩5. SEC. 163. INTEREST. (a) General Rule. - There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. * ↩6. SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS. * *(c) Principal Sum Paid in Installments. - (1) General rule. - For purposes of subsection (a), installment payments discharging a part of an obligation the principal sum of which is, either in terms of money or property, specified in the decree, instrument, or agreement shall not be treated as periodic payments. (2) Where period for payment is more than 10 years. - If, by the terms of the decree, instrument, or agreement, the principal sum referred to in paragraph (1) is to be paid or may be paid over a period ending more than 10 years from the date of such decree, instrument, or agreement, then (notwithstanding paragraph (1)) the installment payments shall be treated as period payments for purposes of subsection (a), but (in the case of any one taxable year of the wife) only to the extent of 10 percent of the principal sum. For purposes of the preceding sentence, the part of any principal sum which is allocable to a period after the taxable year of the wife in which it is received shall be treated as an installment payment for the taxable year in which it is received.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623323/	JOHN J. and CARMEN M. SOLON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSolon v. CommissionerDocket No. 9206-75.United States Tax CourtT.C. Memo 1980-77; 1980 Tax Ct. Memo LEXIS 510; 39 T.C.M. 1245; T.C.M. (RIA) 80077; March 18, 1980, Filed John J. Solon, pro se. James R. Turton, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' income tax for the calendar years 1972 and 1973 in the amounts of $361.37 and $83.36, respectively. By amendment to petition, petitioners claimed a refund of tax for the year 1972 of $4,662.95. The issues for decision are: (1) Whether, with respect to the year 1972, petitioners (a) are entitled to a deduction for automobile expenses in excess of $1,200; (b) are entitled to a deduction for business rental expense1980 Tax Ct. Memo LEXIS 510">511 or a business bad debt in the amount of $6,000 or any portion thereof; (c) are entitled to an additional medical expense deduction of $70 for transportation; (d) are entitled to an investment tax credit on a 1962 Ford automobile, a 1962 Cadillac automobile, a 1968 Pontiac automobile and a 1971 Dodge Van, and, if so, the amount thereof; and (e) are entitled to an investment credit on a 1972 Chrysler automobile in excess of $93.89. 1(2) Whether, with respect to the year 1973, petitioners (a) are entitled to a deduction for automobile expenses in excess of $98.48 and (b) are entitled to a deduction for business use of an office in home in excess of $266. FINDINGS OF FACT Petitioners, husband and wife, who resided in Dallas, Texas at the date of the filing of their petition in this case, filed a joint Federal income1980 Tax Ct. Memo LEXIS 510">512 tax return for the calendar year 1972 with the Internal Revenue Service Center, Austin, Texas. Petitioners filed a joint Federal income tax return for the calendar year 1973 with the District Director of Internal Revenue, Dallas, Texas. Petitioners, for the calendar year 1973, filed a joint amended U.S. Individual Income Tax Return in which they claimed deductions in addition to those claimed on their original return. John J. Solon (petitioner) is a lawyer. He also worked on the 3 p.m. to 11 p.m. shift for Southwest Airmotive Company (later Cooper Airmotive) in Dallas, Texas during each of the years here in issue. Carmen M. Solon is a registered nurse and during the years here in issue worked as a registered nurse on certain days for a blood bank, Nolan Enterprises, and on other days would obtain work from a register which assigned her to different hospitals at different times. However, at no time did she work at more than one location on one day. During the year 1972 petitioner did legal work for a Mr. Frankfurter and in return was furnished office space for his legal practice in the Highlander apartment hotel on Loma Alto in Dallas, Texas. Other than being furnished an1980 Tax Ct. Memo LEXIS 510">513 office by Mr. Frankfurter, petitioner received no compensation for the legal services he rendered to Mr. Frankfurter. Petitioner handled a number of cases for Mr. Frankfurter involving the Highlander Hotel, condemnation of property and other matters. At the time petitioner filed his 1972 income tax return he estimated that the value of the office which he was permitted to use in return for the legal work he did for Mr. Frankfurter was $1,000, and on his Federal income tax return for the year 1972 deducted $1,000 as rent. At the trial petitioner testified that the value of the legal services which he rendered to Mr. Frankfurter was $6,000. Petitioner included no amount in the income reported on his Federal income tax return for 1972 or any other year as compensation received from Mr. Frankfurter for legal services. Petitioners' return was filed on the cash basis of accounting. Around the first of November 1972 petitioner was notified that there would be a rental charge to him for using the office space in the building owned by Mr. Frankfurter. Toward the end of 1972 petitioner moved his desk and law books into the room in his home intended for a dining room, and during the year1980 Tax Ct. Memo LEXIS 510">514 1973 conducted his legal practice from his home. During 1972, when petitioner's office was in the Highlander apartments, at least 5 days a week and sometimes 6 days a week petitioner would drive in the morning from his home to his office in the Highlander apartments, a distance of between 8 and 10 miles. On most of the days, Monday through Friday, petitioner would drive from the Highlander apartments to the County courthouse, the Federal courthouse, or the Municipal courthouse in connection with his legal practice. The distance from his office at the Highlander apartments to each of these courthouses was about 5 miles. Sometimes on Saturday petitioner would drive from the Highlander apartments to the County courthouse library. Petitioner's total driving to the various courthouses from the Highlander apartments and returning to the Highlander apartments averaged about 10 miles per day, 5 days a week. Petitioner would leave the Highlander apartments and drive approximately 10 miles to his work at Cooper Airmotive in order to arrive there at a little before 3 o'clock. When petitioner concluded his work at Cooper Airmotive, usually at 11 p.m., he would drive back to his home, a distance1980 Tax Ct. Memo LEXIS 510">515 of about 10 miles. Generally, Mrs. Solon either drove from her home to her place of employment and back each day or petitioner would drive her to her place of employment each day. Petitioner had his office in the Highlander apartments for about 43 weeks during the year 1972. During the year 1972 petitioners had 10 children, 8 of whom were their dependents. Petitioners and their dependent children made a number of visits to physicians, dentists or clinics during 1972. Transportation to the offices of the physicians, dentists or clinics was by automobiles owned by petitioners. One or two visits were made to the Brown Lanier Clinic, which is approximately 3 miles from petitioners' home or 6 miles round trip. Petitioners or their children visited a doctor on Midway Road two or three times during 1972. This doctor's office is approximately one mile from petitioners' home or two miles round trip. Petitioners or their children visited Dr. Key in connection with eye examinations during 1972. The total payment made by petitioners to Dr. Key was $50. During 1972 Mrs. Solon made at least a dozen trips to visit a dentist. Also, one visit was made to a doctor out near LBJ Highway, 1980 Tax Ct. Memo LEXIS 510">516 a distance of 5 miles from petitioners' home.One visit was made by petitioners or their dependents to the Baylor Dental Clinic, about 10 miles from petitioners' home, and one visit was made to a doctor on Forest Lane, approximately 3 miles from petitioners' home. A visit was made to the Brookhaven Hospital, approximately 5 miles from petitioners home, and another visit was made to the VeracruzRed Cross Hospital, which was approximately 10 miles from where petitioners were staying. Petitioners also drove to a pharmacy on a number of occasions to obtain medicine. In 1971 petitioner acquired a 1962 Ford automobile. This automobile was transferred to petitioner as part of a payment for a legal fee and petitioner included in his reported income as representing the value of the automobile when it was received in 1971 the amount of $10. Petitioner was never able to repair the automobile so as to make it operable and therefore the automobile was never used for business purposes. On August 11, 1970, petitioner purchased a 1962 Cadillac automobile and shortly thereafter began to use it partially in his business. On September 1, 1971, petitioner purchased a 1968 Pontiac and during1980 Tax Ct. Memo LEXIS 510">517 1971 commenced using it partially in his business. On November 25, 1970, petitioner purchased a 1971 Dodge Van and began using it partially in his business as soon as it was purchased. On September 23, 1972, petitioner purchased a new 1972 Chrysler automobile at a cost of $8,048.This automobile was partially used in petitioner's business. During 1973 petitioner maintained his law office in his home. Petitioner moved his desk and his law books into the 10 feet x 10 feet dining room of his home. The area in the dining room was so crowded that there was no space in that room to interview clients. The dining room of petitioner's home was not used by any member of the family other than petitioner, and petitioner's use of this space was entirely in connection with his legal practice. The living room in petitioner's home was 16 feet 5 inch x 13 feet with a small bay window that extended out from the room by approximately 4-1/2 feet. During the hours from 8 a.m. to 2 p.m. petitioner would, when he interviewed a client, use the living room in which to hold the interview. Generally during this period no other member of the family made any use of the living room area. The balance1980 Tax Ct. Memo LEXIS 510">518 of petitioners' house consisted of a 13 foot square bedroom and two other bedrooms each approximately 10 feet x 10 feet, a hallway and a bath and a half-bath. In addition, petitioner had made the garage in the house into a room which could be used by his children if they had company. Petitioners did not have a television in their living room but kept their television in the back bedroom and the family sat in that room when they were watching television. There was also a breakfast room and kitchen in the house. In order to reach the back entrance to the house it was necessary to walk through the breakfast room and part of the kitchen. During 1973 some of petitioners' children were away at college. The members of the family who were at home used the kitchen for cooking food and the breakfast room was used by the family as a place for eating their meals. During the year 1973 depreciation applicable to petitioners' entire house was $2,000, insurance applicable to the entire house was $50, heat and light costs were $480, repairs and maintenance $40, and telephone $92, making a total of $2,662. The entire floor space of petitioners' house was approximately 1,080 square feet. 21980 Tax Ct. Memo LEXIS 510">519 Petitioners, on their tax return for the calendar year 1972, claimed total automobile expenses of $2,589 computed as follows: Van - business miles 10,000Pontiac - business miles 500Total 10,500$ 630First year depreciation - Chrysler1,509Depreciation - Van400Depreciation - 1968 Pontiac50Total$2,589Respondent in his notice of deficiency determined that petitioners were entitled to a deduction of $1,200 as automobile expense with the following explanation: It is determined that a deduction in the amount of $1,200.00 is allowable for automobile expense in lieu of the amount of $2,609.00 claimed on Schedule C. It is further1980 Tax Ct. Memo LEXIS 510">520 determined that you claimed the standard mileage rate plus depreciation. Accordingly, taxable income is increased $1,409.00. See computation as follows: Per ReturnCorrectedAdjustmentStandard Mileage rate$ 600.00$1,200.00($ 600.00)Depreciation: Additional first year1,509.0001,509.00VAN400.000400.00PONTIAC3100.000100.00Totals$2,609.00$1,200.00$1,409.00Petitioners on their 1972 tax return claimed a rental expense deduction of $1,000. Respondent disallowed this claimed deduction and petitioners in their amended petition claimed that they should be entitled to a rental expense deduction or a bad debt loss in connection with legal services rendered in exchange for rent1980 Tax Ct. Memo LEXIS 510">521 of $6,000. In their amended petition, petitioners also claimed additional medical expenses for 1972 for transportation of $70 and investment credit with respect to automobiles computed as follows: AutomobileInvestment Credit1962 Ford$ 300.001962 Cadillac13.751968 Pontiac49.001971 Dodge Van411.351972 Chrysler470.45Total$1,244.55Although petitioners had claimed no investment credit with respect to automobiles on their 1972 tax return as filed, respondent allowed an investment credit with respect to the 1972 Chrysler which he computed in his notice of deficiency as follows: INVESTMENT CREDIT Cost of Auto 9-23-72$8,048.0050% Personal Use4,024.00Business Use$4,024.00Basis for Investment Credit$4,024.00Life 3 to 5 years33-1/3%Total Qualified Investment$1,341.33Investment Credit Percentage7%Allowable Investment Credit$ 93.89In their amended petition petitioners also claimed an additional $360 of automobile expenses for 1972 based on "12"/MILE & TOLLS/3,000. 00 MI. 360.00." Petitioners on their Federal income tax return for 1973 claimed automobile expense of $98.48 based on 8201980 Tax Ct. Memo LEXIS 510">522 business miles driven. They also claimed a deduction for auto repairs and new tires of $186.28. Respondent in the notice of deficiency disallowed the $186.28 deduction claimed by petitioners for auto repairs and new tires. Petitioners on their 1973 Federal income tax return claimed a deduction of $459 explained as follows: 1/10 household/office - 4153 Beechwood - $459.00 Respondent in his notice of deficiency allowed $266 of this claimed deduction based upon expenses of depreciation, insurance, heat and light, repairs and maintenance and telephone, totaling $2,662, with 10 percent allocated to business, and therefore disallowed $193 of petitioners' claimed home office expense. Petitioners in their amended petition for 1973 claimed that 50 percent of their home was used as an office and therefore claimed a deduction for home office expense of $1,331, an increase of $872 over the amount claimed in their petition. OPINION All the issues in this case are purely factual. Petitioners claimed automobile expenses in 1972 based on a combinaion of mileage and claimed depreciation. Respondent allowed petitioners a deduction based on 12 cents a mile, the amount applicable in 19721980 Tax Ct. Memo LEXIS 510">523 for taxpayers computing automobile expenses on a mileage basis, for 10,000 miles and disallowed the balance of the deduction claimed for automobile expense. At the trial petitioner substantiated only approximately 5,000 miles of business driving. The balance of the mileage which petitioner considered to be business driving was clearly commuting expenses representing Mrs. Solon's driving to and from her place of employment and petitioner's driving to his first place of employment and home from his last place of employment. Commuting expenses are not properly deductible. Fausner v. Commissioner,413 U.S. 838">413 U.S. 838 (1973); Heuer,Jr. v. Commissioner,32 T.C. 947">32 T.C. 947 (1959), affd. per curiam 283 F.2d 865">283 F.2d 865 (5th Cir. 1960). Petitioner at the trial substantiated only approximately one-half of the business mileage that respondent allowed in the notice of deficiency.Petitioner is not entitled to deduct automobile expenses based on business mileage driven and also claim a deduction for depreciation of the automobiles. Nash v. Commissioner,60 T.C. 503">60 T.C. 503, 60 T.C. 503">520 (1973). See also Rev. Proc. 70-25, 1970-2 C.B. 506. Were petitioner's1980 Tax Ct. Memo LEXIS 510">524 depreciation computation correct, it might be beneficial to petitioner to claim depreciation with respect to the automobiles rather than 12 cents a mile for the business mileage driven. However, petitioner's computation for depreciation on the automobiles is incorrect. The computation is based on the full cost of each of the automobiles, while the record is clear that these automobiles were not used full-time for business purposes. In fact, the record does not show the percentage of the use of the automobiles which was for business. Therefore, petitioner has failed to show error in respondent's determination of his automobile expense deduction for 1972. The record, however, is clear that petitioner only claimed $2,589 in automobile expenses rather than $2,609 as listed by respondent in his notice of deficiency. Respondent showed the standard mileage rate claimed by petitioner as $600 rather than the $630 claimed by petitioner, and the depreciation claimed on the Pontiac as $100 rather than $50. Respondent did not mention a disallowance of the depreciation claimed by petitioner on his office furniture in the notice of deficiency but rather, apparently by mistake, considered1980 Tax Ct. Memo LEXIS 510">525 the $50 of depreciation claimed on office furniture to have been claimed on the Pontiac automobile. Because of these errors in computation in the notice of deficiency, petitioner is entitled to an additional deduction of $20, whether it be considered as additional automobile expenses or merely an erroneous computation in the notice of deficiency. Petitioners have not shown either the fair value of the office furnished to petitioner by Mr. Frankfurther in return for legal services or the fair value of the legal services rendered. However, it is clear that petitioner exchanged legal services for rent and did not report any value of the rent as income. Therefore, petitioner has effectively offset the value of the services by the value of his rental and is entitled to no deduction from income for rental of office space from Mr. Frankfurter. The basis of petitioner's claim of a bad debt of $6,000 is not clear. Apparently, petitioner feels that his legal services to Mr. Frankfurter in 1972 were worth $6,000 more than the space he was permitted to use was worth in rental value. However, since petitioner, a cash basis taxpayer, reported no income from his legal services to Mr. Frankfurter, 1980 Tax Ct. Memo LEXIS 510">526 there is nothing against which petitioner could offset any amount which Mr. Frankfurter might have owed him but not paid. Furthermore, the record is reasonably clear that petitioner's agreement with Mr. Frankfurter was that petitioner would render legal services in return for use of office space. Therefore, there existed no bad debt to petitioner from Mr. Frankfurter in any event. See Hutcheson v. Commissioner,17 T.C. 14">17 T.C. 14, 17 T.C. 14">19 (1951). Respondent in his brief computed the amount of medical transportation which petitioners had substantiated on the basis of 112 miles at 6 cents a mile, the rate applicable to the cost of automobile transportation for medical purposes in 1972, or a total of $6.72. In this computation respondent used only the mileage which petitioner was able to clearly estimate. In our view, petitioners did show some mileage in addition to the 112 miles which respondent used in his computation. On the basis of the record as a whole we conclude that petitioners have shown medical transportation expenses in 1972 of $15. Petitioners made no showing with respect to how they computed the investment credit claimed on the five automobiles for 1972. Clearly, 1980 Tax Ct. Memo LEXIS 510">527 none of the automobiles, except the 1972 Chrysler, were placed in use during the year 1972. Section 46(c), I.R.C. 1954, 4 provides that qualified investment with respect to any taxable year is the applicable percentage of section 38 property "placed in service by the taxpayer during such taxable year." Section 38 property is defined in section 48 to include tangible personal property. An automobile would clearly fit within this definition. The record shows that petitioners did not place any of their automobiles in use in the taxable year 1972 except the 1972 Chrysle. Petitioners have shown no error in respondent's computation of the investment credit applicable to the 1972 Chrysler and this computation appears correct. Sections, 1.46-3(a)(1) and 1.46-3(b), Income Tax Regs.1980 Tax Ct. Memo LEXIS 510">528 Respondent in his notice of deficiency allowed petitioners the $98.48 claimed as automobile expense in 1973 but disallowed the $186.28 claimed by petitioners on their 1973 tax return for auto repairs and new tires. Petitioners have not substantiated the expenditure of the $186.28 nor shown what portion of this amount would be applicable to business usage of an automobile or automobiles. Petitioners are not entitled to deduct automobile expense on a mileage basis and also deduct cost of repairs and new tires. See Rev. Proc. 70-25, supra. We therefore sustain respondent's determination with respect to the automobile expense for 1973. Petitioners on their income tax return for 1973 claimed use of one-tenth of their home as an office for Mr. Solon. How they arrived at the $459 on this basis is not shown. In the amended petition petitioners claimed a deduction of 50 percent of the depreciation and cost of maintenance, insurance and like items on their house as applicable to petitioner's office. The record clearly shows that the 10 feet X 10 feet dining room in petitioners' house, which was approximately 10 percent of the square footage of the house, was used1980 Tax Ct. Memo LEXIS 510">529 exclusively by petitioner as an office in 1973. The record is clear that no other member of the family went into this room. The record also shows that petitioner made some use of the living room for interviewing clients because there was no space for him to interview clients in the dining room in which he kept his desk and law books. The living room consisted of approximately 215 square feet or 20 percent of the space in the house. However, it is clear that personal usage was made of this room by petitioner's family. In Browne v. Commissioner, 73 T.C. (Jan. 22, 1980), we held that in computing the amount of deduction for home office expense to which a taxpayer is entitled, the allocation to business use is the ratio which results from dividing the total hours of business use, of that portion of the house used partially for business, by the total hours the space is used for all purposes. Using this criterion, we concluded from the testimony and other facts in the record that petitioners' living room was used 50 percent of the time for business purposes and 50 percent for personal purposes. This would mean that an additional 10 percent of depreciation and costs of insurance, 1980 Tax Ct. Memo LEXIS 510">530 repairs and utilities on petitioners' house for 1973 is properly applicable to petitioners' home office expense. Petitioners contend that some business usage was made of the hall, kitchen and bathroom but totally failed to show the amount of any of such usage. We hold that petitioners are entitled to a deduction of $532 for home office expense in 1973 rather than the $266 allowed by respondent. 5Decision1980 Tax Ct. Memo LEXIS 510">531 will be entered under Rule 155. Footnotes1. Because of an increase in the amount of petitioners' gross income, respondent in the notice of deficiency disallowed $43 of the deduction claimed by petitioners for medical expenses for the year 1972. However, there is no issue with respect to this adjustment since the allowable amount is a question of computation after determination of the other issues.↩2. Petitioner in his brief drew a diagram of his house on the basis of which he argued that the overall area of the house was 1,578 sq. ft. However, at the trial respondent conceded that the square footage of petitioners' house was 1,080 sq. ft. Petitioner, based on a diagram placed in evidence, agreed that that figure was approximately correct. The diagram contained in petitioner's brief differs from the diagram placed in evidence by petitioner. We have made our finding based on the evidence presented at trial.↩3. It is clear on petitioners' return that only $50 depreciation was claimed on the Pontiac automobile. In the depreciation schedule petitioners also claimed $50 of depreciation on desk, chairs, etc.The deficiency notice makes no mention of any error in petitioners' claim of depreciation on the desk, chairs or other office furniture. It appears that respondent considered both $50 amounts to be claimed with respect to the Pontiac automobile.↩4. Section 46(c)(1)(A) and (B) of the Internal Revenue Code of 1954, as amended and in effect in the years in issue, provides as follows: SEC. 46. AMOUN OF CREDIT. * *(c) Qualified Investment.-- (1) In general.--For purposes of this subpart, the term "qualified investment" means, with respect to any taxable year, the aggregate of-- (A) the applicable percentage of the basis of each new section 38 property (as defined in section 48(b)) placed in service by the taxpayer during such taxable year, plus (B) the applicable percentage of the cost of each used section 38 property (as defined in section 48(c)(1)) placed in service by the taxpayer during such taxable year.↩5. Petitioner at the trial claimed that he had furnished certain of his records to the Internal Revenue Service which had not been returned to him. He also claimed harassment. Since the record is so clear that all records furnished by petitioner to the Internal Revenue Service were returned to him, and that petitioners were not subject to harassment by the Internal Revenue Service, we have not considered it necessary to discuss petitioners' claims in this respect in this opinion. Also, at the trial petitioner made reference to several other items such as the cost of a trip to Veracruz, Mexico and traveling expenses. Petitioners offered no evidence concerning these items at the trial and therefore we do not consider any issue with respect to these items to be before us.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623324/	CHRISTOPHER STONE and GLORIDA STONE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentStone v. CommissionerDocket No. 7690-85.United States Tax CourtT.C. Memo 1987-454; 1987 Tax Ct. Memo LEXIS 451; 54 T.C.M. 462; T.C.M. (RIA) 87454; September 10, 1987. Herbert Laskin, for the petitioners. Shelia R. Dansby, for the respondent. RAUMMEMORANDUM OPINION RAUM, Judge: The Commissioner determined deficiencies in petitioners income tax as follows: YearDeficiency1980$ 49519817,17519828,101The primary issue concerns the taxation of petitioners in connection with a trust created by petitioners for the benefit of family members. The case was submitted on the basis of a stipulation of facts and attached exhibits. At the time the petition herein was filed, petitioners were husband and wife residing in Los Angeles, California. They filed1987 Tax Ct. Memo LEXIS 451">453 joint returns for the years ended December 31, 1981, and December 31, 1982. During the years in issue petitioner Christopher Stone was the sole shareholder and President of Record Plant Corporation. His wife Gloria Stone was Vice President of Record Plant Corporation. Their combined salaries totaled $ 137,397 in 1981 and $ 145,485.60 in 1982. In 1981 and 1982 petitioners reported total gross income (before adjustments) in the amount of $ 174,749 and $ 222,245. The components that made up that gross income figure were reported as follows: 19811982Salary137,397 145,486 Interest and dividends18,480 6,761 State/local tax refund3,226 4,010 Capital gains13,322 (738)Other income38,280 82,398 Rental property andpartnerships(35,956)(15,672)Total174,749 222,245 On October 3, 1980, petitioners, as trustors, and Herbert Laskin, as trustee, entered into a "Trust Agreement" creating the Stone Family Trust. Herbert Laskin (Laskin or the trustee), the trustee of the trust and petitioners' counsel here, drafted the trust instrument. The trust was funded by petitioners' transfer to the trustee1987 Tax Ct. Memo LEXIS 451">454 of $ 54,000. Shortly after that transfer to the trust, on November 8, 1980, petitioners borrowed this $ 54,000 back from the trust. 1 Interest payments made by petitioners to the trust in connection with this borrowing of the trust corpus appear to be the large part of the income reported by the trust during the period involved here. Interest paid on the loan amounted to $ 990 in 1980, $ 14,350 in 1981, and $ 16,200 in 1982. The trust filed its Forms 1041 "Fiduciary Income Tax Return" on the basis of a fiscal year ending August 31. In its year ending August 31, 1981, the trust reported both total income and interest income of $ 16,867. For the August 31, 1982, year it reported total income of $ 10,437, comprised of $ 85 of interest income qualifying for exclusion, $ 10,000 of "nonqualifying interest", and $ 352 of "nonqualifying dividends". For its August 31, 1983, year, it reported both total income and interest income of $ 16,444. 1987 Tax Ct. Memo LEXIS 451">455 The trust income reported in each of its fiscal years 1980, 1981, and 1982, was used in full either to make distributions to the beneficiaries or to pay "Attorney, accountant, and return preparer fees". The beneficiaries named in the trust were Matthew Stone, Samantha Stone, Lillian Harmel and Fred Harmel. Matthew and Samantha Stone are petitioners' children. The parties stipulated that during the years in issue both Matthew and Samantha were "minors under California law". 2 Lillian and Fred Harmel appear to be the parents of Gloria Stone. The trust agreement provides that "income is to be distributed annually in equal portions to each beneficiary". It further provdies that a distribution to a beneficiary includes payment "to others for the benefit of a beneficiary". In the instrument "the Trustee is directed to pay for the educational expenses of said beneficiary from the Trust income due that child". In addition to "private schooling through the high school level" 1987 Tax Ct. Memo LEXIS 451">456 the term "educational expenses" is defined in the trust instrument as follows: The term "educational expenses" shall be construed to include, but is not limited to, college, post-graduate study, or vocational training (even if not in a college), so long as pursued to advantage by the beneficiary, at an institution of his or her choice; and in determining payments to be made for such education, the Trustee shall take into consideration the beneficiary's related living expenses to the extent that they are reasonable. * * * Despite the provisions of the trust agreement, the trust income was not always "distributed annually in equal portions to each beneficiary", and the educational expenses of petitioners' children apparently were not paid "from the Trust income due that child", but were paid at least in part in addition to the equal portion of the trust income due the child. In both the trust year ending August 31, 1981, and that ending August 31, 1983, petitioners' children received larger distributions than did Lillian and Fred Harmel. In the trust's 1980 through 1982 fiscal years the following distributions of trust income were reported: Fiscal Year198019811982Distribution:Matthew5,6232,4725,955Samantha5,6222,4725,955Lillian2,8112,4721,742Fred2,8112,4711,742Total distributed16,8679,88715,394Fees paid-0-5501,050Total trust income16,86710,43716,4441987 Tax Ct. Memo LEXIS 451">457 Between the trust's creation on October 3, 1980, and the end of its 1982 fiscal year on August 31, 1983, the trust distributed $ 14,050 to Matthew and $ 14,049 to Samantha. Of those amounts distributed, the following amounts were spent for the private schooling of Matthew and Samantha in calendar years 1981 and 1982: 19811982Matthew$ 4,427$ 5,472Samantha3,9304,398$ 8,357$ 9,870The amounts spent on Matthew in 1981 and 1982 were paid to Harvard School, a private school for students in grades 7 through 12; the amounts spent on Samantha were paid to Marlborough School, a private school for girls in grades 7 through 12. Matthew attended Harvard School in 1978, 1979, and 1980, as well as in the years before us. Samantha attended Marlborough School in 1979 and 1980, in addition to the years before us. In the notice of deficiency, the Commissioner determined that "the deductions of $ 990.00, $ 14,350.00, and $ 16,200.00 shown on your returns as interest [paid to the Stone Family Trust] for the taxable years ended December 31, 1980, December 31, 1981, and December 31, 1982, respectively, are not allowed because it has not been1987 Tax Ct. Memo LEXIS 451">458 established that the amounts paid were for interest on a bona fide debt". The Commissioner "further determined in the alternative, that if the alleged loan from the Stone Family Trust which has given rise to the above disputed interest expense deductions is found to be a bona fide obligation, then the amounts paid by the Stone Family Trust for the support of your children is income to you". During the calendar call at which the case was submitted fully stipulated, Government counsel in effect abandoned the first of the two grounds on which the determination of deficiency was based, informing the Court that the Commissioner was not "attacking the validity of the trust" on the basis that petitioners borrowed back the funds used to create it. Also, in its opening brief, the Government reiterated its position, stating that it had "elected not to pursue this theory" of whether the borrowing of the trust corpus "constituted a bona fide debt". Since the bona fide debt issue has not been treated by the parties and instead the case has been presented on the basis of the alternative issue of whether payments made by the trust are properly taxable to petitioners, we limit ourselves to consideration1987 Tax Ct. Memo LEXIS 451">459 of the alternative issue. As a preliminary matter, however, petitioners argue that because of a perceived inadequacy in the notice of deficiency, the Court lacks jurisdiction to decide the issue of whether the educational expenses paid by the trust constitute income to them. Petitioners argue that the notice of deficiency has not "adequately given the Court jurisdiction over the legal issue in this case". They do not argue that the notice is wholly invalid, but contend merely that it is incapable of supporting our consideration of the issue presented to us here. We disagree. The basis for petitioners' argument is that neither the amount of additional income nor the deficiency that would result from an adjustmen based on the theory before us was included in the notice. Instead, the notice computed the additional income and the deficiency on the basis of the disallowance of interest expense deductions. While this is true, nonetheless, the notice serves unequivocally to apprise petitioners that the issue of whether "amounts paid by the Stone Family Trust for the support of your children is income to you" was being raised. It was listed in the notice as an alternative theory. 1987 Tax Ct. Memo LEXIS 451">460 Petitioners cannot seriously contend that they were unaware of the issue. Their petition to the Court evidences their awareness that the issue was raised in the notice. In their petition they both assigned as error the Commissioner's determination in connection with the issue and stated that they relied upon the following facts "as the basis of their case": (b) Amounts paid by the Trust were paid for or to both Petitioners' parents and Petitioners' children. Petitioners have no legal support obligation as far as their parents are concerned and no funds expended for Petitioners' children were used for any support obligation.In sum, petitioners were aware that the Government was raising the issue, it is properly before us, and it will be considered. 31987 Tax Ct. Memo LEXIS 451">461 Section 677(b), IRC 1954, provides in relevant part that: Income of a trust shall not be considered taxable to the grantor under subsection (a) or any other provision of this chapter merely because such income in the discretion of another person, the trustee, or the grantor acting as trustee or co-trustee, may be applied or distributed for the support or maintenance of a beneficiary (other than grantor's spouse) whom the grantor is legally obligated to support or maintain, except to the extent that such income is so applied or distributed. * * [Emphasis supplied.]The subsection was added to the Code in 1943 4 as an exception to the more general provisions of the predecessor to section 677(a). Under section 677(a) the grantor of a trust is treated as "the owner of any portion of a trust * * * whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be -- (1) distributed to the grantor or the grantor's spouse; * * ." (Emphasis supplied.) It is clear under section1987 Tax Ct. Memo LEXIS 451">462 677(a) that the grantor may be treated as the owner of a portion of a trust if trust income merely may be distributed to him or for his benefit, even if it is not actually so distributed. Section 677(b) provides an exception to section 677(a) to the extent trust income may be, but is not, "applied or distributed for the support or maintenance of a beneficiary (other than grantor's spouse) whom the grantor is legally obligated to support or maintain". Only "to the extent that such income is so applied or distributed" is it taxable to the grantor "under subsection (a)". 51987 Tax Ct. Memo LEXIS 451">463 There is no question that the beneficiaries involved here, petitioners' minor children, are beneficiaries that petitioners are "legally obligated to support". The California Civil Code provides that "The father and mother of a child have an equal responsibility to support and educate their child in the manner suitable to the child's circumstances, taking into consideration the respective earnings or earning capacities of the parents". Cal. Civ. Code sec. 196 (West 1982). It is significant that both support and education are recognized in section 196 of the Civil Code as part of the responsibility owed by parents to their minor children. Moreover, children in California are "subject to compulsory full-time education". Cal. Educ. Code sec. 48200 (West 1978). The required education can be attained through attendance at "public full-time day school". Attendance at public school is excused for those children "instructed in a private full-time day school" that complies with the state requirements. Cal. Educ. Code sec. 48222 (West 1978). Petitioners do not challenge that they are legally obligated to support their1987 Tax Ct. Memo LEXIS 451">464 minor children or that education is a basic part of their obligation. Instead, they contend only that "under California law * * * [they] do not have a legal obligation to send their children to private school". The Commissioner agrees that the issue before us is "whether under California law private schooling constitutes a support obligation", but maintains that under the circumstances presented private schooling does constitute a support obligation of petitioners. 61987 Tax Ct. Memo LEXIS 451">465 The issue must be decided with reference to California state law. Consequently, the holdings of other courts with respect to similar obligations under the laws of other states are of only limited aid here. 7 It is, instead, the conclusion drawn from a close examination of California law that will be determinative. 1987 Tax Ct. Memo LEXIS 451">466 It has long been stated by the state courts of California that "the minor is entitled to be maintained in a style and condition consonant with his parent's financial ability and position in society." In re Ricky H.,2 Cal. 3d 513, 521, 468 P.2d 204">468 P.2d 204, 468 P.2d 204">208, 86 Cal. Rptr. 76">86 Cal. Rptr. 76, 86 Cal. Rptr. 76">80 (1970). See, e.g., In re Marriage of Ames,59 Cal. App. 3d 234">59 Cal. App. 3d 234, 59 Cal. App. 3d 234">238, 130 Cal. Rptr. 435">130 Cal. Rptr. 435, 130 Cal. Rptr. 435">438 (Ct. App. 1976); Chapin v. Superior Court,239 Cal. App. 2d 851">239 Cal. App. 2d 851, 239 Cal. App. 2d 851">856, 49 Cal. App. 2d 792">49 Cal. App. 2d 792, 49 Cal. App. 2d 792">798, 29 Cal. Rptr. 183">29 Cal. Rptr. 183, 29 Cal. Rptr. 183">187 (Dist. Ct. App. 1963); Wong v. Young,80 Cal. App. 2d 391">80 Cal. App. 2d 391, 80 Cal. App. 2d 391">395, 181 P.2d 741">181 P.2d 741, 181 P.2d 741">744 (Dist. Ct. App. 1947); Kyne v. Kyne,70 Cal. App. 2d 80">70 Cal. App. 2d 80, 70 Cal. App. 2d 80">83, 160 P.2d 910">160 P.2d 910, 160 P.2d 910">912 (Dist. Ct. App. 1945); Shebley v. Peters,53 Cal. App. 288">53 Cal. App. 288, 53 Cal. App. 288">293, 200 P. 364">200 P. 364, 200 P. 364">366 (Dist. Ct. App. 1921). The concept has been codified in section 196 of the Civil Code which in relevant part provides that parents have a "responsibility to support and educate their child in a manner suitable to the child's circumstances, taking into consideration the respective earnings or earning capacities of the parents." 1987 Tax Ct. Memo LEXIS 451">467 While the issue of a parent's obligation to support his child generally occurs in the divorce context, the child's right to support is not limited to that context. The right under section 196 is the child's right and the child can maintain an action against his parent for support. See In re Marriage of O'Connell,80 Cal. App. 3d 849">80 Cal. App. 3d 849, 80 Cal. App. 3d 849">856, 146 Cal. Rptr. 26">146 Cal. Rptr. 26, 146 Cal. Rptr. 26">30 (Ct. App. 1978); Wong v. Young,80 Cal. App. 2d 391">80 Cal. App. 2d 391, 181 P.2d 741">181 P.2d 741 (Dist. Ct. App. 1947); Kyne v. Kyne,70 Cal. App. 2d 80">70 Cal. App. 2d 80, 160 P.2d 910">160 P.2d 910 (Dist. Ct. App. 1945). This Court has previously treated, in a case involving the same type of determination under section 677(b) as is required here, state court decisions relating to child support in the divorce context as having some import on the section 677(b) issue. See Braun v. Commissioner,T.C. Memo. 1984-285. In Braun, the Court considered New Jersey cases arising in the divorce context, but recognized that some of the factors relevant therein "would have no bearing except in a controversy between divorced parents or between a child and a noncustodial parent." We do the same here. 1987 Tax Ct. Memo LEXIS 451">468 The California cases which deal with the issue of the proper level of educational support to be granted a child are few and far between. Even less available are cases dealing specifically with the obligation to provide a private high school education. As to the expenses of a college education, the California district courts of appeal have generally allowed stand the trial court decisions awarding support to a child that would finance that child's attendance at college, so long as "it is for the best interests of the child to be sent to college and the father is financially able to pay the expense." Rawley v. Rawley,94 Cal. App. 2d 562">94 Cal. App. 2d 562, 94 Cal. App. 2d 562">565, 210 P.2d 891">210 P.2d 891, 210 P.2d 891">893 (Dist. Ct. App. 1949). See Straub v. Straub,213 Cal. App. 2d 792">213 Cal. App. 2d 792, 213 Cal. App. 2d 792">797-798, 29 Cal. Rptr. 183">29 Cal. Rptr. 183, 29 Cal. Rptr. 183">187 (Dist. Ct. App. 1963); Frizzell v. Frizzell,158 Cal. App. 2d 652">158 Cal. App. 2d 652, 158 Cal. App. 2d 652">657, 323 P.2d 188">323 P.2d 188, 323 P.2d 188">192 (Dist. Ct. App. 1958); Hale v. Hale,55 Cal. App. 2d 879">55 Cal. App. 2d 879, 55 Cal. App. 2d 879">882, 132 P.2d 67">132 P.2d 67, 132 P.2d 67">69 (Dist. Ct. App. 1942). The parents' legal obligation under section 196 of the California Civil Code to provide their child with support for education was in 1985 limited by statute to continue1987 Tax Ct. Memo LEXIS 451">469 to apply only to "any unmarried child who has attained the age of 18, is a full-time high school student, and resides with a parent, until such time as he or she completes the 12th grade or attains the age of 19, whichever first occurs." Cal. Civ. Code sec. 196.5 (West 1987 Supp.); Jones v. Jones,179 Cal. App. 3d 1011">179 Cal. App. 3d 1011, 225 Cal. Rptr. 95">225 Cal. Rptr. 95 (Ct. App. 1986). While this amendment substantially limits the obligation under California law of parents to send their children to college, it in no way reduces the obligation of support owed under section 196 for the high school education of a minor child. The obligation to educate a minor child was dealt with in In re Marriage of Aylesworth,106 Cal. App. 3d 869">106 Cal. App. 3d 869, 165 Cal. Rptr. 389">165 Cal. Rptr. 389 (Ct. App. 1980). In that case, private school tuition was requested for two children, but was awarded to only one of the two. The tuition was awarded to a child who had been enrolled in private school for at least 23 months and who had "educational difficulties" apparently connected with epileptic seizures. The private school education was found to be of "personal benefit to him in helping to alleviate his1987 Tax Ct. Memo LEXIS 451">470 past anxieties related to school." In re Marriage of Aylesworth,106 Cal. App. 3d 869">106 Cal. App. 3d at 879. The tuition was not awarded to a child who had never attended private school and who showed no evidence that she would derive any special benefit from private school. Here, it is stipulated that Matthew attended Harvard School during the years 1978 through 1982 and that Samantha attended Marlborough School during the years 1979 through 1982. There is no evidence that the children did not attend private schools in the years before they entered Harvard and Marlborough Schools. Additionally, there is no evidence that would indicate whether either of the children had any special need for or derived any special benefit from their private school education. These lapses in the evidence with respect to the benefit to the children of private education weigh against petitioners' financial ability to pay for the education involved here, which we have obtained from petitioners' returns, indicates that they could well afford to finance their children's private school education. What is even more indicative of both the benefit to petitioners' children of private school education and1987 Tax Ct. Memo LEXIS 451">471 petitioners' ability to pay for that education is the action of petitioners during the years involved here. Petitioners sent their children to private school for at least two or three years before the trust was created. They apparently believed that such an education was of benefit to their children. We can only assume that, as in Braun v. Commissioner,T.C. Memo. 1984-285, the education that petitioners chose for their children was "imminently reasonable in the light of the background, values and goals of the parents as well as the children." The benefits of the private education were apparently perceived as such that petitioners were willing to pay the costs of tuition in the years before the trust was created. They were clearly both willing and able to finance the private high school education of their children. Under these circumstances, we conclude that the expenses paid by the trust in 1981 and 1982 for the private high school education of petitioners' children are amounts "distributed for the support or maintenance of a beneficiary * * whom the grantor is legally obligated to support or maintain" under section 677(b), IRC 1954. Consequently, 1987 Tax Ct. Memo LEXIS 451">472 under section 677(a), IRC 1954, petitioners are treated as "the owner of [the] portion of [the] trust whose income" has been so distributed. Decision will be entered under Rule 155.Footnotes1. On the date petitioners borrowed the $ 54,000, they executed a promissory note in which they promised to pay to Herbert Laskin "the sum of Fifty Four Thousand Dollars ($ 54,000.00); interest payable at twenty percent (20%) per annum until paid". The principal (and any unpaid interest) was "due and payable * * [a]t the end of the fifth (5th) year". As security for the note, petitioners "assigned to Herbert Laskin, Trustee of the Stone Family Trust, * * * Ninety Seven Thousand, Five Hundred (97,500) shares of Sausalito Music Factory, Inc." It is stipulated that both the interest rate payable on the note and the security given for it are adequate. ↩2. California law defines a minor as a person who is "under 18 years of age". Cal. Civil Code sec. 25 (West 1982); see also Cal. Civil Code sec. 25.1↩ (West 1982). 3. Petitioners claim that the burden of proof on this support obligation issue is on the Government. It is petitioners' position that the burden of proof with respect to a determination of increased income is generally on respondent, while only the burden with respect to deductions is on petitioners. To support their position, they cite 9th Circuit cases in which reference is made to the ordinary presumption of correctness usually applied to the Commissioner's notice being denied in the limited circumstance in which the Commissioner's determination that a taxpayer has received unreported income is supported by no evidence but merely by a "naked" or "bare" assessment. See Conforte v. Commissioner,74 T.C. 1160">74 T.C. 1160, 74 T.C. 1160">1179 (1980), affd. in part, revd. in part, and remanded in part on other issues 692 F.2d 587">692 F.2d 587↩ (9th Cir. 1982), for a discussion of these cases. No such circumstance exists here that would call for a relaxation of petitioners' burden. The Commissioner has not argued that any unreported amounts were received by petitioners. Thus, petitioners are not required to prove nonreceipt of any amounts. Instead, it has been stipulated that the trust paid educational expenses of petitioners' children and it is these amounts that the Commissioner has determined are income to petitioners. No evidence showing nonreceipt of income needs to be presented by petitioners here and no relaxation of their burden of proof is warranted. 4. Sec. 134 of the Revenue Act of 1943, ch. 63, Pub. L. No. 235, 58 Stat. 51. ↩5. Under subsection (a) the grantor is taxed on trust income by being "treated as the owner of any portion of a trust". Petitioners misconceive the manner in which they would be taxed under section 677(b) and base an argument that the notice of deficiency was inadequate on that misconception. Petitioners contend that they would be taxed as beneficiaries if the Commissioner were sustained. Consequently, they argue, the Commissioner is first required to make adjustments to the trust return before he can make adjustments to petitioners' return. Even aside from the fact that the argument is based on a misconception of the statute, it does not merit serious discussion. Moreover, petitioners' argument is grounded in a misunderstanding of the mechanics of taxation under sec. 677(b). It is petitioners' understanding (and the basis of their argument that if they are to be taxed on trust income under sec. 677(b), such income will "be taxed to them as if distributed to them as beneficiaries". They depend on sec. 1.662(a)-4, Income Tax Regs., for this proposition. However, sec. 1.662(a)-4, which petitioners read as requiring treatment as a beneficiary in the situation before us, in no way governs whether a grantor is to be treated as a beneficiary. Instead, it interprets sec. 662 so that when a trust makes a payment which discharges a beneficiary's (as opposed to a grantor's) legal obligation, that payment is treated "as though directly distributed to him as a beneficiary". Sec. 662 does not determine whether a taxpayer will be treated as a grantor or as a beneficiary, but merely sets forth the consequences of the treatment prescribed by other sections. It is sec. 667(b) that directs how the grantor will be treated if trust payments are used to discharge the grantor's support obligations. Under sec. 667(b) a grantor is taxed under sec. 662, as a beneficiary, only when the support obligation discharged by the trust is "paid out of corpus or out of other than income for the taxable year". Sec. 677(b), IRC 1954. See Scheft v. Commissioner,59 T.C. 428">59 T.C. 428, 59 T.C. 428">434 (1972); sec. 1.677(b)-1(a) and (b), Income Tax Regs. Otherwise, the grantor is taxed under subsection (a), as the owner of a portion of a trust. To the extent the grantor is so treated as the owner of a portion of a trust, the income from it is taxed to him and the trust is disregarded. Scheft v. Commissioner,59 T.C. 428">59 T.C. 432↩. There is no evidence that the payments made here for the educational expenses of petitioners' children were "paid out of corpus or out of other than income", and thus petitioners are not properly taxable as beneficiaries. 6. The parties' framing of the issue to focus on whether private education is a legal obligation under California law appears to be at least to some extent inconsistent with the language of sec. 677(b)↩. That section governs the treatment of amounts "applied or distributed for the support or maintenance of a beneficiary * * * whom the grantor is legally obligated to support". The legal obligation required by the language seems to be a general one towards the beneficiary, not a specific obligation to expend particular amounts on particular expenses connected with the person to whom the obligation, it will surely also be an expenditure for the "support or maintenance of a beneficiary * * * whom the grantor is legally obligated to support". Consequently, we deal with the issue as narrowly formulated by the parties in their presentation of the case to us here. 7. For instance, petitioners rely heavily on Brooke v. Commissioner,468 F.2d 1155">468 F.2d 1155 (9th Cir. 1972). In that case, the 9th Circuit upheld the District Court of Montana's conclusion that "the expenditures made were not the legal obligations of the taxpayer under Montana law". Brooke v. Commissioner,468 F.2d 1155">468 F.2d at 1158↩. While that case too involved expenditures made for private school tuition, few facts were reported therein and of those that were reported many appeared to be markedly different from those here. In addition, the determinative Montana statute, though similar, was not identical to the California statute before us. Moreover, the Government was evidently able to find only one Montana case interpreting the Montana support statute that awarded child support to cover a child's education, and that case was decided in 1936.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623327/	Sewell L. Avery, Petitioner, v. Commissioner of Internal Revenue, RespondentAvery v. CommissionerDocket No. 112526United States Tax Court3 T.C. 963; 1944 U.S. Tax Ct. LEXIS 106; June 6, 1944, Promulgated 1944 U.S. Tax Ct. LEXIS 106">106 Decision will be entered under Rule 50. 1. Taxpayer created two trusts, one for each of his two daughters and the husband of each, and transferred to each trust 13,000 shares of Montgomery Ward & Co. stock and 8,000 shares of United States Gypsum Co. stock. Held, four gifts of 6,500 shares of Montgomery Ward stock and 4,000 shares of Gypsum stock were made. Helvering v. Hutchings, 312 U.S. 393">312 U.S. 393; United States v. Pelzer, 312 U.S. 399">312 U.S. 399.2. The values of such blocks of stock determined. Leland K. Neeves, Esq., for the petitioner.Gerald W. Brooks, Esq., and Frank T. Donahoe, Esq., for the respondent. Van Fossan, Judge. DisneyJ., dissents. Murdock, J., dissenting. Sternhagen, Turner, Arnold, Kern, and Opper, JJ., agree with this dissent. VAN FOSSAN 3 T.C. 963">963 The respondent determined a deficiency of $ 22,258.49 in the gift tax of the petitioner for the year 1940.The sole issue is the proper valuation of certain shares of the common stock of Montgomery Ward & Co. and United States Gypsum Co. which on December 31, 1940, were transferred as gifts under trust agreements.FINDINGS1944 U.S. Tax Ct. LEXIS 106">107 OF FACT.Certain facts were stipulated and as so stipulated are adopted as findings of fact. They are set forth in great detail in the stipulation, 3 T.C. 963">964 but may be summarized as follows, all other facts and figures therein being incorporated by reference.The petitioner is an individual residing in Evanston, Illinois, and maintains his office in Chicago. He filed his gift tax return for the year 1940 with the collector of internal revenue for the first district of Illinois.On December 31, 1940, the petitioner made gifts of 8,000 shares of the common stock of the United States Gypsum Co., an Illinois corporation, hereinafter called Gypsum, and 13,000 shares of the common stock of Montgomery Ward & Co., an Illinois corporation, hereinafter called Ward, to the Northern Trust Co. of Chicago, Illinois, and Hortense Wisner Avery, as trustees, to hold in trust for the use and benefit of the petitioner's daughter, Nancy Avery Follansbee, and her husband, Rogers Follansbee, and others.On December 31, 1940, and contemporaneously with the above gift, the petitioner made gifts of 8,000 shares of the common stock of Gypsum and 13,000 shares of the common stock of Ward to the Northern 1944 U.S. Tax Ct. LEXIS 106">108 Trust Co. of Chicago, Illinois, and Hortense Wisner Avery, as trustees, to hold in trust for the use and benefit of the petitioner's daughter, Arla Avery McMillan, and her husband, William Benton McMillan, and others.In the petitioner's gift tax return for the year 1940 he reported such gifts as follows:Value attem No.Description of gift, motive and donee's nameDate ofdate ofand addressgiftgift18,000 shares United States Gypsum Co. commonstock, 13,000 shares Montgomery Ward & Co.12-31-40$ 968,000common stock; the Northern Trust Co. andHortense Wisner Avery, co-trustees, underagreement with Sewell L. Avery, datedDec. 31, 1940, for the benefit of Arla AveryMcMillan and William Benton McMillan and others,50 S. LaSalle St., Chicago.28,000 shares United States Gypsum Co. commonstock, 13,000 shares Montgomery Ward & Co.12-31-40968,000common stock; the Northern Trust Co. andHortense Wisner Avery, co-trustees underagreement with Sewell L. Avery, datedDec. 31, 1940, for the benefit of Nancy AveryFollansbee and Rogers Follansbee and others,50 S. LaSalle St., Chicago.Total1,936,0001944 U.S. Tax Ct. LEXIS 106">109 A notation was made in a blank space under schedule B of the said return, otherwise unused, reading as follows:Note: In view of the number of shares involved the market quotations on December 31, 1940 were not indicative of the actual values. The values, as stated above, are as follows -- United States Gypsum Company at 62 1/2, Montgomery Ward & Co. at 36. These values are 2 points and 1 1/2 points, respectively, below the mean market quotations for December 31, 1940.Prior to making the gifts the petitioner held the shares of stock of the corporations for investment. None of the shares of stock have been sold by the donees thereof and the donees have held such shares of stock for investment since the date of the gifts.3 T.C. 963">965 For many years prior to and including the year 1940 Ward published detailed annual reports, which included statements of its properties, financial status, activities, earnings, and dividends. Such annual reports were supplemented by reports of quarterly earnings, as the results of its operations became available during each year. These reports were mailed to stockholders, and digests thereof were given wide circulation by publications recognized as 1944 U.S. Tax Ct. LEXIS 106">110 authoritative in the investment and financial community. Such publications included the Commercial and Financial Chronicle, Standard Statistics, and Poor's and Moody's Industrial Manuals. Quarterly and annual reports were also published in the Wall Street Journal. The company also filed its annual reports with the Securities and Exchange Commission. During all material times herein the accounting period of Ward was the fiscal year ended January 31 in each year.The reports of Montgomery Ward & Co. above referred to were substantially accurate. On January 31, 1941, the outstanding common shares (no par) were 5,217,147. On January 31, 1941, there were 59,373 common shareholders. The common shares were listed and traded on the New York and Chicago Stock Exchanges, and also were traded in the unlisted department on the Boston, Detroit, Los Angeles, Philadelphia, Pittsburgh, and San Francisco Stock Exchanges.The following is a compilation for each month for the period January 1 to December 31, 1940, inclusive, of the recorded number of shares traded, the dates of high prices, high prices, the dates of low prices, and low prices for such period for Ward common stock on the New York1944 U.S. Tax Ct. LEXIS 106">111 Stock Exchange:DateHighLowShares sold1940DatesPricesDatesPricesJanuary(1-3)56 (1-15)50 3/868,100February(2-5)55 (2-1)51 45,800March(3-7)55 (3-16)52 1/857,200April(4-5)55 7/8(4-27)49 3/498,200May(5-1)49 5/8(5-21)31 3/4240,900June(6-28)40 (6-5)33 1/474,200July(7-31)42 1/2(7-10)38 5/831,300August(8-31)42 1/8(8-16)38 1/232,600September(9-6)44 1/4(9-13)38 5/866,700October(10-3)42 3/4(10-29)38 1/273,500November(11-12)41 1/2(11-22)36 1/290,700December(12-2)38 1/8(12-23)35 1/284,400Total for period963,600On December 31, 1940, 5,500 shares of Ward were sold, opening at 37 5/8 and closing at 38. The high and low on that day were 38 and 37, respectively.During the year 1940, 963,600 shares of the common stock of Ward were traded on the New York Stock Exchange. A total of 1,234 different issues were traded on that exchange, of which 41 issues exceeded 960,000 shares traded during the year, or 3.2225 percent of the total 3 T.C. 963">966 number of issues traded. During the year 1941, 797,700 shares were1944 U.S. Tax Ct. LEXIS 106">112 traded. A total of 1,234 different issues were traded in 1941 on the New York Stock Exchange, of which 37 issues exceeded 795,000 shares traded during the year, or 2.99837 percent of the total number of issues traded.For many years prior to and including the year 1940 Gypsum published detailed annual reports, which included statements of its properties, financial status, activities, earnings, and dividends. Such annual reports were supplemented by reports of quarterly earnings, as the results of its operations became available during each year. These reports were mailed to stockholders, and digests thereof were given wide circulation by publications recognized as authoritative in the investment and financial community. Such publications included the Commercial and Financial Chronicle, Standard Statistics, and Poor's and Moody's Industrial Manuals. Quarterly and annual reports were also published in the Wall Street Journal. The company also filed its annual reports with the Securities and Exchange Commission. During all material times herein the accounting period of United States Gypsum Co. was the calendar year.The reports of Gypsum above referred to were substantially accurate. 1944 U.S. Tax Ct. LEXIS 106">113 On December 31, 1940, the outstanding common shares (par $ 20) were 1,195,662, exclusive of 56,159 shares of treasury stock, of which 5,476 shares are under option to officers and managers. On December 31, 1940, there were 7,044 common shareholders. The common shares were listed and traded on the New York and Chicago Stock Exchanges, and also were traded in the unlisted department on the Philadelphia Stock Exchange.The following is a compilation for each month for the period January 1 to December 31, 1940, inclusive, of the recorded number of shares traded, the dates of high prices, high prices, the dates of low prices, and low prices for Gypsum common stock on the New York Stock Exchange:DateHighLowShares sold1940DatesPricesDatesPricesJanuary(1-25)89 (1-15)82 1/210,600February(2-1)86 5/8(2-28)81 1/28,100March(3-27)83 1/2(3-15)80 1/86,300April(4-9)86 3/4(4-27)80 11,600May(5-3)83 1/2(5-23)55 1/226,400June(6-1)59 (6-10)50 18,500July(7-31)65 1/4(7-2)53 1/210,700August(8-30)75 (8-19)63 5,800September(9-24)80 3/8(9-12)* 71 1/28,800October(10-3)81 (10-31)73 1/215,500November(11-1)76 (11-7)67 1/213,200December(12-3)71 1/2(12-27)61 34,300Total for period156,6001944 U.S. Tax Ct. LEXIS 106">114 3 T.C. 963">967 On December 31, 1940, 1,000 shares of Gypsum were sold, opening at 64 and closing at 66. The high and low on that day were 66 and 63, respectively.During January and February 1941 totals of 56,100 and 35,700 shares of Ward common stock were sold on the New York Stock Exchange, with high 39 1/2 and 37 3/8 and low 35 5/8 and 35 1/4, respectively.During January and February 1941 totals of 12,800 and 5,600 shares of Gypsum were sold on the New York Stock Exchange, with high 69 1/2 and 65 and low 62 1/4 and 60, respectively.During the year 1940, 155,800 shares of the common stock of Gypsum were traded on the New York Stock Exchange. A total of 1,234 different issues were traded on that exchange, of which 297 issues exceeded 155,000 shares traded during the year, or 24.06 percent of the total number of issues traded. During the year 1941, 169,700 shares were traded. A total of 1,234 different issues were traded in 1941 on the New York Stock Exchange, of which 244 issues exceeded 169,000 shares traded during the year, or 19.77 percent of the total number of issues traded.On December 31, 1940, the New York Stock Exchange was the exchange where shares of1944 U.S. Tax Ct. LEXIS 106">115 common stock of Gypsum and Ward were principally bought and sold. On that date the market on that exchange for shares of common stock of Gypsum and Ward was a free, fair, open, and unrestricted market, and it was not affected by manipulation. The fair market values per share of the several lots of common stock of Ward and Gypsum which were sold on the New York Stock Exchange were the respective prices per share at which such lots of the stocks were sold in the respective months and on the respective dates as above set forth.On January 30, 1942, a firm of investment security dealers with membership on the New York Stock Exchange offered, after the close of business on the Exchange on that date, a block of 4,700 shares of Gypsum common stock at a fixed price of 46 7/8 net, which was the closing price for the stock on the Exchange on that date. The block was disposed of upon those terms by secondary distribution. The price received by the original vendors from the distributors was 45 3/8.The Commissioner determined that the values of the common stock of Ward and Gypsum on the date the gifts were made (December 31, 1940) were $ 37.50 and $ 64.50 per share, respectively.The record1944 U.S. Tax Ct. LEXIS 106">116 discloses the following additional facts:The trust agreement executed by the petitioner on December 31, 1940, for the benefit of Arla Avery McMillan and her husband, William Benton McMillan, contained the following provisions:Whereas, Settlor desires to create certain trusts for the use and benefit of his daughter, Arla Avery McMillan, and her husband, William Benton McMillan, 3 T.C. 963">968 and the other beneficiaries hereinafter named or described, upon the terms and conditions hereinafter set forth,Now, Therefore, in consideration of the premises and for the purpose of accomplishing the objects hereinafter more specifically set forth, the Settlor has assigned, transferred and set over and by these presents does hereby assign, transfer and set over unto the Trustees Eight Thousand (8,000) shares of the common stock of the United States Gypsum Company, an Illinois corporation, and Thirteen Thousand (13,000) shares of the common stock of Montgomery Ward & Co., Incorporated, an Illinois corporation,To Have and To Hold the same in trust for the following uses and trusts, that is to say:First: The Trustees shall divide the trust estate into two separate trusts, one of the trusts to consist1944 U.S. Tax Ct. LEXIS 106">117 of one-half (1/2) of the trust estate to be held by the Trustees for the benefit of Settlor's daughter, Arla Avery McMillan, and one of the trusts to consist of one-half (1/2) of the trust estate to be held by the Trustees for the benefit of William Benton McMillan, the husband of Settlor's daughter Arla Avery McMillan.Second: The Trustees shall hold, manage, administer and control all of the trust estate, or so much thereof as shall at any time remain in their hands as such Trustees, either as two separate funds under the two trusts hereinbefore created or as one commingled fund as they in their discretion shall determine and the Trustees shall collect all income, rents and profits thereof * * * and after the payment of all such * * * expenses shall distribute the net income to the persons, at the times and in the manner as follows:1. The Trustees shall pay over and distribute to the Settlor's daughter, Arla Avery McMillan, so long as she shall live, all of the net income derived from that certain trust consisting of one-half (1/2) of the trust estate so held by the Trustees for her benefit. * * 2. The Trustees shall pay over and distribute to said William Benton McMillan, so1944 U.S. Tax Ct. LEXIS 106">118 long as he shall live, all of the net income derived from that certain trust consisting of one-half (1/2) of the trust estate so held by the Trustees for his benefit. In the event of the termination by death or otherwise of the interest of said William Benton McMillan in the income of the trust so held for his benefit, the Trustees shall divide and pay over all of the net income from such trust to his wife, Arla Avery McMillan, * * . * * Sixteenth: The Settlor hereby expressly declares that it is his intention that this instrument and the trusts hereby created shall in all respects and for all purposes be governed, controlled and regulated by the laws of the State of Illinois, and that all questions regarding the construction, interpretation or the validity of this trust instrument or any of its provisions shall be determined solely by the laws of that State. * * The trust further provided that upon the death of Arla Avery McMillan the net income from her portion of the trust corpus should be paid to her children for life, and, upon the death of her children, to her sister. The income from her husband's portion of the trust corpus, received by her consequent upon his death, 1944 U.S. Tax Ct. LEXIS 106">119 was, upon her death, to be paid to her children, and, upon their death, to her sister. If all of the beneficiaries named should die, the income was to be paid to the donor's wife for her lifetime, and thereafter to named museums. In the event of the separation of the petitioner's daughter and her husband, 3 T.C. 963">969 the trust provided that all income payable to the husband under paragraph second, 2, should be paid to the wife.The trust agreement for the benefit of Nancy Avery Follansbee and her husband contains provisions identical with those appearing in the trust for her sister, with the names of the beneficiaries properly designated.A secondary distribution of about 80,000 shares of Ward stock was made through the New York Stock Exchange on January 13, 1941. The opening and closing price on that day was 39. The price received by the vendors was 37 1/2. Thereafter, throughout January the price gradually declined.A "secondary distribution" is a process by which a large block of stock is placed on the market through an underwriting syndicate and distributors, immediately after the close of the market, to be sold at the closing price for the day. This method of the sale of 1944 U.S. Tax Ct. LEXIS 106">120 stock by blocks is practically equivalent to a sale by wholesale. Adequate compensation must be paid by the seller to those engaged in this operation. The approval of the stock exchange is required before such a distribution is offered. Protective measures covering the seller, the brokers, and the buying public are carefully imposed and meticulously observed. The net price realized by the vendor varies from $ 1 to $ 2 below the price to the public.On December 31, 1940, if blocks of Ward common stock such as are here involved had been offered for sale on the stock exchange open market, they could not have been sold without demoralizing the market. The stock would have been disposed of through a secondary distribution or by sale in small lots over a period of time. The former method is less subject to speculative fluctuations.The same situation existed with respect to the Gypsum stock. The Gypsum stock was not as active as the Ward stock, and the market would have been less capable of absorbing it in the regular channels. On December 31, 1940, blocks of Gypsum stock of the size here involved would have been marketed by secondary distribution or by gradual sale in small lots1944 U.S. Tax Ct. LEXIS 106">121 during a period of time thereafter.The fair market value of 6,500 shares of Ward stock on December 31, 1940, was $ 36.50 per share, or $ 237,250. The fair market value of 4,000 shares of Gypsum stock on December 31, 1940 was $ 64.50 per share, or $ 258,000. The fair market values of 13,000 shares of Ward and 8,000 shares of Gypsum were $ 474,500 and $ 516,000, respectively.OPINION.The single issue before us is the correct valuation of shares of Montgomery Ward & Co. and United States Gypsum Co. stock made the subject of gift by the petitioner in the trust agreements of December 31, 1940.3 T.C. 963">970 The Commissioner follows and relies on his regulations, 1 which state that the fair market value of stocks and bonds listed on the stock exchange is the mean between the highest and lowest quoted selling price on the day of the gift. On this basis he has determined such value to be $ 37.50 per share for the Ward stock and $ 64.50 for the Gypsum stock.1944 U.S. Tax Ct. LEXIS 106">122 The petitioner contends that the proper basis of valuing stock transferred in large blocks is the price which the seller or transferor would receive under the custom and usage governing such transactions. He contends that Ward and Gypsum stock in blocks of the size here involved could not have been sold in ordinary course on the market and that the normal and usual method of disposing of such blocks is by secondary distribution, a well recognized practice.This and other courts have held that the effect of the size of the block of listed stock, given or transferred, upon the value of the stock per share is a question of fact. Helvering v. Maytag, 125 Fed. (2d) 55; certiorari denied, 216 U.S. 689">216 U.S. 689 (see cases there cited); Commissioner v. Shattuck, 97 Fed. (2d) 790; Helvering v. Safe Deposit & Trust Co. of Baltimore, 95 Fed. (2d) 806, affirming 35 B. T. A. 259; Henry F. du Pont, 2 T.C. 246. In valuing shares of stock for gift tax purposes the correct criterion is the fair market value of all of1944 U.S. Tax Ct. LEXIS 106">123 the stock comprising the gift, not merely a single share thereof. Helvering v. Maytag, supra.Petitioner contends that either the two gifts should be considered as one, in which event the value of the stock should be based on the aggregate blocks of 26,000 shares of Montgomery Ward and 16,000 shares of Gypsum, or the corpus of each trust should be considered separately as the gift to be valued, the amounts in question in each instance being 13,000 shares of Montgomery Ward and 8,000 shares of Gypsum. The respondent argues that the petitioner's donation should be divided into four gifts, one each to his two daughters and their respective husbands, the four being the beneficiaries of the trusts. Respondent cites Helvering v. Hutchings, 312 U.S. 393">312 U.S. 393; Lawrence C. Phipps, 43 B. T. A. 1010; affd., 127 Fed. (2d) 214, and other cases to support his position.Respondent's position that four gifts are presented for valuation is well fortified both in the law (312 U.S. 393">Helvering v. Hutchings, supra;United States v. Pelzer, 312 U.S. 399">312 U.S. 399)1944 U.S. Tax Ct. LEXIS 106">124 and in the provisions of the trust instruments themselves. The trust agreement referring to petitioner's daughter Arla and her husband specifically provided that the "Settlor desires to create certain trusts for the use and benefit of his 3 T.C. 963">971 daughter, Arla Avery McMillan, and her husband, William Benton McMillan, and the other beneficiaries hereinafter named or described, upon the terms and conditions hereinafter set forth."The agreement further provided:First: The Trustees shall divide the trust estate into two separate trusts, one of the trusts to consist of one-half (1/2) of the trust estate to be held by the Trustees for the benefit of Settlor's daughter, Arla Avery McMillan, and one of the trusts to consist of one-half (1/2) of the trust estate to be held by the Trustees for the benefit of William Benton McMillan, the husband of Settlor's daughter, Arla Avery McMillan.The agreement proceeded to provide that:1. The Trustees shall pay over and distribute to the Settlor's daughter, Arla Avery McMillan, so long as she shall live, all of the net income derived from that certain trust consisting of one-half (1/2) of the trust estate so held by the Trustees for her benefit. 1944 U.S. Tax Ct. LEXIS 106">125 * with similar provision for the payment to William Benton McMillan so long as he shall live of all of the net income derived "from that certain trust consisting of one-half (1/2) of the trust estate so held by the Trustees for his benefit."We conclude that for the purposes of the gift tax statutes and for valuation there were four separate gifts, each consisting of 6,500 shares of Montgomery Ward stock and 4,000 shares of Gypsum stock. This conclusion, however, does not entail the consequence urged by respondent that such blocks of stock should be valued as though sold in one day on the open market. We are of the opinion, and the record supports the conclusion, that either secondary distribution or sales over a reasonable period of time after the basic date would have been resorted to to dispose of blocks of stock of the size of the four gifts here in question. To have offered it on the open market in one day would have demoralized the market.We have indicated in our findings the values of the stocks on the basic date, which values will be used in the computation consequent on this opinion. In arriving at these figures we have given due weight to the trend of prices, 1944 U.S. Tax Ct. LEXIS 106">126 the various theories of valuation submitted, and the experience of other vendors making comparable offerings as shown by the record, as well as to the opinion evidence as to values.Decision will be entered under Rule 50. MURDOCK Murdock, J., dissenting: The question here is the value of the gifts which the petitioner made on December 31, 1940. These gifts were in Ward and Gypsum shares, so that the real problem is to determine the value of those shares comprising the gifts. Cf. John J. Newberry, 3 T.C. 963">972 39 B. T. A. 1123. The Commissioner has determined a value by multiplying the number of shares given by the mean of the high and low at which similar shares sold on the stock exchange on the day in question. The petitioner points to the size of the blocks which he gave and says that he could not have obtained the market price of that day for shares in that quantity on the day of the gift. The approach to the question adopted by the majority is to determine how much the donor could have obtained for the shares by a sale on the day of the gift. The obvious, though unstated, conclusion is that he would have marketed them by secondary distribution1944 U.S. Tax Ct. LEXIS 106">127 at a cost of from $ 1 to $ 2 a share and the fair market values of the gifts are the net prices which the petitioner would have received had he sold the stock by secondary distribution on the basic date. This substitutes a new and, to my mind, one-sided rule for the time-tested and satisfactory rule which was stated many years ago and has since been followed in innumerable cases.Fair market value, for present purposes, has been defined as the price at which property would pass from a seller, willing but under no compulsion to sell, to a buyer, able, willing, but under no compulsion to buy, where each has reasonable knowledge of the facts. See Mertens Law of Federal Income Taxation, vol. 10, sec. 59.02, p. 440 et seq.; John J. Newberry, supra, and cases therein cited. The existence of both of these imaginary people must be assumed, and the problem, difficult at best, is to determine the price upon which they would have agreed. The present opinion ignores this rule and considers the question entirely from the standpoint of the seller, apparently a seller who was forced to sell all of the shares on one day, December 31, 1940, and inferentially demands1944 U.S. Tax Ct. LEXIS 106">128 proof of the existence of a willing buyer or buyers. The fact of the matter is that Avery had no desire to sell these shares, and, since compulsion is expressly excluded in the definition, we certainly may not assume that he was forced to sell them. Incidentally, if it were pertinent to inquire how much he could have obtained for his shares on the date of the gift, then it would seem to be equally pertinent to inquire how much money a purchaser would have been required to use had he been under compulsion to buy that many shares on that day. Perhaps it would have cost such a purchaser even more than the current market figures adopted by the Commissioner. Such an examination of both sides of the problem helps to demonstrate the propriety of the old rule of willing buyer and willing seller.The Commissioner, in order to determine the price at which such shares would have passed between a willing buyer and a willing seller, has gone to the stock exchange, the principal market where similar shares actually passed between willing buyers and willing sellers. The findings show that the market was not being manipulated 3 T.C. 963">973 and, indeed, the parties have stipulated that the prices1944 U.S. Tax Ct. LEXIS 106">129 on that market were the fair market values of the lots sold there. Actual sales on open market are generally the best evidence of fair market value, although other evidence may sometimes establish a different value. John J. Newberry, supra, and cases cited therein. Thus, the action of the Commissioner seems reasonable under the circumstances of this case, yet a one-sided approach in the majority opinion has led to a rejection of actual sales as the best evidence of fair market value in this case.The value determined for the gift of the Gypsum stock is the same as that determined by the Commissioner, but the value of the Ward shares is reduced. Even if value were to be established by determining the amount for which Avery could have sold the shares on December 31, 1940, this report would seem to be at fault. There is a finding that "the stock would have been disposed of through a secondary distribution or by sale in small lots over a period of time." The possibility of sale in small lots over a period of time is not discussed, but there is a further finding that the secondary distribution method would be less subject to speculative fluctuations. 1944 U.S. Tax Ct. LEXIS 106">130 This is not sufficient. In the case of Henry F. du Pont, 2 T.C. 246, we apparently assumed that at least 90 days would have been a reasonable period within which to dispose of much larger blocks of stock. There is no showing here that the Ward stock could not have been disposed of within 90 days at prices at least equal to the value determined by the Commissioner. The Ward shares were widely held. It was one of the most active stocks on the exchange. Although the general tendency throughout 1940 had been downward, nevertheless, the tendency at December 31, 1940, and for some time thereafter was upward. The blocks given were not large compared to the number of shares sold within 90 days of the date of this gift. Finally, it appears that the finding of the value of $ 36.50 per share for the Ward stock was arrived at by deducting a commission for the broker or brokers who would act as secondary distributors for the stock. Never, so far as I know, has it been held that fair market value of a gift is determined by taking the current market price of similar property and subtracting the expenses of a sale. Where, as here, the donor had no intention1944 U.S. Tax Ct. LEXIS 106">131 or desire to sell the shares or to have the donees sell them, there would appear to be no justification for deducting any of the possible costs of sales such as commissions. Footnotes. Ex dividend.↩1. Art. 19, Regulations 79 (1936 Ed.), as amended by T. D. 4901↩, May 18, 1939, 1939-1 (Part I) C. B. 341. This regulation also provides that if the formula prescribed therein does not, under the facts, reflect fair market value, a reasonable modification of the formula or other relevant facts shall be considered.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623329/	JOHN M. STAMPER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentStamper v. CommissionerDocket No. 21145-82.United States Tax CourtT.C. Memo 1983-248; 1983 Tax Ct. Memo LEXIS 535; 46 T.C.M. 46; T.C.M. (RIA) 83248; May 5, 1983. 1983 Tax Ct. Memo LEXIS 535">535 Held, in these circumstances, respondent's determinations of an income tax deficiency and an addition to the tax under sec. 6653(a), I.R.C. 1954, sustained. Held further, damages are awarded to the United States in the amount of $500 since this proceeding was instituted merely for delay. Sec. 6673, I.R.C. 1954. John M. Stamper, pro se. David W. Johnson, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to Special Trial Judge Francis J. Cantrel for the purpose of considering and ruling on respondent's Motion for Summary Judgment. After a review of1983 Tax Ct. Memo LEXIS 535">536 the record, we agree with and adopt his opinion which is set forth below. 1OPINION OF THE SPECIAL TRIAL JUDGE CANTREL, Special Trial Judge: This case is before the Court on respondent's Motion for Summary Judgment filed on February 25, 1983, pursuant to Rule 121, Tax Court Rules of Practice and Procedure.2 Therein respondent seeks summary adjudication in his favor on all of the legal issues in controversy, i.e., the determined income tax deficiency and addition to the tax under section 6653(a)3 and an award of damages under section 6673. Respondent, in his notice of deficiency issued to petitioner on May 18, 1982, determined a deficiency in petitioner's Federal1983 Tax Ct. Memo LEXIS 535">537 income tax and an addition to the tax under section 6653(a) for the taxable calendar year 1980 in the amounts of $830.00 and $41.50, respectively. The only adjustment to income determined by respondent in his deficiency notice was for the disallowance of $7,384, claimed by petitioner as a "coversion figure" on his 1980 Federal income tax return. Petitioner timely filed his petition herein on August 20, 1982 (the United States Postal Service's postmeter stamp date on the envelope in which the petition was received by the Court is August 16, 1982). Respondent filed his answer on October 12, 1982, wherein at paragraphs 11.(a) through (e) he makes affirmative allegations of fact in support of his claim for an award of damages. Petitioner filed no reply, the time for the filing of which expired on November 21, 1982. Hence, the affirmative allegations of respondent's answer are deemed denied. However, the pleadings are deemed closed and respondent's motion was filed more than 30 days after the pleadings were closed. See Rules 34, 36, 37, 38, and 121. FINDINGS OF FACT Petitioner's legal address on the date he filed his petition was Post Office Box 707, Belton, Texas. He filed1983 Tax Ct. Memo LEXIS 535">538 an Individual 1980 Federal income tax return with the Internal Revenue Service. On line 8 of that return he reported wage income of $8,205. Attached to the return are copies of Forms W-2 (Wage and Tax Statements) showing wages paid to petitioner in 1980 by the following employers in the following respective amounts: SourceAmountDelta Centrifugal Corp.$6,670.30Western Oil Transportation Co.601.40United Parcel Service, Inc.131.92Halliburton Company801.18$8,204.80On line 28 of his 1980 return petitioner reduced his wage income by $7,384 labelling said reduction as a "conversion figure". On line 31 he reports his adjusted gross income to be $821, which he describes as "fair market value". He reported no tax due on that return and sought a refund of the entire amount of the Federal income tax withheld by his employers amounting to $1,424. Respondent, in his notice of deficiency upon which the petition herein is predicated, gave the following reasons for his disallowance of the claimed "conversion figure"-- "It is determined that you are not allowed a deduction for the conversion figure of $7,384.00 as claimed on your income tax return for1983 Tax Ct. Memo LEXIS 535">539 1980, since this does not constitute an allowable deduction. Accordingly, your tax table income is increased $7,384.00 for the tax year 1980. On your income tax return(s) for the taxable year(s) 1980, you claimed a reduction in your taxable income for 'fair market value' (or 'conversion figure - fair market value'). You are advised that the United States Tax Court and other federal courts have repeatedly rejected the 'fair market value' reduction in income as 'frivolous', and have held that all income, including amounts paid in Federal Reserve Notes, are reportable in their full face value. See for example, Miller v. Commissioner, T.C.M. 1978-459, affd.634 F.2d 1134">634 F.2d 1134 (8th Cir. [1980]), cert. denied,451 U.S. 942">451 U.S. 942 (1981); Sortillon v. Commissioner, T.C.M. 1979-281 and T.C.M. 1982-76; Cline v. Commissioner, T.C.M. 1982-44; Perkins v. Commissioner, T.C.M. 1977-80, affd. unpublished order (9th Cir. 1978); Seigler v. Commissioner, T.C.M. 1979-326; Mathes v. Commissioner, T.C.M. 1977-220; Combs v. Commissioner, T.C.M. 1977-388; Upton v. Commissioner, T.C.M. 1980-325, among others." 41983 Tax Ct. Memo LEXIS 535">540 Petitioner filed individual 1976 and 1977 Federal income tax returns with the Internal Revenue Service whereon he reported the wage income which he received in each respective year and took no deduction for a "conversion figure". Petitioner filed an Individual 1978 Federal income tax return with the Internal Revenue Service. On line 8 of that return he reported wage income of $7,046.40. Attached to that return are copies of Forms W-2 (Wage and Tax Statements) reflecting wages (as reported) paid to petitioner in 1979 by two employers. On line 28 of the return petitioner claimed a deduction of $5,872 describing the deduction "Fair Market Value". He reported no tax due on that return and claimed a refund of $989.49, the entire amount of Federal withholding tax withheld by his employers. Respondent, on June 12, 1980, issued a notice of deficiency to petitioner for the taxable year 1978 in which he determined a deficiency in petitioner's Federal income tax and an addition to the tax in the respective amounts of $624 and $31.20. Therein respondent disallowed the claimed "Fair Market Value" deduction on the following grounds-- "It is determined that you are not allowed a deduction1983 Tax Ct. Memo LEXIS 535">541 for employee business expense (fair market value) of $5,872.00 as claimed on your income tax return for 1978 since it has not been established that this amount constitutes an allowable deduction. Accordingly, your taxable income is increased $5,872.00 for the tax year ended December 31, 1978." Petitioner filed an Individual 1979 Federal income tax return with the Internal Revenue Service. On line 8 of that return he reported wage income of $13,453.00, Attached to that return are copies of Forms W-2 (Wage and Tax Statements) showing wages (as reported) paid to petitioner in 1979 by two employers. On line 24 of that return petitioner claimed a deduction of $12,332.00, labelling said deduction "Fair Market Value". He reported no tax due on that return and claimed a refund of $2,191.00, the entire amount of Federal withholding tax withheld by his employers. Respondent, on January 15, 1981, mailed a notice of deficiency to petitioner determining therein a deficiency in petitioner's Federal income tax and an addition to the tax for the taxable year 1979 in the amounts of $1,957.00 and $97.85, respectively. In that notice respondent disallowed the claimed "Fair Market Value" deduction1983 Tax Ct. Memo LEXIS 535">542 for the following reasons-- "It is determined that you are not allowed a deduction for employee business expense (fair market value) of $12,332.00 as claimed on your income tax return for 1979 since said amount does not constitute an allowable deduction. Accordingly, your taxable income is increased $12,332.00 for the taxable year ended December 31, 1979." On November 17, 1980 and July 6, 1981 the deficiencies in tax and additions to the tax for 1978 and 1979, respectively, were assessed and notices thereof were issued to petitioner. OPINION Rule 34(b) provides in pertinent part that the petition in a deficiency action shall contain "clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability" and "clear and concise lettered statements of the facts on which petitioner bases the assignments of error". It is clear beyond doubt that the petition raises no justiciable error respecting the Commissioner's determinations and no justiciable facts with respect thereto are extant therein. 51983 Tax Ct. Memo LEXIS 535">543 In our view, based upon the record in this case in its entirety, petitioner is yet another in a seemingly unending parade of tax protesters bent on glutting the docket of this Court and others with frivolous claims. We answer his frivolous claims hereinbelow. Petitioner, at pragraph 9.(d) of his petition alleges--"At no time during calendar year 1980 did the petitioner receive wages". 6 At paragraph 2 thereof he states--"The petitioner did not file a proper return of income for the period here involved". We agree. Gross income means all income from whatever source derived including (but not limited to) wages. It includes income received in any form, whether in money, property, or services. Section 61. Income as defined under the Sixteenth Amendment is "gain derived from capital, from labor, or from both combined". Eisner v. Macomber,252 U.S. 189">252 U.S. 189 (1920). Section 61 encompasses all realized accessions1983 Tax Ct. Memo LEXIS 535">544 to wealth. Commissioner v. Glenshaw Glass Co.,348 U.S. 426">348 U.S. 426 (1955). See United States v. Buras,633 F.2d 1356">633 F.2d 1356, 633 F.2d 1356">1361 (9th Cir. 1980), where the Court said--"* * * the Sixteenth Amendment is broad enough to grant Congress the power to collect an income tax regardless of the source of the taxpayer's income". [Citations omitted.] "One's gain, ergo his 'income' from the sale of his labor is the entire amount received therefor without any reduction for what he spends to satisfy his human needs". Reading v. Commissioner,70 T.C. 730">70 T.C. 730 (1978), affd. 614 F.2d 159">614 F.2d 159 (8th Cir. 1980). "Although the wages [gross income] received by [petitioner] may represent no more than the time-value of [his] work, they are nonetheless the fruit of [his] labor, and therefore represent gain derived from labor which may be taxed as income". [Emphasis added.] Rice v. Commissioner,T.C. Memo. 1982-129, and cases cited therein. 71983 Tax Ct. Memo LEXIS 535">545 Petitioner's prncipal contention would seem to be that his 1980 wages consisted of notes and that he had to report, for Federal income tax purposes, only the fair market value of the notes he received. Such constention is patently frivolous. United States v. Benson,592 F.2d 257">592 F.2d 257 (5th Cir. 1979); 8Mathes v. Commissioner,576 F.2d 70">576 F.2d 70 (5th Cir. 1978); United States v. Ware,608 F.2d 400">608 F.2d 400 (10th Cir. 1979), rehearing and rehearing en banc denied Oct. 25, 1979; United States v. Anderson,584 F.2d 369">584 F.2d 369 (10th Cir. 1978); Sibla v. Commissioner,68 T.C. 422">68 T.C. 422 (1977), affd. 611 F.2d 1260">611 F.2d 1260 (9th Cir. 1980); Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). The final matter for consideration is whether, in the circumstances here extant, we should award damages to the United States under section 66739 and, if so, in what amount. In so doing, we are mindful of the statement made in Wilkinson v. Commissioner,71 T.C. 633">71 T.C. 633, 71 T.C. 633">641 (1979),1983 Tax Ct. Memo LEXIS 535">546 where damages were imposed, that "We have used this power sparingly in the past". However, that statement must be weighed in the light of more recent statements. In McCoy v. Commissioner,76 T.C. 1027">76 T.C. 1027, 76 T.C. 1027">1029-1030 (1981), affd. 696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983), we said: "It may be appropriate to note further that this Court has been flooded with a large number of so-called tax protester cases in which thoroughly meritless issues have been raised in, at best, misguided reliance upon lofty principles. Such cases tend to disrupt the orderly conduct of serious litigation in this Court, and the issues raised therein are of the type that have been consistently decided against such protesters and their contentions often characterized as frivolous. The time has arrived when the Court should deal summarily and decisively with such cases without engaging in scholarly discussion of the issues or attempting to soothe the feelings of the petitioners by referring to the supposed 'sincerity' of their wildly espoused positions." [See Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895, 68 T.C. 895">899 (1977).] 1983 Tax Ct. Memo LEXIS 535">547 Here, petitioner filed proper Federal income tax returns for 1976 and 1977 whereon he reported in full the wages he received in those years. Beginning with his 1978 return petitioner, while reporting the full wage income he received in that year, reduced the reported wages by claiming a frivolous "Fair Market Value" deduction. Similarly, on his 1979 return, he reported his full salary (wage income) for 1979 and reduced it by a claimed frivolous "Fair Market Value" deduction. Respondent issued petitioner notices of deficiency for 1978 and 1979, the last of which was issued on January 15, 1981, in each of which respondent specifically advised petitioner that the claimed "Fair Market Value" deduction "does not constitute an allowable deduction". Apparently, petitioner defaulted on those notices for the income tax deficiencies and additions to the tax were assessed, the assessments for the years 1978 and 1979 being made on November 17, 1980 and July 6, 1981, respectively. Petitioner received notice of the foregoing assessments.Totally disregarding the two prior disallowances of his claimed "Fair Market Value" deduction petitioner filed his 1980 return on or about April 15, 1981 claiming1983 Tax Ct. Memo LEXIS 535">548 thereon the same frivolous deduction. For the third time, respondent in his notice of deficiency upon which the petition herein is based, disallowed petitioner's claimed deduction. Of prime significance, in our view, respondent, in this notice, listed nine cases which are highly relevant with respect to the issues herein under consideration. Those cases conclusively inform petitioner that this Court and others have long and repeatedly held that wages are income subject to tax and that the deduction he has claimed is frivolous. Notwithstanding all of the foregoing, petitioner filed his present petition with this Court asserting, in the main, nothing but frivolous contentions. This Court and respondent have been required to consider the same issues again after petitioner has been three times advised by respondent that his claims were impermissible. Petitioners with more genuine controversies have been delayed while we considered this case involving the same issues. In these circumstances, petitioner, cannot and has not shown that he, in good faith has a colorable claim to challenge the Commissioner's determinations. Indeed, he knew when he filed the present case with this Court1983 Tax Ct. Memo LEXIS 535">549 that he had no reasonable expectation of receiving a favorable decision.There has been no change in the legal climate and in view of the extensive case precedents, no reasonably prudent person could have expected this Court to reverse itself in this situation. 10"When the costs incurred by this Court and respondent are taken into consideration, the maximum damages authorized by the statute ($500) do not begin to indemnify the United States for the expenses which petitioner's frivolous action has occasioned. Considering the waste of limited judicial and administrative resources caused by petitioner's action, even the maximum damages authorized by Congress are wholly inadequate to compensate the United States and its other taxpayers. These costs must eventually be borne by all of the citizens who honestly1983 Tax Ct. Memo LEXIS 535">550 and fairly participate in our tax collection system. * * ." Sydnes v. Commissioner,74 T.C. 864">74 T.C. 864, 74 T.C. 864">872-873 (1980), affd. 647 F.2d 813">647 F.2d 813 (8th Cir. 1981). 11Since we conclude that this case was brought merely for delay, the maximum damages authorized by law ($500) are appropriate and will be awarded pursuant to section 6673. As indicated hereinbefore, this Court is not the only Court that has considered the imposition of damages in a proper case. In yet another tax protester situation, where one of the issues was whether the U.S. Constitution forbids taxation of compensation received1983 Tax Ct. Memo LEXIS 535">551 for personal services, the Fifth Circuit Court of Appeals stated in late 1981-- "Appellants' contentions are stale ones, long settled against them. As such they are frivolous. Bending over backwards, in indulgence of appellants' pro se status, we today forbear the sanctions of Rule 38, Fed. R. App. P. We publish this opinion as notice to future litigants that their continued advancing of these long-defunct arguments invites sanctions, however." [Lonsdale v. Commissioner,661 F.2d 71">661 F.2d 71, 661 F.2d 71">72 (5th Cir. 1981), affg. T.C. Memo. 1981-122.]12On July 7, 1982, the Court of Appeals for the Ninth Circuit, in affirming, percuriam, an unreported decision entered by this Court in a tax protester case 13 said-- "Meritless appeals of this nature are becoming increasingly burdensome on the Federal Court system. We find this appeal frivolous,Fed. 1983 Tax Ct. Memo LEXIS 535">552 R. App. 38, and accordingly award double costs to appellee [the Commissioner of Internal Revenue]." (Emphasis added.) Petitioner, in his objection filed on April 6, 1983, which we find to be without merit, exhorts "I want my day in court".On this very point, which is equally applicable here, in Egnal v. Commissioner,65 T.C. 255">65 T.C. 255, 65 T.C. 255">263 (1975), we stated: "Petitioners seek an opportunity to present proof of the factual allegations made in the petitions. They are entitled to that opportunity only if it could result in a redetermination of the deficiencies found by respondent. In these cases, it would be useless for us to hear the proffered evidence, because we have concluded that the legal theories relied upon by petitioners to reduce their taxes are erroneous." Moreover, in these circumstances, petitioner is not entitled to an oral hearing on respondent's motion. The Court of Appeals for the Fifth Circuit in Kibort v. Hampton,538 F.2d 90">538 F.2d 90, 538 F.2d 90">91 (5th Cir. 1976),1983 Tax Ct. Memo LEXIS 535">553 has said: "'[H]earing' does not necessarily mean an oral hearing. What the rule [Rule 56(c), Fed. R. Civ. P.] contemplates is 10 day advance notice to the adverse party that the matter will be heard and taken under advisement as of a certain day. This provides the adverse party with an opportunity to prepare and submit affidavits, memoranda and other materials for the court to consider when ruling on the motion. If the adverse party is given this opportunity, then he has been heard within the meaning of Rule 56." [Footnote reference omitted.] 14Suffice it to say petitioner was given that opportunity here. Rule 121 provides that a party may move for summary judgment upon all or any part of the legal issues in controversy so long as there are no genuine issues1983 Tax Ct. Memo LEXIS 535">554 of material fact. Rule 121(b) states that a decision shall be rendered "if the pleadings * * 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". However, the summary judgment procedure is available even though there is a dispute as to fact under the pleadings, but, through materials outside the pleadings, it is shown that there is no genuine issue of material fact.Such outside materials may consist of affidavits, interrogatories, admissions, documents, or other materials which demonstrate the absence of such an issue of fact despite the pleadings.15The record here contains a complete copy of the notice of deficiency for 1980, the petition, the answer, exhibits attached to respondent's Motion (which include copies of petitioner's 1976, 1977, 1978, 1979 and 1980 Federal income tax returns with W-2 Forms attached thereto, copies of the notices of deficiency for the taxable years 1978 and 1979, certified copies of the Certificates of Assessments and Payments reflecting the1983 Tax Ct. Memo LEXIS 535">555 assessments made on November 17, 1980 and July 6, 1981, and respondent's affidavit). On this record, respondent has amply demonstrated to our satisfaction that there is no genuine issue as to any material fact and, thus, that respondent is entitled to a decision as a matter of law. In such circumstance, summary judgment is a proper procedure for disposition of this case. Respondent's Motion for Summary Judgment will be granted in every respect.An appropriate order and decision will be entered.Footnotes1. Since this is a pretrial motion and there is no genuine issue of material fact, the Court has concluded that the post-trial procedures of Rule 182, Tax Court Rules of Practice and Procedure↩, are not applicable in these particular circumstances. This conclusion is based on the authority of the "otherwise provided" language of that rule.2. All rule references are to the Tax Court Rules of Practice and Procedure. ↩3. All section references are to the Internal Revenue Code of 1954, as amended.↩4. Attached to the petition filed in this case is a copy of respondent's deficiency notice dated May 18, 1982 containing the above-quoted reasons.↩5. In such circumstance, Rule 34(b)(4) states, in part--"Any issue not raised in the assignment of errors shall be deemed to be conceded". See Jarvis v. Commissioner,78 T.C. 646">78 T.C. 646, 78 T.C. 646">658 (1982); Gordon v. Commissioner,73 T.C. 736">73 T.C. 736, 73 T.C. 736">739 (1980). See and compare Russell v. Commissioner,60 T.C. 942">60 T.C. 942, 60 T.C. 942">943-944↩ (1973).6. Such allegation is patently false as is manifest by the Wage and Tax Statements (Forms W-2) supplied by his respective employers, copies of which are in this record. Moreover, he reported the correct amount of those wages on line 8 of his 1980 return.↩7. Indeed, for more than 66 years it has been well established that wages received in exchange for services rendered constitute taxable income. Brushaber v. Union Pac. R.R. Co.,240 U.S. 1">240 U.S. 1 (1916); Tyee Realty Co. v. Anderson,240 U.S. 115">240 U.S. 115 (1916). See also Hebrank v. Commissioner,T.C. Memo. 1982-496↩. Despite petitioner's protestations to the contrary, respondent did not determine that petitioner had additional unreported income, respondent's determination disallowed a claimed frivolous deduction.8. We observe that venue on appeal of this case lies in the United States Court of Appeals for the Fifth Circuit.↩9. Sec. 6673 provides-- "Whenever it appears to the Tax Court that proceedings before it have been instituted by the taxpayer merely for delay, damages in an amount not in excess of $500 shall be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as part of the tax." We note that legislation has recently been enacted by Congress which increases the amount of damages permissable under sec. 6673 from $500 to $5,000↩ for frivolous or groundless proceedings brought to this Court commencing on January 1, 1983.10. " * *[A] person's intent in performing an act includes not only his motive for acting (which may be defined as the objective which inspires the act), but also extends to include the consequences which he believes or has reason to believe are substantially certain to follow." Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806, 73 T.C. 806">814↩ (1980), where damages were awarded.11. See Sommer v. Commissioner,T.C. Memo. 1983-196; Jacobs v. Commissioner,T.C. Memo. 1982-198; Senesi v. Commissioner,T.C. Memo. 1981-723, affd. F.2d (6th Cir. 1983); Swann v. Commissioner,T.C. Memo. 1981-236 (dismissed 9th Cir. 1982). See also Sydnes v. Commissioner,74 T.C. 864">74 T.C. 864, 74 T.C. 864">870-873 (1980), affd. 647 F.2d 813">647 F.2d 813 (8th Cir. 1981), and Ballard v. Commissioner,T.C. Memo. 1982-56↩, where damages were imposed on the Court's own motion.12. Rule 38, Federal Rules of Appellate Procedure, provides -- DAMAGES FOR DELAY. If a Court of Appeals shall determine that an appeal is frivolous, it may award just damages and single or double costs to appellee.↩13. Edwards v. Commissioner,680 F.2d 1268">680 F.2d 1268, 680 F.2d 1268">1271 (9th Cir. 1982). Accord, McCoy v. Commissioner,696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983), affg. 76 T.C. 1027">76 T.C. 1027↩ (1981).14. See also Smart v. Jones,530 F.2d 64">530 F.2d 64, 530 F.2d 64">65 (5th Cir. 1976), cert. denied 429 U.S. 887">429 U.S. 887 (1976); Erco Industries, Ltd. v. Seaboard Coastline R.R.,644 F.2d 424">644 F.2d 424, 644 F.2d 424">431 (5th Cir. 1981); Barker v. Norman,651 F.2d 1107">651 F.2d 1107, 651 F.2d 1107">1118-1119 (5th Cir. 1981); 78 T.C. 646">Jarvis v. Commissioner,supra↩ at 656-658.15. See Note to Rule 121(a), 60 T.C. 1127">60 T.C. 1127↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623330/	Joseph J. Valletta and Jean B. Valletta v. Commissioner. Joseph J. Valletta v. Commissioner.Valletta v. CommissionerDocket Nos. 3623-69 and 3624-69.United States Tax CourtT.C. Memo 1970-232; 1970 Tax Ct. Memo LEXIS 126; 29 T.C.M. 997; T.C.M. (RIA) 70232; August 13, 1970, Filed Joseph B. Alala, Jr., and Richard L. Voorhees, 192 South St., Gastonia, N.C., for the petitioners. Steve C. Horowitz, for the respondent. IRWINMemorandum Opinion IRWIN, Judge: On April 7, 1969, respondent mailed notices of deficiency to1970 Tax Ct. Memo LEXIS 126">127 the petitioners herein in the following amounts: 998 PetitionerYearDeficiencyAdditions to Tax(6653(b))Joseph J. Valletta1962$4,102.36$2,051.18Joseph J. AND Jean B. Valletta19634,981.872,490.9419644,980.292,490.15Petitions in response to respondent's notices of deficiency herein were received and filed by this Court in Washington, D.C., on July 14, 1969, the 98th day after respondent's notices of deficiency were mailed. The envelope in which the petitions were mailed by regular mail from Gastonia, N.C., bore a postmark made by a private postage meter. The postmark date was July 6, 1969 - the 90th day following the transmission of the notices of deficiency. The ordinary time for the delivery of regular mail from Gastonia, N.C., to Washington, D.C., is two days. On August 12, 1969, respondent filed a motion to dismiss the petitions herein for lack of jurisdiction on the ground that the petitions were not filed within 90 days after the mailing of the deficiency notices. See section 6213 of the Code. 1 Petitioners' reply to respondent's motion set forth, in pertinent part, the following arguments (developed on brief) in opposition1970 Tax Ct. Memo LEXIS 126">128 to dismissal: 2. It is admitted that the usual time for delivery of "regular" mail from Gastonia, North Carolina, to Washington, D.C. by the United States Post Office Department is two days. The requirement that the petition be mailed in a duly stamped and addressed envelope on or before the last day of the prescribed period would therefore be met in this case beyond question had the petition reached the Clerk of the Tax Court for filing on July 9, 1969. An accident or error by the Post Office Department at any point along the route of travel leading to a delay of only three days would have brought the petition to the door of the Clerk of the Tax Court on the 12th day of July, 1969, a Saturday, in which case it would not be marked received until Monday, July 14, 1969, the date the petition herein was actually acknowledged by the Clerk of the Tax Court. 3. The fact is notorious that delays of three days and more in the delivery of regular mail are common and has been established beyond doubt in connection with recent Postal Reform proposals made in the Congress. * * * The question of whether1970 Tax Ct. Memo LEXIS 126">129 petitioners' arguments as outlined above are sufficient to satisfy the jurisdictional requirements of section 6213 turns on the evidentiary requirements of section 7502(a) and (b) and the regulations promulgated thereunder. Section 7502(a) provides that where a document, including a petition to this Court, is properly mailed within the period prescribed for its filing, it will be deemed filed on the date of the postmark on the envelope containing it. However, with respect to postmarks made by a private postage meter, section 7502(b) states that the provisions of section 7502 will obtain only to the extent provided by regulations promulgated by the Secretary or his delegate. Pursuant to this direction, respondent has promulgated the following regulations setting forth the conditions under which section 7502 is to be applied to privately metered mail: (b) If the postmark on the envelope or wrapper is made other than by the United States Post Office, (1) the postmark so made must bear a date on or before the last date, or the last day of the period, prescribed for filing the document, and (2) the document must be received by the agency, officer, or office with which it is required1970 Tax Ct. Memo LEXIS 126">130 to be filed not later than the time when a document contained in an envelope or other appropriate wrapper which is properly addressed and mailed and sent by the same class of mail would ordinarily be received if it were postmarked at the same point of origin by the United States Post Office on the last date, or the last day of the period, prescribed for filing the document. However, in case the the document. However, in case the document is received after the time when a document so mailed and so postmarked by the United States Post Office would ordinarily be received, such document will be treated as having been received at the time when a document so mailed and so postmarked would ordinarily be received, if the person who is required to file the document establishes (i) that it was actually deposited in the mail before the last collection of the mail from the place of deposit which was postmarked (except 999 for the metered mail) by the United States Post Office on or before the last date, or the last day of the period, prescribed for filing the document, (ii) that the delay in receiving the document was due to a delay in the transmission of the mail, and (iii) the cause of such1970 Tax Ct. Memo LEXIS 126">131 delay. If the envelope has a postmark made by the United States Post Office in addition to the postmark not so made, the postmark which was not made by the United States Post Office shall be disregarded, and whether the envelope was mailed in accordance with this subdivision shall be determined solely by applying the rule of (a) of this subdivision. Since the petitions herein were not delivered within two days of July 7, 1969 2 - the time period ordinarily required for the transmission of a letter from Gastonia, N.C., to Washington, D.C., petitioners can prevail only if they establish that: (1) the document was actually deposited in the mail in time to be collected from the place of deposit on or before the last day prescribed for filing; (2) the delay in delivery was attributable to a delay in the transmission of the mail; and (3) the cause of such delay. Section 301.7502-1(c)(1)(iii)(b). Compare P. P. Leventis, Jr., 49 T.C. 353">49 T.C. 353, 49 T.C. 353">356 (1968), in which we concluded that the petition was received by the Court within the time period after the metered postmark date ordinarily required for transmission of a letter from South Carolina to Washington.1970 Tax Ct. Memo LEXIS 126">132 Our study of the testimony and exhibits in this case reveals that petitioners have offered no specific evidence with regard to requirements (2) and (3). All that petitioners have offered is what they regard to be universally acknowledged afflictions which beset our postal system and which could have been responsible for the delay in the transmission of their petitions. However, as unequivocally pointed out in Irving Fishman, 51 T.C. 869">51 T.C. 869 (1969), affd. per curiam 420 F.2d 491 (C.A. 2, 1970), these generalizations - no matter the acuity on which they are founded - are not enough to satisfy the strict requirements of respondent's regulations. The following language from our opinion in Fishman, a case which presented a fact pattern almost identical to the one now before us, makes this point abundantly clear: Relying on testimony of the petitioner, Mr. Irving Fishman, and postal regulations requiring corrective postmarking by the Post Office of wrongly dated metered mail (see 39 C.F.R. sec. 143.6(c)), the petitioners urge us to conclude that the petition was deposited in a U.S. mailbox on September 5, 1967, in time to be collected from the place of deposit1970 Tax Ct. Memo LEXIS 126">133 on that day. Based on their assertion of timely mailing and the fact that mail may be delayed in transmission, the petitioners also argue that delay in the delivery of their petition must have resulted from delay in the mails. However, we need not decide whether the petitioners have established that the petition was mailed on September 5 and that the delay in delivery was due to a delay in the transmission of the mail, because it is clear that they have not established the cause of any such delay. The sum total of the evidence produced by the petitioner on this point merely indicates that it is possible for a piece of mail to be delayed for several days with no record of such delay. Yet, proving these possibilities does not fulfill the requirements of the regulations. Proving that there may have been an unrecorded delay in the delivery of a piece of mail falls far short of establishing the reason for such delay. Clearly, the petitioners have failed to qualify under the conditions of the regulations. Since petitioners have failed to prove that their petitions were timely filed, respondent's motion to dismiss for lack of jurisdiction will be granted. 31970 Tax Ct. Memo LEXIS 126">134 An appropriate order will be entered. 1000 Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩2. Because July 6, 1969, was a Sunday, to be timely, Monday, July 7, 1969, was last day on which filing could occur. See section 7503.↩3. Section 324.366 of the United States postal regulations provides that metered mail bearing the wrong date must be cancelled by the post office to reflect the correct date of mailing. Where an erroneously dated letter is properly cancelled pursuant to the above regulation, the post office must notify the sender of such correction. In this case, petitioners' attorneys, who were responsible for mailing the petitions, received no such notice. Nor did the envelope evidence any sign of a post office cancellation. However, because of the large bulk of mail handled, it is not unusual for letters bearing incorrect postmarks to pass through the post office without detection. Accordingly, as was the case in Fishman, we do not feel that the considerations engendered by the introduction of the above postal regulations are enough to carry the day for petitioner in the within proceeding.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623332/	MIECZYSLAW FILA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFila v. CommissionerDocket No. 13314-86.United States Tax CourtT.C. Memo 1988-32; 1988 Tax Ct. Memo LEXIS 32; 55 T.C.M. 1; T.C.M. (RIA) 88032; February 1, 1988; As Amended February 22, 1988 Mieczyslaw Fila, pro se. Mark Humphrey, for the respondent. FAYMEMORANDUM [Text Deleted By Court Emendation] FINDINGS OF FACT AND OPINION FAY, Judge: Respondent has determined deficiencies in petitioner's Federal income tax as follows: Tax YearDeficiency19822,14019834,46319844,023After concessions, 1 the sole issue for decision is whether petitioner, a resident alien of the U.S. for the taxable years at issue, is entitled to claim personal exemptions for1988 Tax Ct. Memo LEXIS 32">34 his children living in Poland. 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. Petitioner was a citizen of Poland and a resident alien of the United States during the taxable years at issue. Petitioner resided in Chicago, Illinois, at the time of filing this petition. Petitioner, while living in Poland, married a citizen of Poland in 1967. Petitioner has four children from that marriage who are also citizens of Poland. Petitioner left Poland in 1978 and resided in the United States during the taxable years at issue, while petitioner's wife and children resided in Gdansk, Poland. Petitioner supported his family during these years by sending them money and provisions. In preparing his 1982, 1983, and 1984 Federal income tax returns, petitioner read and relied on Internal Revenue Service Publications1988 Tax Ct. Memo LEXIS 32">35 519 (U.S. Tax Guide for Aliens) and 501 (Exemptions) (hereinafter collectively referred to as "IRS publications"). These IRS publications explain, among other things, the requirements for claiming a personal exemption by a resident alien taxpayer. The IRS publications state that a resident alien taxpayer may claim personal exemptions according to the same rules as apply to U.S. citizens. The IRS publications also state that a dependent of a resident alien must be a resident of the United States, Canada, or Mexico. Based on petitioner's understanding of these requirements, he claimed his children as dependents for all of the years at issue. Respondent disallowed the dependency exemptions on the grounds that none of petitioner's children were citizens, nationals, or residents of either the United States or certain other countries and determined the above stated deficiencies in petitioner's Federal income tax. 2OPINION In certain situations, section 151(e) 3 allows a taxpayer an exemption for each dependent. As is relevant here, dependent is defined as a son or daughter of the taxpayer. Sec. 152(a)(1). Excluded from the definition of dependent1988 Tax Ct. Memo LEXIS 32">36 is any individual who is not a citizen or national of the United States, unless they are residents of the United States or certain other countries, not including Poland. Sec. 152(a)(3). None of petitioner's four children is a citizen or national of the United States and all are residents of Poland. Accordingly, all are excluded from the definition of dependent and petitioner is not entitled to claim a personal exemption for any of them. Petitioner argues that he should be permitted to claim his children as dependents because he contends the IRS publications are misleading in that they state that a resident alien taxpayer may claim personal exemptions according to the same rules as apply to U.S. citizens. Petitioner's argument is not well taken because U.S. citizens are precluded, just as petitioner is precluded, from claiming children living in Poland, who are not U.S. citizens1988 Tax Ct. Memo LEXIS 32">37 or nationals, as dependents. Sec. 152(b)(3). At any rate, petitioner's argument is basically an estoppel argument. Without delving into the many requirements for the applicability of estoppel in this Court, we hold that estoppel is not here applicable. See . Further, petitioner's reliance on the IRS publications is misplaced as we have held that such publications are not authoritative law in the tax field and may not be relied upon by a taxpayer. , and the cases cited therein.4 Since petitioner's children are not his dependents, petitioner is not entitled to exemptions for his children. Petitioner presented his case ably. His lack of success is the result of the fact that the statute as written by Congress does1988 Tax Ct. Memo LEXIS 32">*38 not allow an exemption for children living in Poland where such children are neither nationals or citizens of the United States. To reflect the foregoing, Decision will be entered [Text Deleted By Court Emendation] under Rule 155.Footnotes1. Respondent has conceded additions to tax under section 6653(a)(1) and 6653(a)(2) and has conceded petitioner may claim a personal exemption for his wife. Petitioner has conceded that he is not entitled to claim a personal exemption for his mother-in-law. ↩2. See n.1 supra.↩3. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question. Section 151(e) has been redesignated as section 151(c) by section 103(b) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2103. ↩4. We held in quoting , no "interpretation by taxpayers of the language used in government pamphlets [can] act as an estoppel against the government, nor [can it] change the meaning of taxing" statutes. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623333/	George Wynn Smith and Maleita E. Smith, Petitioners v. Commissioner of Internal Revenue, RespondentSmith v. CommissionerDocket No. 3776-69United States Tax Court55 T.C. 133; 1970 U.S. Tax Ct. LEXIS 44; October 26, 1970, Filed 1970 U.S. Tax Ct. LEXIS 44">44 Decision will be entered for the respondent. Held: 1. Amounts expended to acquire "upland cotton acreage allotments" were capital expenditures and not deductible as ordinary and necessary business expenses. Secs. 263 and 162, I.R.C. 1954.2. A legal fee paid in connection with the partition of inherited lands was also a nondeductible capital expenditure under sec. 263, I.R.C. 1954. George Wynn Smith, pro se.John M. Wylie, for the respondent. Tietjens, Judge. TIETJENS55 T.C. 133">133 The Commissioner determined deficiencies in petitioners' Federal income tax for the fiscal years ended April 30, 1966 and 1967, in the amounts of $ 5,187.14 and $ 12,338.85, respectively. Due to concessions by petitioners only two issues remain for our decision. The first is whether the cost of acquiring certain upland cotton acreage allotments in each of the years in question is an ordinary and necessary business expense under section 162, I.R.C. 1954, or is a 55 T.C. 133">134 nondeductible capital expenditure under section 263, I.R.C. 1954. 1 The second issue is whether a $ 1,000 legal fee paid to obtain a partition of land inherited by petitioner George Smith, his brother, and sister as tenants in common, is deductible under section 162 or is a nondeductible capital expenditure under section 263.1970 U.S. Tax Ct. LEXIS 44">46 FINDINGS OF FACTSome of the facts have been stipulated. The stipulation and exhibits attached thereto are incorporated herein by this reference.George Wynn and Maleita E. Smith, husband and wife, resided in Tiptonville, Tenn., at the time of the filing of the petition herein. They filed joint Federal income tax returns for the fiscal years ending April 30, 1966 and 1967, with the district director of internal revenue in Nashville, Tenn. Hereinafter, for purposes of clarity, only George Wynn Smith will be referred to as petitioner.During the fiscal years in question petitioner owned farmland in Lake County, Tenn., which was used for growing upland cotton. Petitioner has been in the business of growing and selling upland cotton since 1931.In December of 1965, pursuant to the provisions of the Agricultural Adjustment Act of 1938, as amended, 2 petitioner purchased upland cotton acreage allotments for $ 13,012.01. Similarly in December 1966, petitioner purchased upland cotton acreage allotments for $ 22,162.25. 3 Petitioner has been allocated an acreage allotment for upland cotton for every year in which a national acreage allotment for upland cotton has been promulgated by1970 U.S. Tax Ct. LEXIS 44">47 the Secretary of Agriculture pursuant to the Agricultural Adjustment Act of 1938, as amended. No national allotments for upland cotton were in effect during World War II, 1943-49, nor during the Korean conflict, 1951-53.The Act makes it uneconomical for a farmer to grow upland cotton without an allotment by providing for penalties in such cases. Petitioner has never grown cotton in excess of his allotment, nor has he ever lost an allotment due to failure to grow cotton in at least 1 of 3 successive years as required by the Act.In both of the years 1970 U.S. Tax Ct. LEXIS 44">48 in question petitioners deducted as ordinary and necessary business expenses the cost of the acquired cotton acreage allotments.55 T.C. 133">135 Petitioner was appointed administrator of his mother's estate, who died intestate in March 1965. From 1937 until her death, petitioner's mother owned four farms in Lake County, Tenn. The total acreage was 775 acres: one of 305 acres (A); one of 83 acres (B); one of 167 acres (C); and one of 220 acres (D). At her death title to the farms passed to petitioner, his brother, and his sister as tenants in common under Tennessee law.Petitioner desired to grow cotton on one of the four farms. He did not feel it practical, or economically feasible, to operate all four farms as a unit. At first petitioner's sister favored a partition, but later changed her mind. Petitioner believed a partition necessary so as to properly farm the lands. Petitioner did not care which of the four farms he would receive in a partition.Petitioner retained counsel and instituted suit for partition of the property. However, while the suit was still pending the parties agreed to a partition by which petitioner's sister received farm A, petitioner's brother received farm1970 U.S. Tax Ct. LEXIS 44">49 D, and petitioner received farms B and C.Petitioner paid his attorney $ 1,000 for his services and this amount was deducted by petitioners for fiscal year ended April 30, 1967, as an ordinary and necessary business expense.The Commissioner denied both of the aforementioned deductions. As to the acreage allotments he determined them to be capital assets having indeterminate useful lives and hence not deductible by virtue of section 263. As to the legal fee, the Commissioner determined that such amount was incurred in the acquisition of a capital asset and also not deductible by virtue of section 263.OPINIONWe must decide if two items claimed by petitioners to be deductible business expenses, under section 162, are in fact so deductible or if these items are nondeductible capital expenditures. We hold that both the amounts paid for the cotton acreage allotments and the legal fee are in the nature of capital expenditures and hence not deductible by virtue of section 263.Upland Cotton Acreage AllotmentsSection 263 provides in pertinent part:SEC. 263. CAPITAL EXPENDITURES.(a) General Rule. -- No deduction shall be allowed for -- (1) Any amount paid out for new buildings1970 U.S. Tax Ct. LEXIS 44">50 or for permanent improvements or betterments made to increase the value of any property or estate. * 55 T.C. 133">136 The regulations thereunder include some examples of capital expenditures one of which is:Sec. 1.263(a)-2 Examples of capital expenditures.The following paragraphs of this section include examples of capital expenditures:(a) The cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year.The petitioner contends that a cotton acreage allotment is not within the purview of section 263 because "a Capital Asset must not be ephemeral or fugitive, or of a character to be fickly spirited away." This contention lays great stress on the physical nature of those expenses within section 263. However, the physical or tangible aspect of that acquired by the expenditure is not controlling. What is covered by section 263 is concisely stated in United States v. Akin, 248 F.2d 742, 744 (C.A. 10, 1957):an expenditure should be treated as one in the nature of a capital outlay if it brings about the acquisition 1970 U.S. Tax Ct. LEXIS 44">51 of an asset having a period of useful life in excess of one year or if it secures a like advantage to the taxpayer which has a life of more than one year. [Emphasis supplied.]The Agricultural Adjustment Act of 1938, as amended, governs cotton acreage allotments. Basically the procedure is as follows.Under the Act, if the Secretary of Agriculture determines that the total supply of cotton for the current marketing year will exceed the normal supply of cotton for such marketing year, the Secretary shall proclaim a national marketing quota, in terms of bales of cotton, for the crop of cotton to be produced in the next calendar year. 7 U.S.C. sec. 1342. After the proclamation of the national marketing quota, a referendum is then held before the end of the current marketing year and if two-thirds or more of the cotton farmers voting therein approve the quota, then the quota becomes effective for the next marketing year. 7 U.S.C. sec. 1343. Whenever a national marketing quota is proclaimed, the Secretary of Agriculture then determines and proclaims a national acreage allotment for the next calendar year's cotton1970 U.S. Tax Ct. LEXIS 44">52 crop. The acreage allotment is designed to make available an amount of cotton equal to the national marketing quota. The acreage allotment proclaimed is, in general, based on the national average yield of cotton per acre for the 4 preceding years. 7 U.S.C. sec. 1344(a). The national acreage allotment since 1953 has been apportioned, subject to certain exceptions, among the States based on the acreage planted to cotton during the preceding 5 years. The State then allocates the allotment to each county within the State on the same basis as the national allotment was allocated to the State. Finally the county committee for each county within the State allocates the allotment to 55 T.C. 133">137 the farms within the county on the basis of the acreage allotment of the farm for the preceding year if such farm planted at least 75 percent of its allotment in the preceding year. 7 U.S.C. secs. 1344 (b), (e), (f)(8), 1377.Further, under the Agricultural Adjustment Act of 1949, as amended, 4 the owner of an upland cotton acreage allotment is entitled to (1) price-support payments for cotton grown on allotted acreage; (2) 1970 U.S. Tax Ct. LEXIS 44">53 acreage diversion payments for allotted acreage diverted from cotton production to approved conservation practices; and (3) price-support loans. 7 U.S.C. secs. 1421, 1428(b), 1441, 1444(d).In its simplest terms, an acreage allotment is akin to a license; a license to plant cotton, for to plant domestic cotton without an allotment involves the incurrence of penalties which make such planting economically infeasible. 7 U.S.C. sec. 1346. The holding of this license then entitles the holder to certain benefits enumerated above. (For the principles applicable to the tax treatment of amounts expended for licenses see Morris Nachman, 12 T.C. 1204">12 T.C. 1204, affd. 191 F.2d 934.)However, the most important aspect of the license, aside from the license itself, is that it enables the holder to obtain a renewal of it in the succeeding year. 1970 U.S. Tax Ct. LEXIS 44">54 The Act provides that in determining the apportionment of a county acreage allotment, priority shall go to farms on which cotton has been planted in any one of the immediate 3 preceding years. 7 U.S.C. sec. 1344(f).Considered in light of the penalties provided for growing cotton in the absence of an acreage allotment, it appears that the advantage accruing to petitioner by virtue of his acquisition of acreage allotments is one which will benefit him for more than 1 year. Therefore, we hold that the amounts expended in fiscal years April 30, 1966 and 1967, for purchase of upland cotton acreage allotments are not deductible business expenses but rather are capital expenditures under section 263.Legal FeesPetitioner contends that the $ 1,000 legal fee paid in connection with the partition of lands inherited from his mother is deductible since the fee was "payment for helping to effect a division for the 'management, conservation and maintenance of property held for the production of income.'"We note that this quoted language is that of section 212 relating to the deduction of nontrade or nonbusiness expenses and has no application to the1970 U.S. Tax Ct. LEXIS 44">55 case at hand where petitioner is claiming the expense as an ordinary and necessary business expense.We conclude that the petitioner's purpose in seeking partition was 55 T.C. 133">*138 to obtain sole legal title to a portion of the lands held in tenancy in common and thereafter to operate the farms for the production of cotton. On the facts we hold that the legal fee was paid for the acquisition of a capital asset and is a cost thereof, not deductible under section 263 and section 1.263(a)-2(a) of the regulations. In this connection see Charles J. Livingood, Executor, 25 B.T.A. 585">25 B.T.A. 585, 25 B.T.A. 585">591 (1932), where the Board stated:We have consistently held to the effect that fees paid for legal services, where the acquisition of capital assets or the litigation of matters pertaining to assets of a purely capital nature were involved, were capital expenditures and therefore not deductible as ordinary and necessary expenses.See also Brown v. United States, 280 F. Supp. 854">280 F. Supp. 854 (D.N.M. 1967). Accordingly,Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise stated.↩2. Act of Feb. 16, 1938, ch. 30, sec. 1, 52 Stat. 31, as amended, 7 U.S.C. sec. 1281 (1964 ed.)↩.3. The record does not disclose to whom the payments were made. Apparently, from typical exhibits in evidence, the transfers and divisions of allotments were made on forms and in accordance with conditions prescribed under 7 U.S.C. sec. 1334(a)↩, and the regulations of the Secretary of Agriculture.4. Act of Oct. 31, 1949, ch. 792, tit. IV, sec. 401, 63 Stat. 1054.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623334/	Dependable Packing Co., a Partnership, Petitioner, v. Commissioner of Internal Revenue, Respondent. Dependable Packing and Provision Co., an Illinois Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentDependable Packing Co. v. CommissionerDocket Nos. 442 P. T., 443 P. T.United States Tax Court1 T.C. 861; 1943 U.S. Tax Ct. LEXIS 195; March 31, 1943, Promulgated 1943 U.S. Tax Ct. LEXIS 195">195 Processing Tax -- Jurisdiction. -- A petitioner had all of its hogs slaughtered for it and, therefore, was not liable as a first processor for the processing tax. But, under the erroneous belief that it was liable as a processor of hogs, it filed returns as a processor and paid the taxes assessed thereon. Held, that its petition filed with the Board of Review should not be dismissed for lack of jurisdiction. W. R. Brown, Esq., for the petitioners.W. V. Crosswhite, Esq., for the respondent. Murdock, Judge. MURDOCK 1 T.C. 861">861 OPINION.The Commissioner filed a motion with the United States Processing Tax Board of Review to dismiss these proceedings for lack of jurisdiction. The reason stated is a showing on the face of each petition that the petitioner was not a first processor of hogs, was not liable for the processing taxes but voluntarily paid the taxes of another, and, therefore, had no standing before the Board in a suit for refund. We may assume, for the purpose of this motion, the truth of the facts alleged in the petition, that is, that each petitioner filed monthly returns as a processor of hogs although all of its hogs were actually slaughtered by the Empire1943 U.S. Tax Ct. LEXIS 195">196 Packing Co.; the taxes were assessed against the petitioners on the basis of the returns; and the taxes assessed on the returns were paid by the petitioners to the collector as processing taxes.The Commissioner relies particularly on the case of ; certiorari denied, . The petitioner in that case was not a first processor of hogs, the first processor there being the Burnette company which slaughtered the hogs for the petitioner. The petitioner, however, paid the taxes for the Burnette company. The first payments were 1 T.C. 861">862 made directly to the collector, but they were later returned to the petitioner, turned over to Burnette, and paid by Burnette to the collector. Subsequent payments, except a July payment, were made by the petitioner to Burnette and by Burnette to the collector. Apparently, all of the returns were filed by Burnette and the taxes were assessed on those returns against Burnette. At least it does not appear that the collector ever retained taxes paid directly by Fuhrman & Forster upon a return filed by it reporting that it was itself1943 U.S. Tax Ct. LEXIS 195">197 liable as a first processor of hogs. The court sustained the Board of Review in dismissing the petition of Fuhrman & Forster.The present case is distinguishable. Here each petitioner filed the returns as if it were a first processor liable for the tax, the tax was assessed against the petitioner on the basis of those returns as if it were liable as a processor, and the petitioner paid the tax called for on those returns as its own tax. The petitioner did not pay taxes of or for another.The case of , presents a set of facts similar to those in the present case. The Trunz Pork Stores sued in the District Court for a refund of the tax on the ground that it was not a first processor, owed no tax, and had paid the tax under a misapprehension of its liability. It had its hogs slaughtered by another. The United States Circuit Court of Appeals for the Second Circuit held that suit in the District Court was improper and that the Trunz Pork Stores should have filed a petition with the Processing Tax Board of Review. Here, under similar circumstances, the petitioner has filed a petition with the 1943 U.S. Tax Ct. LEXIS 195">198 Processing Tax Board of Review. Some tribunal must have jurisdiction in such cases.The statute provided that rejected claims for refunds by taxpayers who paid processing taxes upon the processing of commodities used in their own business should be reviewed exclusively by the Board of Review and not by the courts. Sec. 906, Revenue Act of 1936. The statute refers to "any amount paid or collected as processing tax." These taxes were paid by the petitioner upon the theory that they were for the processing by the petitioner of commodities used in its own business and not upon the theory that the petitioner was processing commodities for customers for a charge or fee. They were paid by the petitioner and collected by the collector as processing tax, despite the fact that they may have been paid and collected erroneously. It thus appears that the grounds urged by the Commissioner for dismissal are not supported by the act or authorities and his motion must be denied.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623336/	Sylvester W. Sargeant and Mildred Sargeant Whitford v. Commissioner.Sargeant v. CommissionerDocket No. 2118-65.United States Tax CourtT.C. Memo 1967-255; 1967 Tax Ct. Memo LEXIS 3; 26 T.C.M. 1313; T.C.M. (RIA) 67255; December 27, 1967Ralph R. Bailey, for petitioner Sylvester W. Sargeant. Martin J. Howard, for petitioner Mildred Sargeant Whitford. Walter John Howard, Jr., for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined that the petitioners are liable for the following income tax deficiencies and additions to tax: Addition to TaxSec. 6653(b),YearDeficiencyI.R.C. 19541958$1,085.75$ 542.8819591,816.49908.251960$7,451.65$3,725.8319613,379.651,689.8319623,240.651,620.331967 Tax Ct. Memo LEXIS 3">4 The only issue for decision is whether the respondent correctly determined, on the net worth and cash expenditures method of reconstructing income, that petitioners understated their income for the years 1958 through 1962. The parties agree that the answer to this question depends upon how much cash the petitioners had on hand as of January 1, 1958. Petitioners have conceded that the additions to tax under section 6653(b), Internal Revenue Code of 1954, 1 are to be imposed on any deficiencies determined by the Court to be due for each of the years in issue. 2 Petitioners also concede each of the items appearing in respondent's net worth analysis except for the cash accumulated by petitioners prior to 1958 and which was on hand as of January 1, 1958. Respondent concedes that the petitioners had accumulated cash on hand as of January 1, 1958, in the amount of $7,500 which belonged to Rudolph P. Dierickx and was spent in the year 1960 to purchase a residence for Dierickx at 722 Pine Street, Hood River, Oregon. 1967 Tax Ct. Memo LEXIS 3">5 Findings of Fact Some of the facts have been stipulated by the parties. The stipulations of facts and the exhibits attached thereto are incorporated herein by this reference. Sylvester W. Sargeant and Mildred Sargeant (herein called Sylvester and Mildred individually or petitioners collectively) were husband and wife during the years 1958 through 1962. They both had legal residences in Portland, Oregon, at the time the petition in this proceeding was filed. They filed their joint Federal income tax returns for the years 1958 through 1962 with the district director of internal revenue at Portland, Oregon. Petitioners were married in 1943. Sylvester was then 44 years of age. It was his first marriage. Mildred had been married and divorced twice and was 32 years old in 1943. She had married August Dierickx in 1931 and had one son, Rudolph P. Dierickx, born in 1932. She married Clarence Whitford in 1936 and had no children by such marriage. Petitioners had one son, Gerald Leroy Sargeant, born in 1944. Petitioners were divorced on August 6, 1966, in Portland, and Mildred took the name Mildred Sargeant Whitford. During some part of each of the years in issue Mildred derived substantial1967 Tax Ct. Memo LEXIS 3">6 income from prostitution. Such income was not reported on their original joint income tax returns for the years 1958, 1959, 1960 or 1961. However, they did report net income of $3,572.84 from such source in their joint income tax return for 1962. After respondent's agents began their examination and investigation of petitioners' income tax liabilities, petitioners filed amended tax returns for the years 1959, 1960, and 1961 on which they reported interest income and additional income of $1,500 from "gratuities" and showed a "penalty under Sec. 6653, I.R.C." Second amended returns for those years were filed by the petitioners on April 16, 1963, which set forth the same amount of interest income as the first amended returns plus $1,500 income from "entertaining" in each year. They also reported self-employment tax liability for the years 1959, 1960 and 1961. This additional income, as reported in their first and second amended returns, was not reported in their original income tax returns for those years. Respondent determined the unreported income of petitioners for the years 1958 through 1962 by the net worth and cash expenditures method. The petitioners have1967 Tax Ct. Memo LEXIS 3">7 stipulated and agreed that each of the items appearing therein are correct, except that they contend the net worth statement does not include the property in the form of cash prior to 1958 and on hand as of January 1, 1958. These stipulated statements are as follows: ANALYSIS OF NET WORTH INCREASES195719581959196019611962Cash and uncashed pay checks$ 2,500.00$ 2,500.00$ 2,500.00$ 2,500.00$ 2,500.00Cash in banks - savings accounts: U.S. National - Head Office$ 3,720.454,695.774,977.26257.98172.433.93U.S. National - StadiumBranch2,758.47Oregon Mutual Savings#261689,782.8010,078.6410,388.2410,218.879,308.227,748.72Oregon Mutual Savings#39371$ 2,642.65$ 2,826.38$ 2,671.47$ 6,302.33$ 6,610.86Southern Oregon State Bank#2190, Grants Pass, Oregon3,963.034,082.825,115.495,321.38Investments: U.S. Savings Bonds - SeriesE$26,662.5026,662.5026,662.5039,356.2540,856.2540,856.25Automobiles (at cost).1955 Model 300 Chrysler3,500.003,500.001957 Cadillac6,009.236,009.236,009.236,009.236,009.236,009.231959 Chrysler Imperial7,162.007,162.007,162.007,162.001959 Corvette3,350.001961 Corvette4,188.004,188.00Real Estate Investments: Residence - 722 Pine Street,Hood River, Oregon12,503.6912,503.6912,503.69Improvements & additions byL. C. Baldwin ConstructionCo.7,066.3310,700.04Loans Receivable.Arthur Nashif (Judgment)3,000.00Isadore Winkelman Estates(note and claim filed)2,750.00Total assets and net worth$49,674.98$56,088.79$64,488.64$88,112.31$101,183.97$112,112.57Less prior years ending net worth49,674.9856,088.7964,488.6488,112.31101,183.97Increases in net worth$ 6,413.81$ 8,399.85$23,623.67$ 13,071.66$ 10,928.601967 Tax Ct. Memo LEXIS 3">8 ANALYSIS OF ADJUSTMENTS TO NET WORTH INCREASES19581959196019611962ADDITIONS: Income Taxes Paid: Withheld from salaries and wages$ 923.42$ 966.46$ 996.12$1,004.00$ 1,199.56Additional paid with returns filed37.8522.2620.90Deposited with Internal Revenue Service1,947.54Listed Deductions on Returns Filed: Contributions462.00294.00232.00257.00152.00Taxes (other than income)67.5075.0086.00388.12500.20Medical expenses paid (prior to limitation)588.00655.01599.00536.25533.55Miscellaneous deductions137.50107.00110.00115.001,199.00Rent paid on residential apartment339.13914.21902.85894.89Legal Expenses Paid (criminal defense): Attorneys fees75.00100.0050.00Fines50.00300.00100.00Loss in investments - automobiles850.00350.00Utilities paid - N. W. Bell Telephone Co.39.1297.76110.19111.3883.16Insurance Premiums Paid: Massachusetts Mutual Life Insurance Co.335.34335.34335.34335.34335.34John Hancock Life Insurance Co.179.77179.77179.77State Farm Mutual Automobile Insurance Co.50.1952.50317.66648.94111.60Appliance Purchases: Warren C. Edwards - "A-1" Jewelers75.0075.0075.0075.00Winkelmans (electronic equipment)350.00Estimated Living Expenses: Automobile expense (based on gas tax claimedon returns)411.60449.10450.60733.10914.00Food, clothing, miscellaneous expenses basedon $50 per month per person in household1,800.001,800.001,800.001,800.001,400.00Furnished by taxpayers (per their statements)to son and daughter-in-law (after marriage)for 8-month period at $250 per month2,000.00Total additions$4,889.67$6,221.30$6,643.74$7,609.01$11,821.51SUBTRACTIONS: Adjusted gross income reported on returns$6,342.17$6,926.74$6,914.26$6,976.25$11,264.14Federal and state income tax refunds254.38145.0048.32Insurance proceeds (auto accident)1,130.00Total Subtractions$6,596.55$7,071.74$6,914.26$8,106.25$11,312.461967 Tax Ct. Memo LEXIS 3">9 On January 1, 1958, petitioners had cash on hand in the amount of $7,500 which belonged to their son, Rudolph P. Dierickx. Along with $5,000 in funds withdrawn from savings, the petitioners used the $7,500 in 1960 to purchase property at 722 Pine Street, Hood River, Oregon, for Rudolph P. Dierickx. Sylvester began working in 1914 and was employed as a teamster and farm laborer from that time until 1922. From August 1922 to his retirement in October 1963, Sylvester worked with a right of way maintenance crew for the Southern Pacific Railroad Company, first as a member and later as a foreman of the signal systems maintenance crew. Sylvester was paid either 51 or 53 cents per hour when first employed by the railroad and worked 8 to 10 hours per day, five days a week. Computed on the basis of a 53 cent per hour wage for 50 hours per week, he would have been paid $530 for working 20 weeks in 1922 and $1,378 for the year 1923. His earnings for subsequent years, based on either Southern Pacific Railroad Company's records or his own estimates where no records were available, were as follows: FederalStateWith-With-hold-hold-ingingYearTotal WagesTaxTax1924$ 1,262.2919251,359.7019261,590.9019271,703.7119281,771.8219291,787.7819301,727.6819311,055.15Subtotal(1924-1931)$ 12,259.0319321,700.0019331,700.0019341,700.0019351,700.0019361,048.0019371,685.0019381,827.5019391,989.6519402,154.0019412,472.5119423,000.00Subtotal(1932-1942)$ 20,976.6619433,707.7619443,859.6819453,786.8119463,703.72$ 278.5019473,445.88259.9019484,321.44282.20$ 43.201949$ 4,554.94$ 281.73$ 45.5619504,496.66349.6144.9219514,250.79457.5042.50Subtotal(1943-1951)$ 36,127.68$1,909.44$176.1819525,103.85617.5651.0419536,241.49845.0631.7519546,179.16749.3661.7719555,516.29630.0237.2019565,947.65692.5874.6619576,015.69719.93154.00Subtotal(1952-1957)$ 35,004.13$4,254.51$410.42Grand Totals$104,367.50$6,163.95$586.601967 Tax Ct. Memo LEXIS 3">10 The Federal income tax liabilities of petitioners for the years 1943 through 1945 were as follows: YearFederal tax1943$ 396.871944387.001945356.00Total$1,139.87Under the Railroad Retirement Act of 1937, the following amounts were withheld from Sylvester's salary for railroad retirement: YearsTotal amount1937-1942$ 364.301943-19573,001.50Total 1937-1957$3,365.801958-19621,312.40Total 1937-1962$4,678.20Byron Sargeant (hereinafter called Byron), Sylvester's father, began growing strawberries in 1913. He sold his original tract in 1917 or 1918 for about $3,000 and then grew strawberries on a 9 or 10 acre farm near Riddle, Oregon. Byron later gave this farm to Sylvester who sold it for $1,250 in 1941 or 1942. Sylvester claimed Byron as a dependent on his Oregon income tax returns for the years 1937 through 1941. On his Oregon income tax return for 1937, Sylvester stated that his father had no other means of support, was unable to work, had no income of his own, and owned no property. Byron lived with other relatives during most of 1942, 1943 and 1944. On December 1, 1944, he was admitted to the Douglas County1967 Tax Ct. Memo LEXIS 3">11 Nursing Home with the consent of Sylvester's sister. He died there on February 15, 1946. Byron had no money in 1944. In the period from 1914 to 1922, Sylvester lived with his father on the farm in Riddle, Oregon. From 1922 to 1941, he lived both with Byron on the farm and in a railroad "outfit car" provided by the Southern Pacific Railroad Company. In 1941 or 1942, he moved into a separate outfit car adjacent to his work; and he lived there until his retirement in 1963. Mildred was on public welfare when Sylvester first met her and also just prior to their marriage. She lived in the outfit car, with exceptions later noted, from 1943 through 1957. Petitioner's son, Gerald LeRoy Sargeant, attended schools in Portland, Oregon, at various times through 1956. He attended the Lincoln High School there from September 1958 to June 1962. From August 8, 1958, to August 14, 1959, Mildred resided at the Stadium Court Apartments in Portland, and from August 14, 1959, to 1963 she resided at the Teasdale Apartments in that city. She also rented rooms in several hotels in Portland for considerable periods of time between October 1958 and November 1963 where she engaged in prostitution. Mildred1967 Tax Ct. Memo LEXIS 3">12 was present in Portland for four months in 1958, 10 months in 1959, 11 months in 1960 and in 1961, and 12 months in 1962. Sylvester did not reside with her but visited her about one weekend each month. On their joint income tax return filed with the State of Oregon for the year 1949 the petitioners claimed a casualty loss of $500 for clothing, luggage and personal belongings destroyed by fire. On October 14, 1949, Mildred was arrested under the name of Mildred Whitford for shoplifting four shirts valued at $23.96 from a department store. Three days later she pleaded guilty to the crime of "Larceny from Store" and was given a 90-day suspended sentence. In their joint income tax return filed with the State of Oregon for the year 1954 petitioners claimed a deduction for a theft loss in the amount of $1,000. In response to a request of the State Tax Commission, Sylvester listed the articles stolen, their costs and values, as follows: Bulova wrist watch$ 97.00Man's diamond ring - value $650 -Cost400.00Clock15.00New Schick razor$ 28.75Boy's new air rifle22.00Lady's diamond ring - value muchmore - Cost185.00Philco radio55.00Man's cashmere overcoat150.00Cashmere sweaters 2 - socks - ciga-rettes - trousers - food - money be-tween $5 and $10 change & flash-light - in all70.00Total$1,022.751967 Tax Ct. Memo LEXIS 3">13 On October 2, 1954, Mildred was arrested in Portland on a charge of larceny from a store. The arresting officer's report stated that she had taken two jars of jelly worth $1.18. When arrested, she told a policewoman that the $200 in her possession belonged to her son who was then going to college, that she had no money of her own, that this was the reason she stole, and that she was hungry. On October 26, 1954, she pleaded guilty and was convicted of the crime of petty larceny. She received a 90-day suspended sentence. When Mildred was suspected of prostitution in 1956, her son, Gerald LeRoy, was taken into custody at the Juvenile Home. Such action was based on a petition signed by a policewoman of the Women's Protective Division of the Portland Police Department which alleged that Gerald had an unfit home because of depravity by his mother. A counselor at Multnomah County Juvenile Court interviewed Mildred and Sylvester. Sylvester told the counselor that he had already been informed of Mildred's prostitution activities and was shocked and surprised, but that he had been shocked and surprised before by other things she had done in the past. He further stated that while he only1967 Tax Ct. Memo LEXIS 3">14 earned $300 a month, they managed to save $25,000, mostly in investments and securities. Sylvester also told the counselor that he wondered about some of the jewelry which Mildred purchased, but assumed they were paid for from their savings. Mildred admitted being engaged in prostitution, and the counselor left to petitioners the matter of discussing this with Gerald LeRoy. During the years following their marriage, Sylvester allowed Mildred to handle most of the family finances. Mildred cashed most of Sylvester's pay checks and took responsibility for the money coming from them. On August 4, 1951, the petitioners opened a safety deposit box at the United States National Bank, Portland, Oregon, in their joint names. The two initial entries in August 1951 were made by Sylvester. All subsequent entries to the box through July 3, 1963, were made by Mildred. There were 2 such entries in 1958, 7 in 1959, 5 in 1960, none in 1961, and 4 in 1962. On November 14 and 15, 1963, respondent's agents took an inventory of the United States savings bonds purchased by petitioners. A summary of the total face amount and total cost of such bonds for the period 1942 through 1961 is set forth below: 1967 Tax Ct. Memo LEXIS 3">15 Face AmountYearof BondCost1942$ 175.00$ 131.251943325.00243.751944325.00243.751945225.00168.75195121,000.0015,750.0019537,200.005,400.0019546,300.004,725.00196016,925.0012,693.7519612,000.001,500.00Totals$54,475.00$40,856.25The funds used to purchase the 21 United States savings bonds acquired in 1951 came from the following sources: Withdrawn from savings account,Bank of California 7-2-51$ 4,992.82Withdrawn from savings account,First National Bank 7-28-514,991.77Withdrawn from savings account,U.S. National Bank 7-28-513,900.00Withdrawn from savings account,U.S. National Bank 7-30-51367.00Withdrawn from savings account,U.S. National Bank 9-28-51400.00Cash on hand expended in 1951for bonds1,098.41Total amount expended$15,750.00The funds used to acquire United States savings bonds in 1953 came from the following sources: Withdrawn from savings account,U.S. National Bank 1-13-53$ 3,100.00Cash on hand experded in 1953for bonds2,300.00Total amount expended$ 5,400.00The funds used to acquire United States savings1967 Tax Ct. Memo LEXIS 3">16 bonds in 1954 came from the following sources: Withdrawn from savings account,U.S. National Bank 6-30-54$ 3,675.00Cash on hand expended in 1954for bonds1,050.00Total amount expended$ 4,725.00On April 9, 1965, Mildred was charged in the United States District Court for the District of Oregon, in an information filed by the United States Attorney, with two counts of violation of section 7201 of the Internal Revenue Code of 1954, alleging that she did knowingly and wilfully attempt to evade and defeat a large part of the income taxes due and owing by her and Sylvester by filing and causing to be filed false and fraudulent joint Federal income tax returns on their behalf for the years 1960 and 1961. On April 9, 1965, Mildred entered a plea of guilty before Gus J. Solomon, Judge of the United States District Court for the District of Oregon, to both counts in the information. She was sentenced and imprisoned for a term of 60 days on the first count and given a suspended sentence on the second count which placed her on probation for a period of three years. On January 11, 1966, Sylvester was charged in the United States District1967 Tax Ct. Memo LEXIS 3">17 Court for the District of Oregon, in an indictment returned by the Federal Grand Jury, with five counts of violation of section 7206(1) of the Internal Revenue Code of 1954, alleging that he did wilfully and knowingly make and subscribe a joint Federal income tax return for himself and his wife for each of the calendar years 1958 to 1962, inclusive, which was verified by written declaration that it was made under the penalties of perjury. This indictment was dismissed without prosecution on September 14, 1966, by order of Gus J. Solomon, Judge of the United States District Court for the District of Oregon. Ultimate Finding of Fact On January 1, 1958, the petitioners had the amount of $17,500 cash on hand which had been accumulated in prior years, first in a box kept in the outfit car and later in their safety deposit box. Opinion We are confronted in this case with a narrow factual controversy which had been resolved by our ultimate finding of fact. The deficiencies here determined by respondent were calculated by the so-called net worth method of reconstructing income. Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954); and Lipsitz v. Commissioner, 220 F.2d 8711967 Tax Ct. Memo LEXIS 3">18 (C.A. 4, 1955), affirming 21 T.C. 917">21 T.C. 917 (1954). Petitioners agree in every respect with the net worth statement except opening cash on hand, and have so stipulated. But they sharply dispute respondent's determination of the amount of cash they had on hand as of January 1, 1958. Respondent contends that they had only $7,500 at that time. Petitioners assert that they had a "cash hoard" of $43,000. We are unable to agree with either. Like so many cases of this type, where the factual issue can usually be resolved much more satisfactorily by agreement of the parties, we cannot, after considering conflicting evidence and testimony, accept the position urged by either party. There is, of course, support in this record for respondent's contention and he had made out a rather logical case for his position. He has also fortified that position with evidence tending to show that the petitioners could not have accumulated the substantial sum of $43,000 which they claim to have had on hand on January 1, 1958. However, we are convinced by other evidence that respondent's position is not entirely realistic. We think petitioners did have more than $7,500 but certainly not such a highly1967 Tax Ct. Memo LEXIS 3">19 inflated amount as $43,000. Therefore we have not made either the finding requested by respondent or the finding requested by petitioners because neither would be in accord with our appraisal of the facts. Using our best judgment, based on all the evidence, we have found that petitioners had $17,500 cash on hand as of January 1, 1958. Cf. Cohan v. Commissioner, 39 F.2d 540, 544 (C.A. 2, 1930). See also Baumgardner v. Commissioner, 251 F.2d 311 (C.A. 9, 1957), affirming a Memorandum Opinion of this Court; Michael Potson, 22 T.C. 912">22 T.C. 912 (1954), affirmed sub. nom. Bodoglau v. Commissioner, 230 F.2d 336 (C.A. 7, 1956); and Abraham Galant, 26 T.C. 354">26 T.C. 354 (1956). While respondent has the burden of proving fraud for all the years in controversy, 3 the petitioners have the burden of proving that the basic deficiencies determined by respondent are erroneous. Cf. Louis Halle, 7 T.C. 245">7 T.C. 245 (1946), affd. 175 F.2d 500 (C.A. 2, 1949), certiorari denied 338 U.S. 949">338 U.S. 949; Cefalu v. Commissioner, 276 F.2d 122 (C.A. 5, 1960); Jacob D. Farber, 43 T.C. 407">43 T.C. 407 (1965); and 26 T.C. 354">Abraham Galant, supra.1967 Tax Ct. Memo LEXIS 3">20 Despite this, petitioners have argued that respondent has the burden of proving the cash on hand on January 1, 1958, for purposes of determining the income tax deficiencies as well as the fraud penalty. We need not, and do not, decide who has this burden since our ultimate finding as to the amount of cash on hand on that date reflects our careful examination of all the evidence in this record. See Baumgardner v. Commissioner, supra at pages 318-321. As indicated in our findings of fact, Sylvester's highest annual earnings prior to 1958 were $6,241.49, and his average annual earnings were much less. Although Sylvester and his family may have lived frugally and had few expenses while residing in the railway outfit car, we view as incredulous the contention that the living expenses, including food, clothing, and entertainment, averaged but $300 a year for the period from 1922 to 1942 and $1,800 in the years 1943 through 1957. During many of the years after 1943 Sylvester1967 Tax Ct. Memo LEXIS 3">21 was supporting a wife and children. He dressed well; he drove good automobiles; and the objects for which he claimed a theft loss on the Oregon income tax return for the year 1954 reflect an appreciation of some relatively expensive luxury items. Moreover, in addition to the alleged "cash hoard," petitioners amassed $26,000 in savings bonds and $13,000 in savings accounts prior to January 1, 1958. To accept Sylvester's claim that he and Mildred also accumulated $43,000 in cash, we would have to find that he saved about 70 percent of his average gross salary of $3,100 per annum for the period from 1924 through 1957. On this record we cannot make such a finding. It is true that two persons testified that they saw cash in a box in the petitioners' possession; but they did not count the money and could not testify as to how much cash the petitioners had in the box. Mildred did not testify as to the alleged cash hoard, and we are left with only Sylvester's uncorroborated testimony that there was $43,000 in the box. We observed Sylvester on the witness stand and, as reflected by our findings of fact, we do not have complete confidence in his credibility. Sylvester has attempted to show1967 Tax Ct. Memo LEXIS 3">22 the source of the alleged $43,000 cash hoard; and both parties have presented evidence with respect to specific items included in it. Respondent has conceded that the petitioners had $7,500 on hand as of January 1, 1958, which was earned by and held for Rudolph Dierickx. However, we cannot find from the evidence that any of the other items were specifically a part of petitioners' cash on hand as of January 1, 1958. For example, Sylvester testified that he received $1,000 from the Southern Pacific for running a railroad commissary during the years 1942 to 1945; that he received $1,920 from August Dierickx as support payments for Rudolph; and that he received $6,000 in gifts from Clarence Whitford, Mildred's second husband. Even if these amounts were received, the only evidence that they were added to the claimed "cash hoard" is Sylvester's own self-serving and sometimes unreliable testimony. Mildred was not called to testify with regard to the alleged support payments; and there is no proof that the alleged support payments, gifts, or commissary payments were segregated from other funds of the petitioners. Indeed, the fact that Mildred was receiving welfare aid immediately prior to1967 Tax Ct. Memo LEXIS 3">23 her marriage to Sylvester casts considerable doubt on the ability of her former husbands to make such payments and on her willingness to save such amounts even if they were actually received by her. As to the alleged gifts of $11,250 to Sylvester from his father, Byron Sargeant, the evidence shows that Byron never earned much money from his berry farm, that Sylvester claimed him as a dependent on his Oregon income tax returns from 1937 through 1941, and that Byron died in poverty in the county home a few years later. While Byron did give his farm to Sylvester and Sylvester later sold it for $1,250, the only evidence of the alleged $10,000 gift, besides Sylvester's own testimony, is a statement by Willis Love that Byron told him about such gift. This is insufficient to show that such a gift was actually made. And again, even granting that such a gift was made, there is no evidence to establish that the money was saved and included in the "cash hoard." Petitioners are somewhat critical of respondent for making no effort to call Mildred as a witness. As we see it, respondent had no responsibility to call Mildred, a petitioner in this proceeding, as a hostile witness to testify concerning1967 Tax Ct. Memo LEXIS 3">24 her prostitution activities, her entries into the safety deposit box after 1951, and her handling of the family finances. Since it had already been established that Mildred was a prostitute and had pleaded guilty to the criminal charge of income tax evasion, there was no risk involved except her inability to support Sylvester's testimony of accumulated cash on hand as of January 1, 1958. Mildred handled the family finances during the years 1951 to 1958, and she was the only one who entered the safety deposit box. Moreover, we note that in 1954 Mildred told a policewoman that she had no money of her own except for $200 which belonged to her son in college. Hence the inference urged by petitioners that each entry to the safety deposit box represented a deposit rather than a withdrawal is unwarranted. Although there is no evidence to show that any particular funds were part of the "cash hoard" claimed by petitioners, we nevertheless believe, as previously found, that they did have cash on hand in excess of the $7,500 held in trust for Rudolph Dierickx. This belief is supported by testimony of others who claim to have seen the box holding some money and also by the petitioners' habits1967 Tax Ct. Memo LEXIS 3">25 of frugality and amassing savings. To reiterate, we hold that the petitioners had a total of $17,500 cash on hand on January 1, 1958, including the $7,500 they kept for Rudolph Dierickx. To reflect the concessions made by the parties and the conclusion reached on the disputed issue, Decision will be entered under Rule 50. Footnotes1. All statutory references herein are to the Internal Revenue Code of 1954 unless otherwise specified. ↩2. Petitioners concede that the year 1958 is not barred by the statute of limitations and agree that they executed timely consents for the taxable years 1959 and 1960 extending the statute of limitations to June 30, 1965.↩3. This burden has been met by petitioners' concession that additions to tax under section 6653(b)↩ are to be imposed on any deficiencies determined by the Court to be due for the years 1958 through 1962.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623337/	FRANK D. YUENGLING, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Yuengling v. CommissionerDocket No. 54730.United States Board of Tax Appeals27 B.T.A. 782; 1933 BTA LEXIS 1311; February 20, 1933, Promulgated 1933 BTA LEXIS 1311">1311 1. The income of trusts created by petitioner was used by the trustee to pay premiums on insurance on petitioner's life. Held that such income is taxable to petitioner under section 167, Revenue Act of 1928. Frederick B. Wells,19 B.T.A. 1213">19 B.T.A. 1213, and Irenee DuPont v. Commissioner, 63 Fed.(2d) 44, followed. 2. Corporations, of which petitioner was president, paid premiums on insurance on petitioner's life. The beneficiary under the policies was a trustee who held the policies for the benefit of petitioner's wife and children. Held that the amount of the premiums so paid constituted income to petitioner. George Matthew Adams,18 B.T.A. 381">18 B.T.A. 381, followed. R. H. Crook, C.P.A., for the petitioner. Dean P. Kimball, Esq., and E. C. Adams, Esq., for the respondent. ARUNDELL27 B.T.A. 782">782 OPINION. ARUNDELL: The respondent has determined a deficiency in income tax for the year 1928 in the amount of $3,068.72. The error alleged by petitioner is the inclusion in his income of an amount of trust income which the trustee, under trusts created by petitioner, used to pay premiums on policies1933 BTA LEXIS 1311">1312 of insurance on the life of petitioner. In his answer, counsel for respondent alleged error in failing to include in petitioner's income certain specified amounts alleged to have been received from three corporations in 1928, and asked that the deficiency be increased accordingly. A stipulation of facts was filed, with accompanying exhibits, which we adopt as our findings of fact. The facts, in brief, are that in 1921 the petitioner assigned to the Safe Deposit Bank of Pottsville, Pennsylvania, as trustee, a group of policies of insurance on his life, and also caused one policy to be issued directly to said bank as trustee. The policies, except the one issued directly to the bank, were originally payable to petitioner's administrators, executors, or assigns, but with respect to 27 B.T.A. 782">783 each of them petitioner executed an assignment in due form to the Safe Deposit Bank. On August 12, 1921, the bank executed a declaration of trust describing the policies and reciting their assignment to it, and declaring that it held the policies in trust for the purpose of collecting the proceeds, which it was to invest and upon the death of petitioner to pay one-third of the income to1933 BTA LEXIS 1311">1313 petitioner's wife for life or until she should remarry, the other two-thirds to be divided among petitioner's children. Other provisions made respecting the manner of distribution of income to the children in the event petitioner's wife predeceased him, and upon the event of her death or remarriage before the children reached specified ages, are not material here. On the same date, August 12, 1921, the Safe Deposit Bank executed another declaration of trust reciting that petitioner had assigned to it certain investment securities and declaring that it held such securities in trust for purposes of collecting the income therefrom and out of such income paying premiums on insurance on the life of the petitioner, the balance of the income to be held in trust during the life of petitioner and upon his death one-third to be paid to his wife for life or until she should remarry, and the other two-thirds to be paid to petitioner's children. Other provisions were made respecting the distribution of income to be made in the event the wife predeceased petitioner and upon her death or remarriage, and also for the ultimate distribution of the corpus among the children. These provisions are1933 BTA LEXIS 1311">1314 not material here, except perhaps from the negative point of view, that is, that there were no provisions under which any of the income was to be paid to petitioner nor was any part of the corpus to revert to him. On August 22, 1923, petitioner and his wife by written instruments requested the trustee bank to cancel and annul the declarations of trust above described and to execute new declarations respecting the insurance policies and securities theretofore assigned to it. On August 28, 1923, the trustee bank did execute new declarations of trust, in which minor changes were made with respect to the manner of distribution of income and corpus. During the year 1923 some of the policies assigned to the trustee matured as endowments and others became paid-up policies and the trustee collected and invested the proceeds and/or dividends thereon. During the year 1928 the trustee received net income from the trusts in the amount of $23,117.12, of which $22,572.99 was taxable, and paid premiums of $14,594.34 on the policies of insurance held in trust. The trustee has filed income tax returns, as trustee, since the creation of the trusts and has reported therein the income received1933 BTA LEXIS 1311">1315 27 B.T.A. 782">784 as trustee without claiming any deduction for premiums paid on the insurance policies held in trust. The respondent included as taxable income to the petitioner for 1928 the amount of $14,250.82 which represents that portion of the taxable income of the trusts which was used to pay life insurance premiums. In several cases we have held that where the income of trusts created by a taxpayer is to be used to pay premiums on insurance on his life, the income of such trusts should be included in his income. ; ; ; affd., . Those cases arose under the Revenue Acts of 1924 and 1926, while the present case is governed by the Revenue Act of 1928, but the applicable provisions of all three statutes are identical. Cf. section 219(h) of the Revenue Acts of 1924 and 1926; section 167 of the Revenue Act of 1928. Accordingly, on authority of the above cases we sustain the respondent on the first issue. From 1921 to 1925 petitioner owned all the stock and was president of D. G. Yuengling and Son, Inc. 1933 BTA LEXIS 1311">1316 , and Yuengling Realty Co., Inc. In April 1925, petitioner acquired all of the stock of the Yuengling Securities Corporation, which in turn acquired all the stock of the other two corporations. Between 1921 and 1927 these three corporations procured several policies of insurance on the life of petitioner. In some of the policies the corporation procuring them was named beneficiary, but prior to 1928 such policies were assigned to the Safe Deposit Bank of Pottsville as trustee. In the other policies the Safe Deposit Bank was named as beneficiary. The several policies were received by the bank, as trustee, in trust for purposes similar to those declared in the trusts described under the first issue, that is, to collect the proceeds and pay the income therefrom to petitioner's wife and children. Premiums on the several policies were paid in 1928 to the insurance companies by the corporations that procured them, as follows: D. G. Yuengling and Son, Inc$7,623.35Yuengling Realty Company, Inc2,789.30Yuengling Securities Corporation4,711.00The premiums so paid were not included in income by petitioner in his 1928 return, nor were they included by the respondent1933 BTA LEXIS 1311">1317 in the notice of deficiency. The premiums paid by the above companies on the insurance on petitioner's life are the amounts which respondent in his answer 27 B.T.A. 782">*785 alleges that he erred in failing to include in petitioner's income for 1928. This issue must be decided in favor of the respondent on the authority of prior decisions holding that premiums paid by corporations on insurance on the lives of officers or employees, where the corporation is not a beneficiary, constitute income to the insured. ; . Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623338/	R. A. Klefeker v. Commissioner.Klefeker v. CommissionerDocket No. 20971.United States Tax Court1951 Tax Ct. Memo LEXIS 153; 10 T.C.M. 677; T.C.M. (RIA) 51221; July 31, 19511951 Tax Ct. Memo LEXIS 153">153 Emett C. Choate, Esq., and Douglas D. Felix, Esq., for the petitioner. Percy C. Young, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion This proceeding was initiated to test the correctness of the respondent's determination of deficiencies in income tax for the years 1943 and 1944, in the respective amounts of $10,862.15 and $9,012.01. The question for decision is the validity of a family partnership between petitioner and his wife, R. B. Klefeker, during the taxable years. Findings of Fact The petitioner and his wife, R. B. Klefeker, are individuals who resided in Miami, Florida, at all times pertinent herein. Petitioner filed his income tax returns for the taxable years 1943 and 1944 with the collector of internal revenue at Jacksonville, Florida. Petitioner moved to Florida in 1925, prior to which time he resided in Oklahoma City, Oklahoma. Immediately prior to coming to Florida petitioner was employed as a salesman at a salary of $50 per week, and at that time he was possessed of no property or money other than his weekly salary which was used for the support of himself, his wife, and six small children. In 1924 and 1925 petitioner's1951 Tax Ct. Memo LEXIS 153">154 wife, R. B. Klefeker, in order to help the family finances, engaged in manufacturing and selling candy, the manufacturing being conducted at the family home in Oklahoma City. Immediately prior to the time petitioner came to Florida his wife had on hand money from the profits of the candy business and from other sources and also owned a house in Oklahoma City. A portion of her wealth came originally from her father and from a legacy left by an aunt. In October, 1925, after having advanced $1,000 to petitioner, the latter's wife still had deposits in the American National Bank of Oklahoma City of $1,335.24. Petitioner and his brother, Paul W. Klefeker, visited Miami, Florida, in February, 1925, to ascertain the advisability of opening a produce business there and thereafter, in August, 1925, petitioner moved to Miami and with the funds advanced him by his wife opened a bank account in the name of his wife, R. B. Klefeker, with the authority in himself to draw on that account. With the use of funds from that bank account petitioner thereafter opened and operated a vegetable business in the name of R. B. Klefeker at 1338 N. E. Second Avenue, Miami, Florida. Petitioner's wife, R. 1951 Tax Ct. Memo LEXIS 153">155 B. Klefeker, mortgaged her home in Oklahoma City in 1924 and loaned the net proceeds of $2,037.38 to petitioner's brother, Paul W. Klefeker, and Ella S. Klefeker, Paul's wife, taking a promissory note dated February 24, 1925. This money was loaned to Paul and Ella to persuade them to come to Florida to join in the produce business which R. A. Klefeker and R. B. Klefeker had begun in a small way in Miami. Paul W. Klefeker came to Miami in October, 1925, and immediately thereafter purchased a one-half interest in the business of R. B. Klefeker by the contribution of equipment and cash to that business. The name of the business was then changed to Klefeker Bros. A new bank account was then opened in the name of Klefeker Bros. with money withdrawn from the R. B. Klefeker account. Petitioner's wife, in addition to the abovementioned funds, contributed limited services to the business during this period. In 1927 petitioner's wife, R. B. Klefeker, purchased the interest of Paul W. Klefeker and the assets of Klefeker Bros. by cancelling the note given to her in 1925 for the money theretofore loaned to him and by the transfer of some minor assets. After the withdrawal of Paul the assets1951 Tax Ct. Memo LEXIS 153">156 of the business were owned solely by R. B. Klefeker, petitioner's wife, and that business was thereafter operated in the name of "Klefeker Produce Company" until 1930. During that period petitioner and his wife both contributed services to the business. In March, 1930, R. B. Klefeker exchanged the assets of Klefeker Produce Company for all of the capital stock of Klefeker Produce, Inc., which stock was issued as follows: 48 sharesR. B. Klefeker (wife)1 shareR. A. Klefeker (petitioner)1 shareE. A. Klefeker (petitioner'sdaughter)Total50 sharesKlefeker Produce, Inc., was operated from 1930 to 1942, approximately 13 years with petitioner as president, R. B. Klefeker, vice president and secretary, and E. A. Klefeker, daughter of petitioner, as treasurer. During the life of the corporation petitioner was paid a salary ranging from $5,000 to $6,000. Only one dividend was paid by Klefeker Produce, Inc. This dividend was paid in 1932 in the amount of $10,000. R. B. Klefeker's part of this dividend was $9,600 and was reported by her in her income tax return for the calendar year 1932. R. B. Klefeker was actively engaged in rendering services1951 Tax Ct. Memo LEXIS 153">157 to the Klefeker Produce, Inc., during the entire life of the corporation. Klefeker Produce, Inc., was dissolved by operation of law on account of the nonpayment of Florida Capital Stock taxes on June 30, 1942, but the stockholders of that corporation did not learn of its dissolution until about November of that year. The business was operated through December, 1942, as though the corporate charter had not been revoked. Petitioner's wife, R. B. Klefeker, was the beneficial owner of all the corporate stock and with the dissolution of the corporation she became the owner of all the corporate assets. During that period petitioner and R. B. Klefeker discussed the formation of a partnership. From 1925 to 1942 petitioner's wife worked from four to five days a week in the produce business calling on local and out of town customers, going down to the warehouse, collecting difficult accounts, and attending to other details of the business. During September, October, and November, 1942, petitioner's wife loaned to the business approximately $3,000. In January, 1943, petitioner and his wife, R. B. Klefeker, entered into an oral partnership agreement. Under this agreement petitioner's wife1951 Tax Ct. Memo LEXIS 153">158 contributed the net assets of the Klefeker Produce, Inc., that were hers by virtue of the dissolution of that corporation and the petitioner agreed to supervise and manage the business, giving his entire time thereto. It was agreed that he and his wife would be equal partners. Petitioner and his wife each filed during 1943 estimated income tax declarations for the year 1943, each declaring on the basis of one-half of the estimated profits of the business. Payments under these declarations accompanied the declarations and were made by checks drawn on the business and those checks were charged to petitioner and R. B. Klefeker as withdrawals. The partnership information return was filed for the calendar years 1943 and 1944 by the Klefeker Produce Company. Individual income tax returns for the petitioner and his wife were filed wherein each reported the distribution of equal shares of the earnings from the Klefeker Produce Company and they paid the tax reported on those returns. No partnership books, including capital accounts, were set up for the partnership until January or February, 1944. Respondent determined that petitioner was the sole owner of the Klefeker Produce Company1951 Tax Ct. Memo LEXIS 153">*159 and taxed him on all the net income from the business. Opinion ARUNDELL, Judge: From the findings of fact it is clear that petitioner's wife furnished the capital under which the partnership operated and, in fact, she was the one who furnished the capital when the business was started in a small way back in 1925. During most of the life of the business petitioner's wife, R. B. Klefeker, also rendered important services to the business, although after a heart attack in 1943 she was able to render little in the way of services. The findings that have been made in this case are in substantial agreement with findings proposed by the respondent. These facts lead to only one conclusion and that is that a genuine and real partnership existed between petitioner and his wife during the taxable years, and it follows that respondent erred in taxing the entire income of the business to petitioner. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623339/	MICHAEL ANTHONY AND CYNTHIA M. CHIPLE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentChiple v. CommissionerDocket No. 37309-84.United States Tax CourtT.C. Memo 1986-114; 1986 Tax Ct. Memo LEXIS 491; 51 T.C.M. 671; T.C.M. (RIA) 86114; March 24, 1986. Michael A. and Cynthia M. Chiple, pro se. Steven M. Walk, for the respondent. WILLIAMSMEMORANDUM OPINION WILLIAMS, Judge: This case is before the Court on respondent's motion for summary judgment pursuant to Rule 121. 1 There are no genuine issues of material fact and summary judgment is appropriate. The Commissioner determined a deficiency in petitioners' Federal income taxes for the taxable year 1981 of $2,924.42. The sole issue which we must determine is whether equipment purchased and installed by petitioners qualifies for a residential energy income tax credit as geothermal1986 Tax Ct. Memo LEXIS 491">492 renewable energy source property. The facts of this case have been fully stipulated pursuant to Rule 122 and are so found. Petitioners resided in Wadsworth, Ohio at the time their petition was filed. Petitioners installed a Thermal Energy Trnasfer Corporation (TETCO) "Geothermal Ground-Water Heat Extractor" in their principal residence, in the United States, in 1981. Petitioners' equipment used as its energy source underground water which had a relatively constant year round temperature of 11.1 degrees Celsius. Petitioner reported $7,311.06 as geothermal renewable energy source costs on their joint income tax return for which they claimed an income tax credit of $2,924.42 pursuant to section 44C. 21986 Tax Ct. Memo LEXIS 491">493 The sole point of controversy in this case concerns the validity of the temperature limitation of section 1.44C-2(h), Income Tax Regs. This section of respondent's regulations defines "geothermal deposit," for purposes of section 44C(c)(5)(A)(i), as a geothermal reservoir which has a temperature exceeding 50 degrees Celsius measured at the wellhead. Section 1.44C-2(h), Income Tax Regs. Petitioners contest the validity of this regulation, arguing that it is arbitrary and inconsistent with Congressional intent. This Court recently considered and upheld the validity of this regulation in Peach v. Commissioner,84 T.C. 1312">84 T.C. 1312 (1985), on facts indistinguishable from those of the present case. 3 We find that our holding in Peach squarely applies to this case, and on this basis we hold that petitioners' equipment fails to qualify as geothermal renewable energy source property within the meaning of section 44C(c)(5). Petitioners' claim for a residential energy income tax credit based on their purchase and installation of the TETCO "Geothermal Ground-Water Heat Extractor" was thus properly disallowed by respondent. 41986 Tax Ct. Memo LEXIS 491">494 Petitioners claim in the alternative that their equipment qualifies as a "Geosolar System, employing solar pond collection system." The stipulation of facts, however, declares that petitioners' equipment uses underground water as its energy source. Section 1.44C-2(f), Income Tax Regs., defining solar energy property, specifically excludes heated underground water from the scope of its definition. On this basis we hold that petitioners' equipment does not qualify as solar energy property within the meaning of section 44C(c)(5). To reflect the foregoing, Decision will be enetered for the respondent.Footnotes1. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year here in issue. Section 44C provided: SEC. 44C. RESIDENTIAL ENERGY CREDIT. (a) General Rule.--In the case of an individual, there shall be allowed as a credit against the tax imposed by this chapter for the taxable year an amount equal to the sum of-- (1) the qualified energy conservation expenditures, plus (2) the qualified renewable energy source expenditures. (b) Qualified Expenditures.--For purposes of subsection (a)-- * * (2) Renewable Energy Source.--In the case of any dwelling unit, the qualified renewable energy source expenditures are 40 percent of so much of the renewable energy source expenditures made by the taxpayer during the taxable year with respect to such unit as does not exceed $10,000.* * * (c) Definitions and Special Rules.--For purposes of this section--* * * (5) Renewable Energy Source Property.--The term "renewable energy source property" means property-- (A) which, when installed in connection with a dwelling, transmits or uses-- (i) solar energy, energy derived from the geothermal deposits (as defined in section 613(e)(3)), or any other form of renewable energy which the Secretary specifies by regulations, for the purpose of heating or cooling such dwelling or providing hot water or electricity for use within such dwelling, or (ii) wind energy for nonbusiness residential purposes, (B) the original use of which begins with the taxpayer, (C) which can reasonably be expected to remain in operation for at least 5 years, and (D) which meets the performance and quality standards (if any) which-- (i) have been prescribed by the Secretary by regulations, and (ii) are in effect at the time of the acquisition of the property. (6) Regulations.-- (A) Criteria; Certification Procedures.-- The Secretary shall be regulations-- (i) establish the criteria which are to be used in (I) prescribing performance and quality standards under paragraphs (3), (4), and (5), or (II) specifying any item under paragraph (4)(A)(viii) or any form of renewable energy source property. * * *↩3. See also Reddy v. Commissioner,T.C. Memo. 1984-395↩, affd. by Court Order No. 85-1074 (4th Cir. August 29, 1985).4. See also Bayless v. Commissioner,T.C. Memo. 1986-113↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623340/	PHYLLIS L. BABCOCK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBabcock v. CommissionerDocket No. 16424-83.United States Tax CourtT.C. Memo 1986-168; 1986 Tax Ct. Memo LEXIS 440; 51 T.C.M. 931; T.C.M. (RIA) 86168; April 24, 1986. Jay Richard Rosner, for the petitioner. Theodore L. Marasciulo, for the respondent. JACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined the following deficiencies in, and additions to, petitioner's Federal income tax: Additions to TaxYearDeficiencySec. 6651(a)(1)Sec. 6653(a)Sec. 6654 11975$127.00$0$0$019762,718.00381.27135.9045.8019772,689.00368.27134.4520.5619782,573.00257.12128.6520.5619794,935.05661.05246.7586.6719807,342.71964.74367.13190.7719814,167.00418.17208.35159.511986 Tax Ct. Memo LEXIS 440">441 Further, respondent filed a motion seeking damages pursuant to section 6673. After concession by respondent, the issues for decision are (1) whether petitioner has a valid constitutional basis to refuse to pay Federal income taxes because of a conflict between her religious beliefs and the use to which the Government applies tax proceeds, (2) whether petitioner is subject to the additions to tax (a) for failing to file returns, (b) for failing to pay tax due to negligence or intentional disregard of the rules and regulations, and (c) for failing to pay estimated tax for the years in issue, and (3) whether damages should be awarded to the United States under section 6673. FINDINGS OF FACT Petitioner resided in Philadelphia, Pennsylvania, at the time she filed her petition. During the years in issue, petitioner received compensation as a school teacher. She also received unemployment compensation in 1980. Petitioner has been an active member of the Religious Society of Friends (Quakers) since 1978, having been an "attender" since 1971. The underlying1986 Tax Ct. Memo LEXIS 440">442 tenets on which Quakerism is premised include pacifism. Petitioner's faith dictates that she not participate, directly or indirectly, in war or in "war making" activities, or in the acquisition of weapons; accordingly, she refused to pay income taxes which would be used by the Government to fund the military or military activities. Petitioner filed a blank Form 1040 on October 20, 1976, for the 1975 taxable year, and blank Forms 1040 on September 11, 1979, for the 1976, 1977 and 1978 taxable years to which was attached a letter outlining her position. 2 She filed no returns for the years 1979 through 1981. Petitioner determined that approximately one-half of her tax liability would be used by the Government to fund non-military programs; therefore, she authorized an amount equal to one-half of her tax liability to be withheld from her salary. She has actively supported1986 Tax Ct. Memo LEXIS 440">443 legislation which would accommodate her beliefs, such as the World Peace Tax Fund Bill. 3 That Bill would create a separate fund to receive and expend taxpayers' funds for non-military purposes. OPINION Petitioner argues that the First Amendment to the Constitution permits her to withhold tax payments otherwise due when the activities to which the proceeds are applied conflict with her religious convictions. Otherwise, she argues, to compel her to pay taxes to support such activities would interfere with the free exercise of her religion. In cases of this sort, taxpayers have taken different approaches in attempts to obtain the same result. In some cases, taxpayers have claimed a deduction or credit reflecting their distaste for war. Graves v. Commissioner,698 F.2d 1219">698 F.2d 1219 (6th Cir. 1982),1986 Tax Ct. Memo LEXIS 440">444 affg. without published opinion a Memorandum Opinion of this Court; Lull v. Commissioner,602 F.2d 1166">602 F.2d 1166 (4th Cir. 1979), affg. Memorandum Opinions of this Court; First v. Commissioner,547 F.2d 45">547 F.2d 45 (7th Cir. 1976), affg. a Memorandum Opinion of this Court; Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806 (1980); Anthony v. Commissioner,66 T.C. 367">66 T.C. 367 (1976). 4 In other cases, taxpayers have simply refused to pay that percentage of the tax which they deemed would have been used for military purposes. Russell v. Commissioner,60 T.C. 942">60 T.C. 942 (1973); Muste v. Commissioner,35 T.C. 913">35 T.C. 913 (1961). In these cases, as well as in others, we have unequivocally rejected the argument that requiring taxpayers to pay taxes which would be used to support activities contrary to their religious beliefs deprives them of their constitutional right to free exercise of religion. 1986 Tax Ct. Memo LEXIS 440">445 Petitioner argues that the standards set forth in United States v. Lee,455 U.S. 252">455 U.S. 252 (1982), mandates a re-examination of the judicial inquiry into resolving a conscientious objector's conflict between adherence to his religious and moral beliefs and compliance with his obligation under the Federal income tax law. In Lee, the Supreme Court addressed the question of whether the imposition of social security taxes was unconstitutional as to an Amish employer who objected on religious grounds to receipt of public insurance benefits and to payment of taxes to support public insurance funds. In holding that there was no such constitutionally required exemption, the Court analyzed the problem by applying the following three step inquiry: 1.whether the payment of social security taxes interferes with the Amish religious beliefs; and if so 2. whether the burden on such religious beliefs is essential to accomplish an overriding governmental interest; and if so 3. whether accommodating the Amish belief unduly interferes with fulfillment of the governmental interest. The Court accepted the Lees' argument that the payment of social security taxes interfered with1986 Tax Ct. Memo LEXIS 440">446 their religious beliefs; however, the Court recognized the "difficulty in attempting to accommodate religious beliefs in the area of taxation" because "'we are a cosmopolitan nation made up of people of almost every conceivable religious preference.'" The Court then stated, "[t]o maintain an organized society that guarantees religious freedom to a great variety of faiths requires that some religious practices yield to the common good." 455 U.S. 252">455 U.S. at 259. Finding that the broad public interest in maintaining the integrity of the social security system was of such a high order, the Court held that religious beliefs opposed to the payment of taxes to finance such system affords no basis to resist the tax. Petitioner argues that she is not seeking an exemption from tax, as were the Lees, but instead is asking to be allowed to pay her entire tax liability in a way that comports with her religious beliefs. Thus, she contends, the following statements made by Chief Justice Burger in Lee are not applicable in her situation: The obligation to pay the social security tax initially is not fundamentally different from the obligation to pay income taxes; the difference - 1986 Tax Ct. Memo LEXIS 440">447 in theory at least - is that the social security tax revenues are segregated for use only in furtherance of the statutory program. There is no principled way, however, for purposes of this case, to distinguish between general taxes and those imposed under the Social Security Act. If, for example, a religious adherent believes war is sin, and if a certain percentage of the federal budget can be identified as devoted to war-related activities, such individuals would have a similarly valid claim to be exempt from paying that percentage of the income tax. 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 * . [Citations omitted. 455 U.S. 252">455 U.S. at 260.] Petitioner argues that accommodating her religious beliefs by earmarking her tax payments for non-military expenditures would have no resultant harm to the tax system. By segregating her tax payments from the general funds so that none of her tax dollars go to finance military programs, petitioner contends, she may be included within the tax system and yet at the same time comply with her religious belief1986 Tax Ct. Memo LEXIS 440">448 not to support war. Petitioner's argument is based on the supposition that the mandatory payment of taxes, the proceeds of which might be used for military purposes, interferes with her free exercise of religious rights. That supposition is not correct. Objection on religious grounds to the manner in which the Government spends tax payments is not a basis upon which one can claim a constitutional right not to pay taxes. 35 T.C. 913">Muste v. Commissioner,supra;60 T.C. 942">Russell v. Commissioner,supra.In Autenrieth v. Cullen,418 F.2d 586">418 F.2d 586 (9th Cir. 1969), the Ninth Circuit stated: The Income Tax Act does not "aid one religion, aid all religions or prefer one religion over another." Nor does it punish anyone "for entertaining or professing religious beliefs or disbeliefs." [Citation omitted.] It taxes plaintiffs like all others, because they are citizens or residents who have taxable income. On matters religious, it is neutral. If every citizen could refuse to pay all or part of his taxes because he disapproved of the government's use of the money, on religious grounds, the ability of the government to function could be impaired or destroyed. 1986 Tax Ct. Memo LEXIS 440">449 * * There are few, if any, governmental activities to which some persons or groups might not object on religious grounds. [418 F.2d 586">418 F.2d at 588-589.] In Muste, we said: the Constitution does not relieve a pacifist or a conscientious objector of the duty to pay taxes, even though they may be used for war or for the preparation for defense. Indeed, article I, section 8 of the Constitution specifically provides that the Congress shall have the power to lay and collect taxes and provide for the common defense and general welfare of the United States and to provide for and maintain an Army and Havy. This article and the 16th amendment to the Constitution empower the Congress to lay and collect taxes on incomes from whatever source derived. 35 T.C. 913">35 T.C. 919. It is Congress, and not this Court, that can give refuge to petitioner. The relief which petitioner seeks is contained in the proposed United States Peace Tax Fund Act. Accordingly, we hold that the conflict between petitioner's religious beliefs and the use to which the Government applies tax proceeds is not a proper basis on which petitioner may refuse to pay Federal income taxes. Further, 1986 Tax Ct. Memo LEXIS 440">450 we hold that petitioner is liable for the additions to tax under sections 6651(a)(1), 6653(a), and 6654. Section 6651(a)(1) imposes an addition to tax for failure to file a return on the date prescribed therefor unless it is shown that such failure is due to reasonable cause and not due to willful neglect. Petitioner filed blank Forms 1040 for 1975, 1976, 1977, and 1978. These do not qualify as tax returns. Beard v. Commissioner,82 T.C. 766">82 T.C. 766 (1984), on appeal (6th Cir. Sept. 24, 1984). Petitioner did not make even this effort for 1979, 1980, and 1981; she filed nothing for these years. The burden is on petitioner to show that this failure to file was due to reasonable cause and not willful neglect. She does not offer an argument to excuse her delinquency. The fact that petitioner sent a letter to respondent accompanying several of her blank Forms 1040 outlining her reasons for both not paying the tax due and not filing returns is adequate evidence on which to base a finding that she willfully neglected to file returns for all years in issue. See 35 T.C. 913">Muste v. Commissioner,supra.Petitioner also has the burden of proving that none of1986 Tax Ct. Memo LEXIS 440">451 the underpayment was due to negligence or intentional disregard of the rules or regulations or else suffer the addition to tax provided for by section 6653(a). Harper v. Commissioner,T.C. Memo. 1973-214, affd. without published opinion 505 F.2d 730">505 F.2d 730 (3d Cir. 1974). This she has failed to do. This is a situation where petitioner obviously knew of her legal obligation to pay income taxes yet believed she should not have to pay them. It is apparent to us that petitioner intentionally disregarded this obligation for each of the years in issue. See Doyle v. Commissioner,T.C. Memo. 1982-740, affd. without published opinion 742 F.2d 1433">742 F.2d 1433 (2d Cir. 1983); Hollingshead v. Commissioner,T.C. Memo. 1984-158. Section 6654 provides for an addition to tax where there has been an underpayment of estimated tax by an individual. The application of this addition to tax is absolute; there is no mental standard which need first be met. To the extent the minimum required installment of estimated tax exceeds the amount of tax deemed paid through withholding for each installment period (see section 6654(g)), petitioner is1986 Tax Ct. Memo LEXIS 440">*452 liable for the addition calculated on this amount. Respondent's determination is sustained. Finally, respondent has requested that he be awarded damages under section 6673. Upon due consideration, we do not think section 6673 damages should be awarded in this case. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩2. In a letter dated September 11, 1979, petitioner stated that she had no tax liability nor duty to file returns because "I believe that the government's forcing me to pay taxes, when these monies are to be used for war and war preparation, would be forcing me to act against my moral and religious principles."↩3. Since 1977, Senator Hatfield has introduced a bill (under the name World Peace Tax Fund Bill) to amend the Internal Revenue Code of 1954 to permit a taxpayer conscientiously opposed to war to have his income tax payments spent for non-military purposes. In 1985, Senator Hatfield's bill was introduced under the name U.S. Peace Tax Fund Bill. S.1468, 99th Cong., 1st Sess.; See 131 Cong.Rec. S9740-1 (daily ed. July 18, 1985).↩4. See also Hollingshead v. Commissioner,T.C. Memo 1984-158; Gruber v. Commissioner,T.C. Memo 1983-259; Doyle v. Commissioner,T.C. Memo 1982-740; Senesi v. Commissioner,T.C. Memo 1981-723↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623342/	Louis H. Lewis and Annette Lewis, et al. 1 v. Commissioner. Lewis v. CommissionerDocket Nos. 83732, 83733, 85162, 85749, 85750, 91963, 94018, 94019.United States Tax CourtT.C. Memo 1962-306; 1962 Tax Ct. Memo LEXIS 3; 21 T.C.M. 1647; T.C.M. (RIA) 62306; December 31, 1962William P. Rosenthal, Esq., 110 S. Dearborn St., Chicago, Ill., for the petitioners. Seymour I. Sherman, Esq., and Joseph T. deNicola, Esq., for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: In these consolidated cases respondent determined deficiencies in income taxes of the petitioners for the taxable years and in the amounts as follows: DocketTaxableNumberPetitionerYearDeficiency83732Louis H. Lewis and Annette Lewis1955$24,316.08195628,202.8783733Estate of Hyman Furst, Deceased, Louis H. Lewis,Executor195540,992.05195642,908.0385162Samuel Pearl and Mary Pearl195525,806.08195626,976.62195738,048.9885749Louis H. Lewis and Annette Lewis195755,511.5485750Estate of Hyman Furst, Deceased, Louis H. Lewis,Executor195788,514.9894018Louis H. Lewis and Annette Lewis195862,892.92195965,234.8594019Estate of Hyman Furst, Deceased, Louis H. Lewis,Executor195896,952.86195999,411.6691963Samuel Pearl and Mary Pearl195836,720.41195948,846.281962 Tax Ct. Memo LEXIS 3">5 The issues presented for decision are: (1) Whether petitioners are entitled to deductions as interest paid of amounts paid to Corporate Finance and Loan Corporation of Boston, Massachusetts, in 1955 and 1956. (2) If the claimed interest deductions are not allowable, whether petitioners should be allowed for 1956 and 1957 deductions for losses incurred in transactions entered into for profit or as losses incurred because of alleged fraud or misrepresentation, or, in the alternative deductions for long-term capital losses in amounts which represent the difference between the amounts received and the amounts paid out by each petitioner in the transactions. (3) Whether petitioners are entitled to deductions as premiums for borrowing bonds of amounts paid by them to M. Eli Livingstone in the taxable years 1957, 1958, and 1959. Findings of Fact Some of the facts have been stipulated and are found accordingly. Louis H. Lewis and Annette Lewis, husband and wife residing in Chicago, Illinois, filed a joint Federal income tax return on the cash basis for each of the calendar years 1955, 1956, 1957, 1958, and 1959 with the district director of internal revenue at Chicago, Illinois. 1962 Tax Ct. Memo LEXIS 3">6 Samuel Pearl and Mary Pearl, husband and wife residing in Chicago, Illinois, filed a joint Federal income tax return on the cash basis for each of the calendar years 1955, 1956, 1957, 1958, and 1959 with the district director of internal revenue at Chicago, Illinois. Louis H. Lewis is a duly appointed and authorized executor of the last will and testament of Hyman Furst, deceased. Hyman Furst filed his Federal income tax returns for the calendar years 1955, 1956, 1957, 1958, and 1959 on the cash basis with the district director of internal revenue at Chicago, Illinois. Annette Lewis and Mary Pearl did not actively participate in any of the transactions here involved. Louis H. Lewis (hereinafter referred to as Lewis) and Hyman Furst (hereinafter referred to as Furst) were partners in a collection agency known as "Furst and Furst," with offices in Chicago, Illinois. Samuel Pearl (hereinafter referred to as Pearl) is an attorney with offices in Chicago, Illinois. Lewis had known Pearl for approximately 8 years in 1955. Lewis, Furst, and Pearl reported adjusted gross income for Federal income tax purposes for the years and in the amounts as follows: YearLewisFurstPearl1955$ 78,270.13$ 80,568.00$ 97,745.601956106,140.34114,765.1487,886.171957117,217.42120,597.76114,247.30195882,708.9572,185.1991,255.491959101,338.9290,881.61107,132.971962 Tax Ct. Memo LEXIS 3">7 In 1955 Lewis visited Maxwell Abbell (hereinafter referred to as Abbell) for the purpose of having Abbell draw his will. Abbell discussed with Lewis the amount of his income and the portion thereof which he paid in tax and suggested that he could assist Lewis in making investments, including purchases of timber, Government securities, and certain stock, the income from which would be more favorably treated from a tax point of view. Abbell stated that he would have a gentleman call upon Lewis and shortly thereafter, Gerald G. Bolotin (hereinafter referred to as Bolotin) came to Lewis' office and Lewis learned that he had been referred to Bolotin by Abbell. Bolotin told Lewis of opportunities to buy securities which would be explained to Lewis in greater detail at subsequent meetings. Bolotin was a Chicago attorney who acted for M. Eli Livingstone in seeking to interest persons in Livingstone's plans. At all times material M. Eli Livingstone was a security dealer in Boston, Massachusetts, doing business in the form of a sole proprietorship under the name of Livingstone and Company. Both M. Eli Livingstone and Livingstone and Company will be referred to hereinafter as "Livingstone. 1962 Tax Ct. Memo LEXIS 3">8 " Livingstone developed and promoted a number of plans attractive to taxpayers with large incomes, an essential feature of which was the deduction for income tax purposes of amounts characterized as consideration for the borrowing of funds or securities. Bolotin received a fee or commission for each contact produced by him for Livingstone which resulted in a transaction. Lewis, Furst, and Pearl first became aware of the activities of Livingstone through Bolotin. After his first meeting with Bolotin, Lewis held other meetings with Bolotin and with Livingstone, or with both Bolotin and Livingstone. At one of these meetings Livingstone suggested to Lewis that Lewis purchase large amounts of Government securities. This same plan was suggested by Livingstone to Pearl and Furst. Lewis asked Livingstone to outline his plan in writing so that he could study the proposal in detail. A proposal in writing was subsequently submitted to Lewis by Livingstone. While Lewis was debating the advisability of proceeding with the plan, he received a copy of a legal opinion addressed to Bolotin from a Chicago law firm. After reading the proposal, Lewis contacted Arthur Wasserman, an attorney in1962 Tax Ct. Memo LEXIS 3">9 Boston, Massachusetts, who was a friend of Lewis and asked for information about Livingstone. Wasserman stated that he knew Livingstone and told Lewis that Livingstone had been in the securities and investment business for some time, that he had been successful in that business, that he had a home that was worth about $250,000, and was quite wealthy. Lewis then discussed Livingstone's proposal and the legal opinion addressed to Bolotin with a certified public accountant in Chicago. Lewis regarded this accountant as a tax expert. The accountant examined the proposal and cautioned Lewis that if he entered the transaction, he should be certain to receive the serial numbers of the bonds, and should refuse to enter the transaction without such assurance. By letter dated November 18, 1955, Livingstone informed Lewis that he felt very strongly that the turning point in the bond market was at hand. He stated further that, historically, there is a premium for the "rollover" privilege on bonds which are held by an investor. Livingstone explained that "rollover" means the right to exchange the expiring or maturing issue for a new one which replaces it. Livingstone urged Lewis to buy United1962 Tax Ct. Memo LEXIS 3">10 States Treasury 2 7/8 percent notes because of the favorable condition and the generous yield that they offered. He stated also that the future prospect is a very substantial capital appreciation owing to the rollover privilege. Upon the basis of the information and advice he had received, Lewis decided to enter into the transactions proposed by Livingstone. His reasons for making this decision were that his income tax bracket enabled him to make good use of a deduction for interest which would not otherwise be available, the bonds purchased might acquire additional value if the Government would permit them to be exchanged on maturity for bonds of a higher interest rate, he was given an option to sell the bonds which limited his losses if the bonds declined in value, and there was the possibility of a rise in value of the bonds which might result in an economic gain to him. Lewis also considered the fact that any gain on the sale of the bonds would be taxable as a capital gain. Louis would not have entered into the transaction under the plan submitted to him by Livingstone except for the anticipated tax benefit to be derived therefrom. Petitioners Furst and Pearl relied upon Lewis' 1962 Tax Ct. Memo LEXIS 3">11 investigation of Livingstone's proposals. They felt that Lewis was methodical and would explore a business proposal carefully. They also decided on November 25, 1955, to enter into the transactions proposed by Livingstone. Their decision was based largely upon Lewis' conclusion as to the advisability of entering into the transactions and their primary purpose in entering the transactions was also to reduce their Federal income taxes. Pearl also relied on the legal opinion of the Chicago law firm issued to Bolotin. On or about November 22, 1955, Lewis directed Livingstone to purchase for his account $1,000,000 face value United States Treasury 2 7/8 percent notes due March 15, 1957, with interest coupons due March 15, 1956, and September 15, 1956, detached. A letter dated November 22, 1955, sent to Lewis by Livingstone stated, in part, as follows: We have this day sold to you: $1,000,000 U.S. Treasury 2 7/8% Notes due March 15, 1957, with 3/15/56 and 9/15/56 coupons detached For $1.00 and other valuable consideration, receipt of which is hereby acknowledged, we hereby grant you an irrevocable option to sell these notes to us on September 15, 1956, at a price of 100 3/4. 1962 Tax Ct. Memo LEXIS 3">12 It is intended that the above identified notes shall be used in exercising this option, and the option, if exercised, shall be exercised through the sale by you or your assigns to us of the above identified notes. Livingstone made no charge for the option to sell or "put" the Treasury notes. Enclosed in a letter from Livingstone to Lewis dated November 22, 1955, were a confirmation slip showing a purchase by Lewis of $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957, with interest coupons due March 15, 1956, and September 15, 1956, detached at a price of 97 1/2 or a total price in the amount of $975,000, a note for Lewis' signature, letters of instruction for Lewis' signature, and the letter dated November 22, 1955, a part of which has been quoted heretofore. Also enclosed were copies of the papers for Lewis' signature for his file and Livingstone's check in the amount of $32,500 as an advance. This amount was paid to Lewis as security for the option granted to him to sell the notes to Linvingstone at a price in excess of par at maturity. Lewis did not sign a notice for this amount and it was not accounted for until the close of the transaction in 1956 when1962 Tax Ct. Memo LEXIS 3">13 it was charged to Lewis' account. Livingstone's check for $32,500 was deposited in Lewis' regular account and was not set aside in a special fund or placed in escrow. No commission was charged by Livingstone for the transaction stated to be a sale to Lewis of the $1,000,000 United States Treasury 2 7/8 percent notes. The lack of a charge for commission is customary where a broker sells Government notes as principal, and for his own account. The confirmation slip indicated that this transaction was one in which Livingstone acted as principal in the sale of the bonds. Lewis was requested to sign the note and letter of instruction and return them to Livingstone's office, together with his check in the amount of $40,218.75 made payable to Corporate Finance and Loan Corp. (hereinafter referred to as CF&L), which amount was stated to represent Lewis' prepayment of interest. By means of the prepared letters furnished him by Livingstone, Lewis directed Livingstone to deliver the notes against payment of $975,000 to CF&L and directed CF&L to pay this amount and receive the notes from Livingstone. Lewis executed an instrument dated November 22, 1955, in the form of a one-year promissory1962 Tax Ct. Memo LEXIS 3">14 note in favor of CF&L in the amount of $975,000, with interest at 4 1/8 percent per annum through November 22, 1956, in the amount of $40,218.75 having been prepaid by Lewis. The note recited that Lewis had deposited with CF&L as collateral $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957, with March 15, 1956, and September 15, 1956, coupons detached. The note contained no provision for the reimbursement of interest in any amount to Lewis by CF&L if the principal amount were paid previous to the due date recited therein. This note contained a provision that it should be construed and interpreted in accordance with the laws of the State of Illinois, and also contained the following provisions: The undersigned gives to the obligee a lien against the securities pledged for the amount of the obligation set forth herein and gives to the obligee the right to hypothecate and use the securities pledged for any purpose while so pledged. Said right is not to be inconsistent in any manner with the ownership by the undersigned of the said collateral, and with the right of the undersigned to obtain the return of the collateral at any time upon tender of payment of the1962 Tax Ct. Memo LEXIS 3">15 amount due hereunder. The transactions were recorded on the the books of CF&L by entries showing a debit to the account entitled "Notes Receivable, Clients" and a credit entry to the account entitled "Loans Receivable [Livingstone] & Co." in the amount of $975,000. Livingstone placed an order with Salomon Brothers and Hutzler (hereinafter called Salomon), dealers in Government securities, designated as and for the account of Lewis, directing the delivery of $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957, to the Chemical Corn Exchange Bank of New York (hereinafter referred to as Chemical Bank) against payment. The Chemical Bank was instructed by Livingstone to receive the foregoing notes from Salomon against payment. Livingstone placed an order with Salomon directing the sale for the account of CF&L, and the receipt of $1,000,000 United States Treasury 2 7/8 percent notes, due March 15, 1957, from Chemical Bank against payment. Livingstone instructed Chemical Bank to deliver the foregoing notes to Salomon covering both transactions, and Salomon issued confirmation slips to Livingstone covering both transactions. Livingstone paid Salomon the differential1962 Tax Ct. Memo LEXIS 3">16 between the purchase and sale prices. Chemical Bank credited and debited Livingstone's account in the amounts of the sale price and purchase price, respectively, of the foregoing securities, and issued a credit advice and a debit advice accordingly. It ultimately received a clearing fee for its services. The notes in question never left the office of Salomon, and neither Lewis, Livingstone, nor CF&L ever acquired actual physical possession thereof. It is common practice among security dealers to "pair off" orders to buy and orders to sell the same security, and to dispense with physical delivery except as to any net excess of purchases or sales. The confirmation slip sent to Salomon in response to Livingstone's order to deliver mentioned Lewis by name only because of Livingstone's request. This was not normally done in the usual course of Salomon's business. Lewis issued a check dated December 1, 1955, in favor of CF&L in the amount of $40,218.75. A document designated as an interest statement of CF&L dated November 22, 1955, was sent to Lewis with the following notation thereon: "Interest on loan of $975,000.00 (a) 4 1/8% for one year from 11/22/55 through 11/22/56 - $40,218.75." 1962 Tax Ct. Memo LEXIS 3">17 By letter dated December 7, 1955, CF&L advised Lewis that it had received from Livingstone for Lewis $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957, with March 15, 1956, and September 15, 1956, coupons detached, bearing certain bond sic numbers [presumably note numbers], which it purported to set forth therein. CF&L is a corporation which was organized in 1954 under Massachusetts law with $1,000 of contributed capital. Thereafter, no further capital contributions were made. Harry W. Cushing, a friend and former law associate of Livingstone, was at all times material hereto, an attorney in Boston, Massachusetts. Cushing's law office and the office of CF&L were located at all times here material, in the same premises at 70 State Street in Boston. During the period here in issue, Cushing was the president and treasurer and one of the shareholders of CF&L. All other shareholders were friends, relatives or clients of Cushing. Cushing and one of his children, who served as clerk at the directors' meetings, held three or four times each year, were the corporation's only employees. For the fiscal year ending March 11, 1956, they received salaries of $15,8821962 Tax Ct. Memo LEXIS 3">18 and $3,975, respectively, from the corporation. The tangible assets of CF&L consisted of client folders, books and records, a supply of letterhead stationery and promissory notes executed in its favor by clients. The correspondence of CF&L was typed and prepared on its letterhead stationery by Livingstone's office, for which service CF&L paid Livingstone. Cushing's principal activities as the president and treasurer of CF&L were to receive and deposit payments from clients and pay out corporate funds. Substantially all the business of CF&L was received on reference from Livingstone. CF&L never sought or received a credit on any person with whom it did business. CF&L maintained its books and records on the basis of a fiscal year ending March 31. For its fiscal years 1955 and 1956 it filed "Certificates of Condition" with the Secretary of State of the Commonwealth of Massachusetts, showing the following assets and liabilities: Fiscal Year EndedFiscal Year EndedMarch 31, 1955March 31, 1956AssetsCash$ 7,504.07$ 2,783.06Accounts Receivable Customers65,950,323.55280,430,957.38Prepaid Insurance, Interest Taxes45.9937.47Total Assets$65,957,873.61$280,433,777.91LiabilitiesAcounts Payable$57,249,044.32$270,812,038.97Accrued Bond Expense472,085.944,001,327.50Deferred Interest2,922,092.956,613,528.32Bonds Borrowed6,240,000.00Payroll Taxes Withheld195.00Capital Stock, without part1,000.001,000.00Surplus(926,349.60)(994,311.88)Total Liabilities$65,957,873.61$280,433,777.911962 Tax Ct. Memo LEXIS 3">19 At the end of each fiscal year, Livingstone and Cushing decided the amounts to be paid to Livingstone by CF&L for the transactions which had taken place. Livingstone sent a letter to Lewis dated September 5, 1956 enclosing the necessary documents to close out Lewis' transaction involving the $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957. Livingstone requested Lewis to sign the enclosed instruction letters as indicated to release the notes from Lewis' account and return the papers to Livingstone's office. Livingstone stated further that on September 15, 1956, he would confirm purchase of these securities from Lewis, discharge his loan, and have his "paid and cancelled" note returned to him. Also enclosed was a statement prepared as of September 15, 1956 reflecting the status of Lewis' account. The latter indicated at the bottom of the page that a carbon copy was being sent to Maxwell Abbell. A confirmation slip dated September 15, 1956, was sent by Livingstone to Lewis, stating that Livingstone, as principal and for their own account, bought of Lewis $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957 at 100 3/4. The confirmation1962 Tax Ct. Memo LEXIS 3">20 slip does not show any commission charged. Pursuant to Livingstone's instruction, by letter dated September 15, 1956, Lewis directed CF&L to deliver from his account to Livingstone $1,000,000 United States Treasury 2 7/8 percent notes due March 15, 1957 against a payment by Livingstone of $975,000. He also directed CF&L to use the proceeds to discharge his outstanding loan. Livingstone issued a ledger statement or statement of account to Lewis dated September 15, 1956, indicating the following: Sold orDateDeliveredDescriptionPriceDebitCreditBalance9/15/561000MU.S. Treasury100 3/4$1,007,500.002 7/8 percentNotes dueMarch 15, 1957Paid to the$975,000.00CorporateFinance LoanCorp. foryour accountPaid to you32,500.00Balance$0.00Thereupon CF&L made entries in its books indicative of payment of the amount of $975,000 shown thereon as due to it from Lewis and sent to Lewis, marked as paid, the instrument date November 22, 1955, in the form of the 1 year promissory note to CF&L signed by Lewis. The net out-of-pocket expense to Lewis resulting from the1962 Tax Ct. Memo LEXIS 3">21 foregoing transactions of November 22, 1955 and September 15, 1956, was in the amount of $7,718.75, the difference between the amount paid out designated as interest of $40,218.75 and the amount received from Livingstone as security for the put in the amount of $32,500 and subsequently credited to Lewis' account. Furst and Pearl entered into transactions at about the same time as Lewis identical in all material respects with those described herein with respect to Lewis, except that in the case of Furst, the face amount of the securities involved was $1,400,000; the amount designated as the purchase price and as the loan from CF&L was $1,365,000; the amount designated as interest paid to CF&L was $56,306.25; the advance by Livingstone was $45,500 and net-of-the-pocket expense was in the amount of $10,806.25. On or about March 22, 1956, Lewis, Furst and Pearl each entered into another transaction planned by Livingstone. On or about March 22, 1956, Lewis directed Livingstone to purchase for his account $1,000,000 face-value United States Treasury 2 7/8 percent notes due June 15, 1958, with interest coupons due June 15, 1956 and December 15, 1956 detached. Under date of March 22, 1956, Livingstone1962 Tax Ct. Memo LEXIS 3">22 delivered a letter to Lewis which stated, in part, as follows: We have this day sold to you: $1,000,000 U.S. Treasury 2 7/8% Notes due June 15, 1958 with 6/15/56 and 12/15/56 coupons detached. For $1.00 and other valuable consideration, receipt of which is hereby acknowledged, we hereby grant you an irrevocable option to sell these notes to us at any time from December 15, 1956, through June 15, 1957, at a price of 101. It is intended that the above identified notes shall be used in exercising this option, and the option, if exercised, shall be exercised through the sale by you or your assigns to us of the above identified notes. Livingstone made no charge for the option to sell or "put" the above-mentioned Treasury notes. On or about March 22, 1956, Livingstone advanced Lewis the amount of $36,250 by check as security for the option granted to Lewis to sell the notes to Livingstone at a price in excess of par at maturity. Livingstone sent Lewis a confirmation slip dated March 22, 1956, stating that as principal and for their own account they had sold to Lewis $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958, with June 15, 1956 and December 15, 1956 coupons1962 Tax Ct. Memo LEXIS 3">23 detached at a price of 97 3/8 or a total price in the amount of $973,750. No commission was charged for this transaction. Lewis directed Livingstone to deliver the notes against payment of $973,750 to CF&L and directed CF&L to pay this amount and to receive these notes from Livingstone. Lewis executed an instrument dated March 22, 1956 in the form of a promissory note due August 20, 1957, in favor of CF&L in the amount of $973,750 "with interest at the rate of 4 1/4% per annum, through August 20, 1957, in the amount of $58,397.93, of which $44,022.93" was recited as having been paid, and the coupons maturing on June 15, 1957, having a value of $14,375 were assigned to CF&L. The instrument stated further that the obligation of Lewis to prepay interest was limited to $44,022.93, that Lewis would not be obligated to make any payment of the assigned interest coupons, and that Lewis deposited as collateral with CF&L $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958, with June 15, 1956 and December 15, 1956 coupons detached. The note contained no provision for the reimbursement of interest in any amount to Lewis by CF&L if the principal amount were paid previous1962 Tax Ct. Memo LEXIS 3">24 to the due date recited therein. It contained a provision that it should "be construed and interpreted in accordance with the laws of the State of Illinois," and also contained the following provision: The undersigned gives to the obligee a lien against the securities pledged for the amount of the obligation set forth herein and gives to the obligee the right to hypothecate and use the securities pledged for any purpose while so pledged. Said right is not to be inconsistent in any manner with the ownership by the undersigned of the said collateral and with the right to the undersigned to obtain the return of the collateral at any time upon tender of payment of the amount due hereunder. The undersigned shall not be called upon to furnish additional collateral during the term of this Note. CF&L made a debit entry on its books in the amount of $973,750 to the account entitled "Notes Receivable, Clients" and a credit entry in the same amount to the account entitled "Loans Receivable, Livingstone & Company." Livingstone placed an order with Salomon designated as for the account of Lewis directing the delivery of $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958 to1962 Tax Ct. Memo LEXIS 3">25 the Chemical Bank against payment. Livingstone instructed the Chemical Bank to receive the foregoing notes from Salomon against payment. Livingstone placed an order with Salomon directing the sale for the account of CF&L and the receipt of $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958 from the Chemical Bank against payment. Livingstone instructed the Chemical Bank to deliver the foregoing notes to Salomon against payment. Livingstone issued confirmation slips to Salomon covering both transactions, and Salomon issued confirmation slips to Livingstone covering both transactions. Livingstone paid Salomon the difference between the purchase and the sales price. The Chemical Bank credited and debited Livingstone's account in the amounts of the sale price and purchase price, respectively, of these securities, and issued a credit advice and a debit advice accordingly. It ultimately received a clearing fee for its services. The notes never left the office of Salomon, and neither Lewis, Livingstone, nor CF&L ever acquired actual physical possession thereof. It is common practice among security dealers to "pair off" orders to buy and orders to sell the same1962 Tax Ct. Memo LEXIS 3">26 security, and to dispense with physical delivery, except as to any net excess of purchases or sales. The confirmation slips sent to Salomon in response to Livingstone's order to deliver mentioned Lewis by name only because of Livingstone's request. This was not normally done in the usual course of Salomon's business. On May 15, 1956, Lewis issued a check to CF&L in the amount of $44,022.93. CF&L in a letter to Lewis dated June 14, 1956 set forth the serial numbers of the $1,000,000 United States Treasury 2 7/8 percent notes of June 15, 1958, with June 15, 1956 and December 15, 1956, coupons detached which were stated in this letter to have been received by CF&L from Livingstone for Lewis' account. On March 4, 1957, Lewis advised Livingstone that he wished to exercise the option granted to him on March 22, 1956, on the following day. A confirmation slip dated March 5, 1957 was sent to Lewis by Livingstone stating that Livingstone as principal and for their own account bought $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958, at 101, plus $6,318.68 interest, making a total of $1,016,318.68. The confirmation slip does not show any commission charged. 1962 Tax Ct. Memo LEXIS 3">27 By letter dated March 5, 1957, Lewis directed CF&L to deliver from his account to Livingstone $1,000,000 United States Treasury 2 7/8 percent notes due June 15, 1958, against payment from Livingstone of $980,068.68. Lewis further requested that these proceeds be used to discharge his obligation to CF&L in the amount of $973,750 plus interest due of $6,318.68. By letter of the same date Lewis directed Livingstone to receive from his account at CF&L these Treasury notes against payment to them of $980,068.68. A ledger statement or statement of account from Livingstone to Lewis dated March 5, 1957, reflects the following: Sold orDatedeliveredDescriptionPriceDebitCreditBalanceMarch 5,$1,000,000U.S.101$1,016,318.681957Treasury2 7/8percentnotes dueJune15, 1958Cash$980,068.68Balance$36,250.00(checkenclosed)CF&L sent Lewis a statement of the account of Lewiswith CF&L dated March 5, 1957, whichshowed the following: Note dated March 22, 1956$973,750.00Interest due to cover period December 15, 1956through March 5, 19576,318.68Total$980,068.681962 Tax Ct. Memo LEXIS 3">28 RECEIVED PAYMENT March 5, 1957 (Signed) Harry N. Cushing CF&L made entries in its books showing a payment in the amount of $973,750 to it by Lewis and sent to Lewis marked as paid, the instrument dated March 22, 1956, in the form of a promissory note to CF&L signed by Lewis. The net out-of-pocket expense to Lewis resulting from these transactions was in the amount of $7,772.93, which amount represents the difference between the amount paid by Lewis to CF&L less the amount of $36,250 received by Lewis from Livingstone. Furst and Pearl entered into transactions at or about the same time as Lewis identical in all material respects with those which Lewis entered into, except that in the case of Furst, the face amount of the securities involved was $1,250,000; the amount designated as the purchase price and as the loan from CF&L was $1,217,187.50; the amount designated as interest paid to CF&L was $55,028.66; the advance by Livingstone was in the amount of $45,312.50; and the net out-of-pocket expense was in the amount of $9,716.16. Livingstone sent Lewis a letter dated January 4, 1957, outlining a proposal for the short sale of United States Treasury bonds and the purchase1962 Tax Ct. Memo LEXIS 3">29 of United States Treasury notes and enclosing a memorandum indicating the tax consequences of the plan to an individual filing a joint income tax return whose top income tax bracket was 90 percent. The memorandum indicated a net after tax profit in the amount of $35,094.53 to such an individual on a combination short sale of $1,000,000 United States Treasury 2 3/4 percent bonds and a purchase of $1,000,000 United States Treasury 1 1/2 percent notes. In a letter to Lewis dated May 6, 1957, Livingstone agreed to defend, at his own expense, any litigation which might arise in connection with any challenge by the Treasury Department with regard to any phase of the transaction involving the combination short sale of the United States Treasury bonds and the purchase of United States Treasury notes. In a second letter to Lewis dated May 6, 1957, Livingstone stated that he was clarifying and amplifying the transaction for the sale by Lewis of United States Treasury 2 3/4 percent bonds and purchase of United States Treasury notes. This letter further stated: 1. It is our understanding that the 1 1/2% Notes are owned by you, and that in the event that you return to us the 2 3/4% Bonds at1962 Tax Ct. Memo LEXIS 3">30 any time, we are obligated to return to you or your order the 1 1/2% Notes and any cash collateral remaining to your credit. 2. It is our further understanding that we have agreed to accept the 1 1/2% Notes and the cash deposited by you, as sufficient collateral, with the full realization that this cash deposit will be utilized for the payment of future coupon expense, and with the understanding that we are not to have the right to call for additional collateral at any time. On or about May 7, 1957, Lewis instructed Livingstone to sell short for his account $3,000,000 United States Treasury 2 3/4 percent bonds due September 15, 1961, and to sell to him $3,000,000 United States Treasury 1 1/2 percent notes due October 1, 1961. By letter dated May 6, 1957, Lewis directed Livingstone Securities Corporation to deliver to Salomon for his account $3,000,000 United States Treasury 2 3/4 percent bonds due September 15, 1961, against payment from Salomon of $2,922,105.98. By letter of the same date Lewis directed Salomon to receive from Livingstone Securities Corporation these securities against payment. Livingstone placed an order with Salomon, designated as for the account of Lewis, 1962 Tax Ct. Memo LEXIS 3">31 for the sale to Salomon of $3,000,000 United States Treasury 2 3/4 percent bonds due September 15, 1961. A confirmation slip dated May 7, 1957, from Salomon to Lewis indicated that Salomon, as principal, purchased from Lewis $3,000,000 United States Treasury 2 3/4 percent bonds at 97. The principal amount came to $2,910,000 and the accrued interest was $12,105.98, making a total of $2,922,105.98. At the bottom of the slip the following appeared: Del'y Terms 5/8/57 IN NY (a) CHILDS A confirmation slip showing a contract date of May 6, 1957, from Livingstone to Lewis indicated that Livingstone, acting as agent for another, sold to Lewis $3,000,000 United States Treasury 1 1/2 percent notes of October 1, 1961, at 91 5/8. The principal amount was $2,748,750 and interest $4,549.18, making a total of $2,753,299.18. No commission was charged. Simultaneously, Livingstone Securities Corporation, an entity controlled by Livingstone, placed an order with C. S. Childs & Co. (hereinafter called Childs) dealers in Government securities, for the purchase by it from Childs of $3,000,000 United States Treasury 2 3/4 percent bonds due September 15, 1961, and their delivery against payment to1962 Tax Ct. Memo LEXIS 3">32 Salomon for the account of Lewis. Livingstone instructed Salomon in a letter dated May 7, 1957, to receive from Childs the $3,000,000 United States Treasury 2 3/4 percent bonds against payment to Childs of $2,922,105.98. By a letter to Livingstone dated May 8, 1957, Lewis acknowledged receipt of the same United States Treasury 2 3/4 percent bonds which had been purchased from Childs and simultaneously sold to Salomon. Lewis agreed that in return for the "loan" of these securities he would deposit with LivingstoneUnited States Treasury 1 1/2 percent notes in the face amount of $3,000,000. Lewis further agreed that he would deposit with Livingstone cash in the amount of $168,806.80 to be applied together with coupons earned on the United States Treasury 1 1/2 percent notes to reimburse Livingstone for coupons due Livingstone on the securities "borrowed" by Lewis. The amount of $168,806.80 represents the excess of the amount realized on the sale of the 2 3/4 percent notes and on the amount paid for the 1 1/2 percent notes. Any balance remaining in Lewis' favor on September 15, 1961, was to be accounted for by Livingstone. Lewis further agreed to pay Livingstone for the "loan" of1962 Tax Ct. Memo LEXIS 3">33 the United States Treasury 2 3/4 bonds a premium in the amount of $33,750 of which $8,437.50 was stated to be paid in advance, and a balance of $25,312.50 was to be paid in equal installments on or before August 1, 1957, October 1, 1957, and December 1, 1957. By letter dated May 8, 1957, Livingstone acknowledged receipt from Lewis of $3,000,000 United States Treasury notes of October 1, 1961, and $168,806.80 in cash. The letter further stated: The cash deposit in the amount of $168,806.80 together with coupons earned by you on the securities, is to be deposited with us as security to reimburse us for coupons on the securities loaned to you. We agree that neither we nor any of our agents will call for the return of the securities loaned to you until September 15, 1961, and that neither we nor any of our agents will call upon you for any additional collateral during the term of this contract, and that you shall not be liable for the return of these securities unless the securities deposited by you shall be returned simultaneously. In consideration, we are to receive the sum of $33,750.00 as premium for the loan of securities to cover your short position, of which $8,437.50 is1962 Tax Ct. Memo LEXIS 3">34 payable in advance, and the balance of $25,312.50 is to be paid as follows: $8,437.50 on or before August 1, 1957 $8,437.50 on or before October 1, 1957 $8,437.50 on or before December 1, 1957 The ledger sheet of Lewis' account with Salomon as of May 9, 1957, reflects the following: Bought orSold orDatereceiveddeliveredDescriptionPriceMay 8, 1957$3,000,000U.S. Treasury972 3/4 percentnotes dueSept. 15, 1961May 9, 1957$3,000,000U.S. TreasuryRCD2 3/4 percentnotes dueSeptember 15,1961DateDebitCreditBalanceMay 8, 1957$2,922,105.98$2,922,105.98 CRMay 9, 1957$2,922,105.98.00 By letter dated May 21, 1957, Livingstone Securities Corporation informed Lewis that, in connection with their confirmation to Lewis of the $3,000,000 United States Treasury 1 1/2 percent notes of October 1, 1961, and their delivery for Lewis' account of $3,000,000 United States Treasury 2 3/4 percent bonds of September 15, 1961, Livingstone Securities Corporation had acted solely as the agent of Livingstone and that Lewis had no responsibility to Livingstone1962 Tax Ct. Memo LEXIS 3">35 Securities Corporation whatsoever. The letter stated further that the corporation had not loaned Lewis any securities nor was it holding any securities belonging to Lewis; that his contract was with Livingstone and Company and that his sole responsibility was to that separate corporation. In letters dated in June and July 1957, from Livingstone to Lewis numbers for 2 3/4 percent bonds and 1 1/2 percent bonds stated to have been loaned to Lewis and held for Lewis were listed. During 1957 Lewis issued four checks to Livingstone, each in the amount of $8,437.50. By letter dated January 15, 1958, Livingstone issued the following statement of account to Lewis: For your 1957 Income Tax purposes, we submit the following: On the $3,000,000 U.S. Treasury 2 3/4% Bonds of 9/15/61, borrowed from us on May 8, 1957, we debited your account with the following expense: 9/15/57 Coupons$41,250.00Less Accrued Interest12,105.98Net Expense$29,144.02 On the $3,000,000 U.S. Treasury 1 1/2% Notes of October 1, 1961, being held as collateral by us, you had the following income: 10/1/57 Coupons$22,500.00Less Accrued Interest4,549.18Net Income$17,950.821962 Tax Ct. Memo LEXIS 3">36 A premium of $33,750.00 was paid for borrowing the 2 3/4% Bonds as follows: $8,437.50 on June 18, 1957 $8,437.50 on August 1, 1957 $8,437.50 on September 30, 1957 $8,437.50 on December 3, 1957 which is deductible from your Federal Income Tax. By a letter dated January 15, 1959, Livingstone issued the following statement of account to Lewis: For your 1958 Income Tax purposes, we submit the following: On the $3,000,000 U.S. Treasury 2 3/4% Bonds of September 15, 1961, borrowed from us on May 8, 1957, we debited your account with the following expense: 3/15/58 Coupons$41,250.009/15/58 Coupons41,250.00Total Expense$82,500.00 On the $3,000,000 U.S. Treasury 1 1/2% Notes of October 1, 1961, being held by us as collateral, you had the following income: 4/1/58 Coupons$22,500.0010/1/58 Coupons22,500.00Total Income$45,000.00 Your net deduction on this transaction is $37,500.00. By a letter dated January 14, 1960, Livingstone issued the following statement of account to Lewis: For your 1959 Income Tax purposes, we submit the following: On the $3,000,000 U.S. Treasury 2 3/4% Bonds of September 15, 1961, borrowed from us on1962 Tax Ct. Memo LEXIS 3">37 May 8, 1957, we debited your account with the following expense: 3/15/59 Coupons$41,250.009/15/59 Coupons41,250.00Total Expense$82,500.00 On the $3,000,000 U.S. Treasury 1 1/2% Notes of October 1, 1961, being held by us as collateral, you had the following income: 4/1/59 Coupons$22,500.0010/1/59 Coupons22,500.00Total Income$45,000.00 Your net deduction on this transaction is $37,500.00. Furst and Pearl entered into transactions at or about the same time as Lewis involving 2 3/4 percent bonds and 1 1/2 percent notes identical in all material respects with those described with respect to Lewis, except that in the case of Furst the face amount of the bonds stated to have been sold short and borrowed and the notes stated to have been purchased was $4,000,000; the amounts designated as the selling price of the bonds and purchase price of the notes were $3,986,141.30 and $3,655,000, respectively; the amounts designated as payments to Livingstone in 1957, 1958, and 1959 were $83,858.70, $110,000, and $110,000, respectively; and the amounts reported as interest income on the United States Treasury notes in 1957, 1958, and 1959 were $23,934.43, 1962 Tax Ct. Memo LEXIS 3">38 $60,000, and $60,000, respectively. Lewis and Pearl entered into the 1957 transactions for the purpose of effecting a tax savings, and with the hope of obtaining an economic gain if the 2 3/4 percent bonds depreciated sufficiently in value. They believed that the transactions initiated in May 1957 would be carried out as set forth in Livingstone's letter of January 4, 1957. Lewis and Pearl were unaware of the financial condition of CF&L and of the fact that the securities involved in the transactions of November 1955 and March 1956 were simultaneously purchased for their accounts and sold for the account of CF&L. On and after May 7, 1957, Lewis and Pearl followed the prices of United States Treasury 2 3/4 percent bonds in the daily market reports. In his income tax return for the year 1955 Lewis deducted $40,218.75 as interest paid to CF&L and in his income tax return for the year 1956 deducted $44,022.93 as interest paid to CF&L. In his income tax return for 1957, Lewis deducted the amount of $29,144.02 as "Cost of Borrowing U.S. Treasury Bonds" and the amount of $33,750 as "Premium paid for borrowing U.S. Treasury Bonds." In his 1958 income tax return Lewis deducted $82,5001962 Tax Ct. Memo LEXIS 3">39 as "Cost of borrowing U.S. Treasury Bonds" and in his 1959 income tax return deducted $82,500 as "Cost of borrowing U.S. Treasury Bonds." In his notices of deficiency respondent disallowed the claimed interest deductions for 1955 and 1956 and the claimed deductions for 1957, 1958, and 1959 for premiums paid for and costs of borrowing United States Treasury bonds with the explanation that the amounts so claimed are not deductible under any section of the Internal Revenue Code of 1954. In his income tax return for 1955, Furst deducted $56,306.25 as interest paid to CF&L and in his income tax return for 1956, he deducted $55,028.66 as interest paid to CF&L. In his income tax return for 1957 Furst deducted $45,000 as "Premium paid for loan of securities to cover short position," and $55,000 as "Coupon expense on $4,000, 000 U.S.T. 2 3/4% Notes due 9/15/61." In his income tax return for 1958 Furst deducted $110,000 as "coupon expense - cost of short position," and in his income tax return for 1959 deducted $110,000 with the same explanation. Respondent in his notices of deficiency disallowed the claimed interest deductions for 1955 and 1956 and the claimed deductions1962 Tax Ct. Memo LEXIS 3">40 for coupon expense and cost of borrowing bonds for 1957, 1958, and 1959 with the explanation that these amounts were not deductible under any provision of the Internal Revenue Code of 1954. In his income tax return for 1955 Pearl deducted $40,218.75 as interest paid to CF&L and in his income tax return for 1956 deducted $44,022.93 as interest paid to CF&L. In his income tax return for 1957, Pearl deducted $29,144.02 and $33,750 as "the cost of borrowing U.S. Treasury Bonds" and "Premium paid for borrowing U.S. Treasury Bonds." In his income tax return for 1958, Pearl deducted $82,500 for "cost of borrowing U.S. Treasury Bonds" and in his income tax return for 1959 deducted $82,500 with this same explanation. Respondent in his notices of deficiency disallowed the deductions claimed as interest paid to CF&L during 1955 and 1956 and the deductions claimed in 1957, 1958, and 1959 as cost of borrowing Treasury bonds and premiums paid for borrowing United States Treasury bonds with the explanation that the amounts were not deductible under any provision of the Internal Revenue Code of 1954. The parties have agreed that if the interest deductions claimed by each petitioner for 19551962 Tax Ct. Memo LEXIS 3">41 and 1956 are not allowed, each petitioner's taxable income for the years 1956 and 1957 should be reduced by the amounts reported by him as long-term capital gains in those years as follows: Petitioner19561957Lewis$32,500.00$36,250.00Furst45,500.0045,312.50Pearl32,500.0036,250.00The parties have agreed that if the deductions claimed for cost of borrowing United States Treasury bonds by each petitioner in 1957, 1958, and 1959 are not allowed, each petitioner's taxable income for the years 1957, 1958, and 1959 should be reduced by the amounts reported by him as interest income received on the 1 1/2 percent notes in those years, as follows: Petitioner195719581959Lewis$22,250.00$45,000$45,000Furst30,000.0060,00060,000Pearl17,950.8245,00045,000Opinion The facts with respect to the claimed interest deduction for 1955 and 1956 in each of these consolidated cases are in all material respects the same as the facts in Perry A. Nichols, 37 T.C. 772">37 T.C. 772 (1962) on appeal (C.A. 5, February 15, 1962). In that case we held that there was no actual purchase of Government securities, that the1962 Tax Ct. Memo LEXIS 3">42 petitioner's loans from CF&L were wholly lacking in substance since CF&L had no funds to lend and, therefore, no payment was made of "interest" on "indebtedness" to CF&L within the meaning of section 163 of the Internal Revenue Code of 1954. 2In the instant case, Livingstone directed the simultaneous purchase and sale of large amounts of Government notes. There was no actual purchase of Government notes; merely a purchase and offsetting sale of the same notes on the same day. CF&L was in no position to make loans of the magnitude required, and, in fact, the evidence clearly shows that the funds used to pay for the notes ostensibly purchased were generated by the simultaneous sale of the same notes. 37 T.C. 772">Perry A. Nichols, supra, is controlling and dispositive of the issue of the claimed interest deductions in 1955 and 1956. The transactions here described were similarly lacking in substance and were shams which can have no effect for tax purposes. Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178 (1958),1962 Tax Ct. Memo LEXIS 3">43 affd. 267 F.2d 127 (C.A. 1, 1949); George C. Lynch, 31 T.C. 990">31 T.C. 990 (1959), aff. 273 F.2d 867 (C.A. 2, 1959); Leslie Julian, 31 T.C. 998">31 T.C. 998 (1959), affd. 273 F.2d 867 (C.A. 2, 1959); and Becker v. Commissioner, 277 F.2d 146 (C.A. 2, 1960), affirming on this issue a Memorandum Opinion of this Court. Petitioners contend that since CF&L did not have sufficient funds to loan to petitioners to purchase the notes, it used a conventional method to finance the transaction, that of the short sale. In effect, petitioners argue that the simultaneous sale by CF&L of the notes purchased from Salomon was a short sale. Their interpretation of the facts indicates that CF&L borrowed petitioners' notes in order to effect a short sale. The evidence of record does not support this contention. There is no evidence of a short sale by CF&L on November 22, 1955, or on March 22, 1956. The only evidence bearing on this issue is that which points to a simultaneous sale of the securities purchased on those dates. CF&L did not purchase securities to close out or cover the transactions, but merely through bookkeeping entries accounted1962 Tax Ct. Memo LEXIS 3">44 to petitioners for the proceeds of the purported loan. Petitioners further contend that their purpose in entering these transactions was to make a profit on the rise in prices of the 2 7/8 percent United States Treasury notes. Petitioners offer no support for their purported belief that there might be a substantial increase in the prices of the notes. See Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001 (1959). They also argue that the possibility of a rollover or the opportunity to exchange their notes of a lesser interestpaying face for notes of a higher interest value indicates that this was a profit-seeking transaction. There is no evidence to show any reasonable basis for petitioners to believe that any economic gain could result to them from these transactions aside from the tax benefit they hoped to obtain. There was nothing of substance to be gained by petitioners from the entire transaction other than a tax deduction. Cf. Knetsch v. United States, 364 U.S. 361">364 U.S. 361 (1960). However, even if some reasonable expectation of an economic gain had existed, this fact would not cause any real indebtedness by petitioners to CF&L to exist on which interest was paid. Cf. Rubin v. United States, 304 F.2d 7661962 Tax Ct. Memo LEXIS 3">45 (C.A. 7, 1962). Petitioners contend that if the amounts claimed by them as interest paid for 1955 and 1956 are not deductible, they should be allowed to deduct in 1956 and 1957 their out-of-pocket losses which occurred on the conclusion of the transactions of those years. The out-of-pocket losses or expenses result from the difference in the amount each petitioner paid to CF&L and the amount each received from Livingstone. Petitioners first contend that the net out-of-pocket losses or expenses are deductible as an ordinary loss on a transaction entered into for profit, under section 165(c)(2) of the Internal Revenue Code of 1954. 3Petitioners argue that they expected to make an after-tax profit on1962 Tax Ct. Memo LEXIS 3">46 these transactions and that, therefore, the transactions were entered into for profit. The evidence does not support petitioners' contention. The facts show that the only profit petitioners could reasonably expect was in tax benefit. In Eli D. Goodstein, supra 30 T.C. 1178">30 T.C. 1178, 1192-1193) we stated: * * Since the petitioner did not intend to purchase and did not purchase any Treasury notes, it cannot be said that there was a transaction entered into for profit within the meaning of section 23(e) of the Internal Revenue Code of 1939. [now section 165(c) of the Internal Revenue Code of 1954] * * * It is clear that the type of transaction to which the statute refers is one which has substance and in which there is a true motive of deriving a profit. * * * Our holdings in 30 T.C. 1178">Eli D. Goodstein, supra, and in Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356 (1960) that a transaction may not be considered as a transaction entered into for profit if the only economic gain to be derived therefrom results from anticipated tax reduction are controlling here. Petitioners next contend that their out-of-pocket losses are attributable to misrepresentations1962 Tax Ct. Memo LEXIS 3">47 by Livingstone as to the manner in which the transactions would be carried out. Petitioners contend that such alleged misrepresentations border on fraud and that such fraud is an additional ground for allowing a deduction of the out-of-pocket losses. Had each transaction proceeded precisely in accordance with Livingstone's prospectus, petitioners would have suffered the identical out-of-pocket losses that they did in fact realize. No part of such losses can be said to be due to any alleged misrepresentation of Livingstone. Cf. Miles v. Livingstone, 301 F.2d 99 (C.A. 1, 1960). Petitioners further contend that they are entitled to deductions for out-of-pocket losses as long-term capital losses under the decision in Becker v. Commissioner, supra, and MacRae v. Commissioner, 294 F.2d 56 (C.A. 9, 1961). Although their argument is not spelled out, it would necessarily involve section 1234 of the Internal Revenue Code of 19544 (the predecessor section 117(g)(2) of the 1939 Code was in issue in Becker and MacRae). 1962 Tax Ct. Memo LEXIS 3">48 Section 1234 is clearly inapplicable to petitioners' out-of-pocket losses. Here there was no loss attributable to the sale or exchange of an option, nor was there a loss attributable to the failure to exercise an option. In both the taxable years 1956 and 1957 petitioners exercised their options with Livingstone. We hold that petitioners are not entitled to deductions in 1956 and 1957 for their out-of-pocket losses on the transactions with Livingstone in 1955 and 1956. The final question presented here is whether petitioners are entitled to deductions in the taxable years 1957, 1958, and 1959 for amounts claimed as a premium paid Livingstone for borrowing United States Treasury 2 3/4 percent bonds in connection with the alleged short sale of these bonds in 1957 and for payments of interest in 1957, 1958, and 1959 in connection with carrying a short position in these bonds. Petitioners' position with respect to the claimed deductions for premiums paid and costs of borrowing bonds is that they made a purchase of United States Treasury 1 1/2 percent notes in 1957 and at the same time made a short sale of United States Treasury 2 3/4 percent bonds using the 1 1/2 percent notes as1962 Tax Ct. Memo LEXIS 3">49 collateral for the loan from Livingstone of the 2 3/4 percent bonds sold short. They argue that payments to Livingstone of a premium for the loan of the 2 3/4 percent bonds and the annual interest payments on the short sale are deductible under section 212 of the Internal Revenue Code of 1954. 5Respondent replies that petitioners' dealings with Livingstone were formulated and executed solely with reference to tax-saving purposes, were entirely without substance, and should be disregarded for Federal income tax purposes. Respondent denies that in fact a short position was ever held and that securities were ever borrowed. We agree with respondent's contention. On May 7, 1957, Salomon confirmed the purchase of $3,000,000 in United States Treasury 2 3/4 percent bonds from Lewis at a total price of $2,922,105.98. The confirmation slip indicates that this amount would be paid on the following day1962 Tax Ct. Memo LEXIS 3">50 in New York at Childs. On the same day, May 7, 1957, Livingstone placed an order with Childs for the purchase by it from Childs of $3,000,000 United States Treasury 2 3/4 percent bonds and their delivery against payment to Salomon for the account of Lewis. As a result of this simultaneous transaction, the short sale by Lewis of the 2 3/4 percent bonds was immediately canceled by the purchase of the identical bonds from another broker. Lewis' account with Salomon indicates that his credit balance resulting from the sale of the bonds was cleared on the following day by the delivery to Salomon of the identical bonds. No proof has been offered that Livingstone owned bonds of this kind in the amounts which he could loan Lewis or that Livingstone possessed funds in sufficient amount to purchase such bonds and lend them to petitioners. Nor is there any evidence that he did lend Lewis these bonds. Thus, the record indicates that Lewis never borrowed securities from Livingstone and that Lewis did not maintain a short position with regard to these bonds. We conclude that these transactions considered as a whole, had no independent economic or business purpose apart from anticipated tax benefits1962 Tax Ct. Memo LEXIS 3">51 and were wholly without substance. 30 T.C. 1178">Eli D. Goodstein, supra.Cf. Empire Press, Inc., 35 T.C. 136">35 T.C. 136 (1960); 31 T.C. 1001">Egbert J. Miles, supra; MacRae v. Commissioner, supra; and 37 T.C. 772">Perry A. Nichols, supra. Petitioners contend that the record demonstrates that they purchased the 1 1/2 percent Treasury notes in 1957 and that there is nothing in the record to show that these notes were disposed of during the period here involved. The record does not support petitioners' contention. There is no evidence to show that these bonds were ever actually purchased by petitioners. However, even if petitioners had actually purchased the 1 1/2 percent notes, they would not be entitled to deduct costs of maintaining a short position in 2 3/4 percent bonds which they had not in fact borrowed. We sustain respondent in his disallowance of the deductions claimed by petitioners as premiums paid and costs of borrowing United States Treasury bonds in the years 1957, 1958, and 1959. Decision will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Louis H. Lewis and Annette Lewis, Docket Nos. 83732, 85749, and 94018; Estate of Hyman Furst, Deceased, Louis H. Lewis, Executor, Docket Nos. 83733, 85750, and 94019; and Samuel Pearl and Mary Pearl, Docket Nos. 85162 and 91963.↩2. SEC. 163↩. INTEREST. (a) General Rule. - There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.3. 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 - * (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and * ↩4. 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).↩5. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year - (1) for the production or collection of income; * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623344/	Estate of Charles L. Woody, Deceased, Charles L. Woody, Jr., Rhoma Woody Gilbert and Irving Trust Company, Executors, Petitioners, v. Commissioner of Internal Revenue, RespondentEstate v. Woody v CommissionerDocket No. 78817United States Tax Court36 T.C. 900; 1961 U.S. Tax Ct. LEXIS 90; August 29, 1961, Filed 1961 U.S. Tax Ct. LEXIS 90">90 Decision will be entered under Rule 50. Held, decedent's daughter's claim against his estate was based upon "adequate and full consideration in money or money's worth" ( sec. 2053, I.R.C. 1954), and was deductible from the gross estate; it was not a device for making a testamentary disposition. James F. Watson, Esq., for the petitioners.Norman L. Rapkin, Esq., for the respondent. Raum, Judge. RAUM36 T.C. 900">900 The Commissioner determined a deficiency in estate tax in the amount of $ 7,385.64. Petitioners claim a $ 5,318.70 overpayment.The question presented is whether decedent's obligation to pay $ 14,000 to his daughter after his death, assumed in exchange for his daughter's release of his son from an indebtedness in a like amount, was "contracted bona fide and for an adequate and full consideration in money or money's worth" as is required for a deductible claim for estate tax purposes under the provisions of section 2053 of the 1954 Code.Certain other unrelated issues are no longer in contest.FINDINGS OF FACT.Most of the facts were stipulated. The stipulation of facts and attached exhibits are incorporated by this reference.Charles L. Woody (hereinafter referred to as the decedent) was an attorney who died testate at the age of 87 on June 13, 1956, a resident 36 T.C. 900">901 of1961 U.S. Tax Ct. LEXIS 90">92 Port Jefferson, Suffolk County, New York. His last will and testament, dated January 25, 1950, together with a codicil thereto, dated March 28, 1951, were duly admitted to probate in the Surrogate's Court of Suffolk County, New York, and letters testamentary were issued on July 3, 1956, by said court to Charles L. Woody, Jr., Rhoma Woody Gilbert, and the Irving Trust Company, the executors under decedent's will. The estate tax return for decedent's estate was filed at the office of the district director of internal revenue, Brooklyn, New York.Decedent was survived by his wife, Ella Rhoma Woody, his son, Charles L. Woody, Jr. (hereinafter referred to as Charles), and his daughter, Rhoma Woody Gilbert.On or about May 18, 1948, Charles borrowed $ 68,000 from Rhoma in order to purchase a seat on the New York Stock Exchange. Of this amount, $ 54,000 had been borrowed by Rhoma from the Irving Trust Company under an agreement whereby her securities in a custodian account with the bank were pledged as security for repayment of the loan and the interest on her $ 54,000 loan was charged against Charles' account with the bank. The remaining $ 14,000 lent by Rhoma to Charles was from her1961 U.S. Tax Ct. LEXIS 90">93 own funds and was lent without interest.Charles soon thereafter acquired a seat on the New York Stock Exchange for $ 68,000. On May 27, 1948, Charles and Rhoma signed a "Voluntary Payment Subordination Agreement" covering the $ 68,000 loan which was filed with the New York Stock Exchange in accordance with the rules of the exchange. By this agreement, among other things, Charles acknowledged his indebtedness in the amount of $ 68,000 to Rhoma and Rhoma acknowledged that her rights as a creditor were subject to the priorities created in the existing constitution, rules, and practice of the exchange.On or about March 2, 1951, decedent advised Rhoma that he wanted his son to own the stock exchange seat free of any encumbrances. On or about March 22, 1951, decedent and his wife wrote a letter to Charles which read in part as follows:Today I delivered mine and your mother's check totaling $ 54,000.00 to the Irving Trust Company in payment of your note for that amount given to them to purchase your seat on the New York Stock Exchange.This is a gift from your mother and I to enable you to hold your seat free and clear of any debts.The note referred to in the letter was in fact 1961 U.S. Tax Ct. LEXIS 90">94 Rhoma's note and not Charles' note, having been given in consideration of the loan from the Irving Trust Company which Rhoma obtained for her brother's benefit.Decedent and his wife on or about March 22, 1951, paid $ 54,000 to the Irving Trust Company in discharge of Rhoma's indebtedness to the bank. Of this $ 54,000, $ 44,000 was paid by decedent and $ 10,000 36 T.C. 900">902 was paid by decedent's wife. At the same time decedent assumed the indebtedness of Charles to Rhoma in the amount of $ 14,000. Decedent executed a codicil to his will 1 on March 28, 1951, which read in part as follows:FIRST: I acknowledge that I owe, as a debt to Rhoma Woody Gilbert, $ 14,000.00, which I have assumed that she paid to CHARLES L. WOODY, Jr., as part of the purchase price of his stock exchange seat on the NEW YORK STOCK EXCHANGE. Debt to be paid only after my death.The same codicil also added Rhoma as one of the executors of decedent's will. No interest was paid to Rhoma with respect to the $ 14,000 indebtedness by either the decedent or his estate.1961 U.S. Tax Ct. LEXIS 90">95 On or about March 22, 1951, Charles wrote a letter to Edwin B. Peterson, secretary of the New York Stock Exchange, stating that he had paid Rhoma the sum of $ 68,000 in complete satisfaction of his obligation to her under the subordination agreement in connection with his membership in the exchange. Rhoma also signed this letter, with the notation: "Payment received and obligation discharged."Gift tax returns for the calendar year 1951 were not filed until after the decedent's death by decedent's wife and the executors of his will on or about April 30, 1957. In these returns, a cash gift of $ 44,000 from decedent to Charles, a cash gift of $ 10,000 from decedent's wife to Charles, and the assumption by decedent of Charles' indebtedness to Rhoma in the amount of $ 14,000 were reported with March 22, 1951, indicated as the date of each gift.Rhoma made demand upon the executors of decedent's estate for payment to her of the amount of $ 14,000 which decedent acknowledged as a debt to her in the first paragraph of the codicil to his will, and the executors paid $ 14,000 to Rhoma on January 15, 1957.On the estate tax return filed by the decedent's estate on August 14, 1957, the $ 14,0001961 U.S. Tax Ct. LEXIS 90">96 paid to Rhoma was deducted as a debt of the decedent in arriving at decedent's taxable estate. This deduction was disallowed by the Commissioner as "an obligation not based on consideration in money or money's worth."Rhoma's claim against the decedent's estate in the amount of $ 14,000 was contracted bona fide for an adequate and full consideration in money or money's worth.OPINION.To be deductible for estate tax purposes under section 2053 of the 1954 Code, 21961 U.S. Tax Ct. LEXIS 90">97 a claim against an estate must be "contracted 36 T.C. 900">903 bona fide and for an adequate and full consideration in money or money's worth." 3 The only matter in controversy in the instant case is whether the $ 14,000 claim which Rhoma held against the decedent's estate was in fact contracted for such statutory consideration. We think that it was.Since this case involves what was essentially an intrafamily transaction, the alleged obligation which resulted therefrom bears special scrutiny. It has been said that the statutory consideration requirement herein in issue was specifically drafted "to prevent deductions, under the guise of claims, of what were in reality gifts or testamentary distributions. * * The things which the statute was intended to 1961 U.S. Tax Ct. LEXIS 90">98 disallow were colorable family contracts and similar undertakings made as a cloak to cover gifts." Carney v. Benz, 90 F.2d 747, 749 (C.A. 1). We have viewed the facts herein with this statutory purpose in mind.The obligation of the decedent to pay the debt in question arose in 1951 when he promised Rhoma he would pay her $ 14,000 in consideration for her discharging his son Charles from a bona fide indebtedness in a like amount. Rhoma agreed, released her brother from the debt, and the decedent executed a codicil to his will in which he acknowledged the indebtedness to Rhoma and provided that it be paid only after his death. For Rhoma, the transaction amounted to little more than a novation, an exchange of debtors; she was to gain nothing. For Charles, the transaction amounted to the receipt of an inter vivos gift from the decedent which, along with the simultaneous gift of $ 54,000 paid in his behalf by decedent and his wife to the Irving Trust Company, freed his seat on the New York Stock Exchange from all existing encumbrances in the amount of $ 68,000. For the decedent, 36 T.C. 900">904 the transaction meant that he was able to consummate the 1961 U.S. Tax Ct. LEXIS 90">99 gift in praesenti to his son, using a $ 14,000 asset of his daughter Rhoma for that purpose and undertaking to repay her that amount at his death.It seems clear to us on these facts that Rhoma's claim against the estate was based on "adequate and full consideration in money or money's worth." In no sense was decedent's obligation to Rhoma a device for making a testamentary gift to her. She received not a cent more than she was entitled to prior to the transaction, and Charles' preexisting debt to her was based upon a bona fide $ 14,000 loan which she had made to Charles out of her own funds.In substance the decedent contracted a debt in order to make an inter vivos gift to his son. Had he borrowed the $ 14,000 from a bank or from Rhoma herself for that purpose, there could hardly be any serious question that the debt would have been supported by the requisite statutory consideration. The situation is not changed merely because the transaction was carried out by means of having Rhoma cancel Charles' obligation to her and accepting the decedent as obligor in his place.The Commissioner presses upon us the argument that the statutory requirement was intended to prevent one from1961 U.S. Tax Ct. LEXIS 90">100 diminishing his taxable estate by creating obligations which are not correspondingly offset by the consideration received in exchange for such obligations. Cf. Estate of John M. Goetchius, 17 T.C. 495">17 T.C. 495, 17 T.C. 495">502, 17 T.C. 495">505; Paul, Federal Estate and Gift Taxation, sec. 11.20. But the fundamental error in the Commissioner's position here is the assumption that the decedent or his estate did not benefit by Rhoma's release of her $ 14,000 claim against her brother. The evidence shows that the decedent intended to and did make an inter vivos gift to his son. Had he made that gift out of his own funds, his estate would have been depleted by $ 14,000. He achieved the same result by inducing Rhoma to cancel Charles' $ 14,000 debt to her in exchange for his undertaking to pay a like amount to her. By thus obtaining Rhoma's release of Charles' debt, the decedent's estate was $ 14,000 richer than it would have been had he made the gift directly out of his own funds. In every real sense, therefore, the decedent's obligation was supported by "adequate and full consideration in money or money's worth," and the principle relied upon by the Commissioner is inapplicable to1961 U.S. Tax Ct. LEXIS 90">101 the facts of this case.We conclude that the claim here in question, though payable only after the decedent's death, meets the statutory test.Decision will be entered under Rule 50. Footnotes1. The terms of decedent's will, executed Jan. 25, 1950, provided that his entire estate should go to his wife for life, and upon his wife's death one-half to Charles outright and the other one-half to Rhoma for life and upon her death to Charles outright. Charles and the Irving Trust Company were named as executors.↩2. SEC. 2053. EXPENSES, INDEBTEDNESS, AND TAXES.(a) General Rule. -- For purposes of the tax imposed by section 2001, the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts -- * * (3) for claims against the estate, * ** * * as are allowable by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered. * * (c) Limitations. -- (1) Limitations applicable to subsections (a) and (b). -- (A) Consideration for claims. -- The deduction allowed by this section in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded on a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money's worth; * *↩3. This precise language has been a part of the revenue laws since it was first introduced in section 303(a)(1) of the Revenue Act of 1926, 44 Stat. 72. The earlier Revenue Acts of 1916, 1918, and 1921 made deductibility of claims depend only on their being allowed under State law irrespective of the nature of the consideration. The Revenue Act of 1924 added the requirement that claims be "incurred or contracted bona fide and for a fair consideration in money or money's worth." The successive changes thus consistently narrowed the class of deductible claims which would be allowed for estate tax purposes. Cf. Taft v. Commissioner, 304 U.S. 351">304 U.S. 351, 304 U.S. 351">355-356↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623345/	Rubin Hess and Marilyn Hess v. Commissioner.Hess v. CommissionerDocket No. 4822-70 SC.United States Tax CourtT.C. Memo 1971-242; 1971 Tax Ct. Memo LEXIS 90; 30 T.C.M. 1043; T.C.M. (RIA) 71242; September 23, 1971, Filed. Rubin Hess and Marilyn Hess, pro se, 125 1/2 S. Sycamore Ave., Los Angeles, Calif.Allan D. Hill, for the respondent. JOHNSTON Memorandum Findings of Fact and Opinion JOHNSTON, Commissioner: Respondent determined a deficiency of $597.89 in petitioners' Federal income tax for the year 1967. The issues for decision are (1) whether petitioners are entitled to certain claimed charitable deductions under the provisions of section 170 1 of the Internal Revenue Code of 1954(2) whether petitioner Marilyn Hess incurred certain expenses in the trade or business of being an entertainer during the taxable year 1967 which are deductible under the provisions of section 162 or (3) whether such expenses are deductible under section 212 as expenses incurred for the production or collection of income. Findings of Fact Some of the facts have been stipulated and they are so found. Petitioners, husband and wife, 1971 Tax Ct. Memo LEXIS 90">92 were residents of Los Angeles, California when they filed their petition. On petitioners' joint 1967 Federal income tax return, an attached schedule of deductions listed the following amounts as contributions: Synagogue$100Salvation Army250Other Organized Charities125State of Israel200Macabee Athletic Club 204$879Respondent disallowed claimed charitable contributions during 1967 in the amount of $424. Respondent allowed the petitioners deductions for a non-cash contribution to the Veterans' Salvage Shop in the amount of $250, for a $1 contribution to the Heart Fund and for mileage incurred by Rubin Hess as a Macabee athletic coach in the amount of $204. Rubin Hess made a contribution of $200 to the State of Israel. This contribution was made at a rally which he attended in Los Angeles at about the time of the outbreak of the Arab-Israeli War. Marilyn Hess began performing as a professional entertainer in 1950 at the age of five. She performed mostly on the East Coast as a member of a trio until her family moved to California in 1963. After a short time the trio disbanded because of lack of work on the West Coast. She was employed as a1971 Tax Ct. Memo LEXIS 90">93 singer with a group called the "Young Americans" from Fall 1964 through March 1965 and which toured around the United States with Johnny Mathis. In May or June of 1965 the group was booked in the Melody Land Theatre with Tennessee Ernie Ford. This was the only work performed in 1965. Petitioners were married on June 12, 1965. At some period during 1966, Marilyn Hess appeared with the "Young Americans" at the Greek Theatre in Hollywood with Judy Garland who became ill so that the show ran for not more than two weeks. She also appeared at a benefit performance at the Hollywood Bowl for one night. She had no other employment as an entertainer in 1966. In 1967 Marilyn Hess was employed as a clerical worker at Beverly Stationers, J. Rotell, Temporarily Yours and B&B Typewriter Company. The employment at 1044 B&B Typewriter Company was full time as a clerk. She worked there eight hours a day for five days a week. The annual compensation she received from B&B Typewriter Company was $3,559.39 in 1967. Her salary ranged between $75 and $85 per week while so employed. On petitioners' joint Federal income tax return for 1967 they reported $100 as "income as entertainer" and took deductions1971 Tax Ct. Memo LEXIS 90">94 for claimed unreimbursed business expenses of Marilyn Hess necessary for the production of income as follows: DescriptionAmountAccompanists, Sheet Music & Records$175.00Hair Styling260.00Make up364.00Parking72.00Periodicals & Trade papers104.00Professional Photos76.00Rent390.00Telephone, Telegraph, Cable144.00Theatre & Movie Tickets for business520.00Costume Wardrobe Maintenance158.00Wigs and Hair Pieces35.00Coaching 60.00Total$2,358.00Marilyn Hess took an honorary withdrawal in 1967 from a union called the American Guild of Variety Artists in which she had held membership since age five. She had neither a manager nor an agent in 1967. No deduction was claimed by Marilyn Hess for union dues payments to American Guild of Variety Artists in 1967. Ultimate Findings of Fact Petitioner Marilyn Hess was not engaged in the trade or business of entertaining in 1967 and did not incur any of the claimed expenses for the production or collection of income. Opinion On their 1967 Federal income tax return, petitioners deducted claimed charitable contributions of $879. The District Director allowed petitioners1971 Tax Ct. Memo LEXIS 90">95 $455 made up of a noncash contribution of $250 to the Veterans' Salvage Shop, a $1 contribution to the Heart Fund and mileage in the amount of $204 incurred by Rubin as a Macabee athletic coach. In the statutory notice of deficiency for 1967, respondent disallowed $424 of petitioners' claimed contributions. These disallowed items were designated on the return as $200 cash contribution to the State of Israel, a $100 cash contribution to a synagogue and $124 in cash contributions to Other Organized Charities. On trial, petitioners apparently abandoned their claimed deductions of $250 to the Salvation Army and $124 to Other Organized Charities but raised the amount claimed to have been contributed to the State of Israel to $250 and claimed that the remainder of the $424 or $174 had been given to various synagogues. Section 170 of the Internal Revenue Code of 1954 states: (1) GENERAL RULE - There shall be allowed as a deduction any charitable contribution (… ) payment of which is made within the taxable year. A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary or his delegate. The name1971 Tax Ct. Memo LEXIS 90">96 of each organization to which a contribution was made and the amount and date of actual payment of each contribution should be stated in the tax return. However, where numerous contributions were made to one organization during the taxable year, only the organization's name and the total amount of the cash contributions need be shown. Income Tax Regs. 1.170-1(a)(3). Not only was the necessary information omitted from the return, it was not even supplied at the trial. Petitioners offered no support for these alleged cash contributions to a synagogue or synagogues other than vague estimates. Rubin's testimony indicated that he attended several synagogues. He produced no receipts, records, cancelled checks or other specific evidence to substantiate any portion of the amount claimed. He gave no convincing explanation as to why he claimed $100 in contributions to a synagogue on their return and then at the trial claimed to have contributed a total of $174 to several synagogues. It is impossible on the trial record to determine the amounts, if any, given to any particular synagogue. The vague and conflicting testimony of Mr. Hess with respect to these alleged contributions can be given1971 Tax Ct. Memo LEXIS 90">97 little or no weight. His self-serving statements are not sufficient to substantiate the amount of the charitable contributions originally claimed or as increased at the trial. The $174 claimed to have been given as a charitable contribution to synagogues must be disallowed as a deduction on account of lack of substantiation. 1045 Petitioners claimed a charitable contribution of $200 to the State of Israel on their 1967 Federal income tax return which amount petitioners raised to $250 on trial. The type of organization which qualifies as a proper donee of a charitable contribution is limited by the Internal Revenue Code of 1954. Section 170(b)(1)(A)(i-viii). The government of a foreign country does not qualify as a recipient organization to which proper donations can be made. Section 170(c)(2)(A). If the organization was not created in the United States, a contribution thereto is not deductible under section 170 of the 1954 Code. Muzaffer ErSelcuk, 30 T.C. 962">30 T.C. 962 (1958). The State of Israel is a foreign government obviously not created in the United States and any contribution to it is not allowable as a deduction under section 170 of the Internal Revenue Code1971 Tax Ct. Memo LEXIS 90">98 of 1954. Petitioners argue on brief that the contribution was given to a domestic organization described in Rev. Ruling 63-252, C.B. 1963-2, 101. Not only is there no record support for this argument, but the brief doesn't even suggest the name of any such organization. Accordingly, the petitioners have failed to show that the respondent erred with respect to the disallowance of the claimed charitable contributions. Marilyn Hess described her activities in 1967 in connection with theatre work somewhat as follows: I tried to find some work for myself. I even tried to put together a group of my own. I went to the musicians union because I didn't even know where to start. I tried to find work locally or anywhere really just to get some income. I figured if I got together a trio I would probably have more success. So, I just spent all of my time running around auditioning. I tried out for a number of choruses and other singing groups. I just kept in touch with everyone and started rehearsing with this group that I got together and nothing ever came of that - just a lot of auditions. Marilyn testified that she earned $100 in 1967 for entertaining before a group at its annual or1971 Tax Ct. Memo LEXIS 90">99 semi-annual dance in a temple auditorium in either Los Angeles or Hollywood. Petitioners claimed a deduction on their 1967 Federal income tax return in the amount of $2,358 which they denominated "Unreimbursed Expenses Necessary to Production of Income." Marilyn claims to have paid all of her disbursements in cash. Such records as she claimed to have had appear to have been inadequate - occasional receipts but no bookkeeping records. She testified that she hadn't thought too much about receipts and whatever receipts she did have were destroyed by a flood in their apartment in July 1968. She said that businesses patronized by her in 1967 were no longer in business so that she could not get duplicate receipts. However, she failed to testify as to the names and former addresses of such businesses. She produced no receipts, records or other specific evidence to substantiate any portion of the amount of her expenses "Necessary to Production of Income." Most of her testimony was only general, consisting of stated conclusions. Furthermore, the record does not show in what respect the claimed expenses were necessary to the production of income. Something more is required than mere statements1971 Tax Ct. Memo LEXIS 90">100 that the expenses were incurred. Cf. Betsy Lusk Yeomans, 30 T.C. 757">30 T.C. 757 (1958). Practically all of the claimed expenses with the exception of those for an accompanist 2 and studio rent were for items which might normally be considered personal living expenses. 3 The record does not show how certain of these expenditures related to the total of all similar expenses for which a deduction was not claimed. For example, a deduction of $144 was claimed for mostly telephone calls, yet we do not know whether this constitutes the total telephone bill of petitioners or some part of it. It is difficult to believe that no personal telephone calls were incurred. For some reason, petitioners chose not to document their telephone expenses although Marilyn testified she made many long distance calls. Similarly, with respect to theatre and movie tickets and parking. Certainly other expenses, such as hair styling, make up, wigs and hair pieces are prima facie personal expense. Petitioner has produced no evidence which would lead to a different conclusion. We do not know whether the constumes for which a 1046 maintenance deduction is claimed were not suitable for personal or private1971 Tax Ct. Memo LEXIS 90">101 wear. Without going into further detail, we do not believe that petitioners have substantiated any of the items of claimed expenses necessary to the production of income nor have they proved their business necessity. And in any event, it would appear that when these expenses were incurred Marilyn was carrying on no trade or business. She was seeking new employment. Such expenses are not deductible. George A. Dean, 56 T.C. - No. 69, July 29, 1971; Frank B. Polachek, 22 T.C. 858">22 T.C. 858 (1954), Morton Frank, 20 T.C. 511">20 T.C. 511 (1953) and McDonald v. Commissioner, 323 U.S. 57">323 U.S. 57 (1945) affirming 139 F.2d 400 affirming 1 T.C. 738">1 T.C. 738 (1943). 41971 Tax Ct. Memo LEXIS 90">102 We think that her actions in 1967, demonstrate that she did not intend to pursue a theatrical career. We have found that she paid no union dues to the American Guild of Variety Artists in 1967. Moreover she actually withdrew from the union in that year. In addition she had neither a manager nor an agent in 1967. Finally, on the basis of her average weekly salary, it appears that she worked about 45 weeks in 1967 for the B&B Typewriter Company and practically a full year, when her other employment is considered, outside the entertainment industry. We think this shows that she did not intend to carry on a business of professional entertainer in 1967. We hold that Marilyn Hess was not in a trade or business in 1967 and we hold further that the expenses incurred by her and claimed as a deduction in her 1967 return were not incurred for the production of income. The petitioners have failed to sustain their burden of proof that the respondent erred in disallowing the deductions claimed by petitioners. Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered for the respondent. Footnotes1. References to Code sections are to the internal Revenue Code of 1954, as amended.↩2. The record does not show the amount allegedly paid to the accompanist. ↩3. Income Tax Reg. § 1.212-1 provides "Nontrade or nonbusiness expenses * * (f) Among expenditures not allowable under section 212 are the following: Commuter's expenses; expenses of taking special courses or training; expenses for improving personal appearance; * * * expenses such as those paid or incurred in seeking employment or in placing oneself in a position to begin rendering personal services for compensation * * *. ↩4. See Raymond Collier, a memorandum opinion of this Court, September 3, 1954.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623346/	Woodward Governor Company, an Illinois Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentWoodard Governor Co. v. CommissionerDocket No. 1317-68United States Tax Court55 T.C. 56; 1970 U.S. Tax Ct. LEXIS 51; October 19, 1970, Filed 1970 U.S. Tax Ct. LEXIS 51">51 Decision will be entered under Rule 50. The petitioner is in the business of manufacturing aircraft and nonaircraft governors. It organized a foreign subsidiary corporation to purchase certain of the petitioner's aircraft governors and resell them overseas and to act as sales agent for the petitioner's overseas sales of nonaircraft governors. Held, the respondent abused his discretion in determining that certain income earned by the foreign subsidiary corporation should be reallocated to the petitioner under sec. 482, I.R.C. 1954, and the petitioner has established that its sales of aircraft controls to the foreign subsidiary corporation were at an arm's-length price. Lajos Schmidt and Robert H. Aland, for the petitioner.Seymour I. Sherman, for the respondent. Simpson, Judge. SIMPSON55 T.C. 56">56 The respondent1970 U.S. Tax Ct. LEXIS 51">52 determined a deficiency in the petitioner's income tax for its taxable year ended September 30, 1963, in the amount of $ 146,333.49. One of the issues in this case has been settled. The remaining question to be decided is whether the respondent was authorized under section 482 of the Internal Revenue 55 T.C. 56">57 Code of 19541 to allocate to the petitioner certain income which the parties treated as earned by its subsidiary, Woodward Governor GmbH.FINDINGS OF FACTSome of the facts have been stipulated, and those facts are so found.The petitioner is an Illinois corporation, which had its principal office and place of business in Rockford, Ill., at the time its petition was filed in this case. It filed its Federal income tax return for its taxable year ending September 30, 1963, using the accrual method of accounting, with the district director of internal revenue, Chicago, Ill.The petitioner is engaged in the manufacture of prime mover controls, 1970 U.S. Tax Ct. LEXIS 51">53 also known as governors, for various types of power units. These controls are divided into three separate product lines: (1) General aircraft (gas turbine and propellor) controls; (2) industrial engine (diesel and gas) and industrial turbine (steam and gas) controls; and (3) hydraulic turbine controls. The manufacture and proper installation and use of its products in power units, particularly of the more complex type such as aircraft engines, require considerable technical and engineering sophistication and know-how.In addition to its main manufacturing facilities at Rockford, Ill., the petitioner had manufacturing plants in Fort Collins, Colo.; Slough, England; Schiphol, the Netherlands; and Tokyo, Japan. The Schiphol, Slough, and Tokyo plants began operations in 1955, 1958, and 1961, respectively. All three foreign plants had assembly, testing, and service facilities, as well as limited machine shop capabilities. The products manufactured in the Schiphol and Slough plants were sold primarily throughout Europe and were for use on industrial engines and turbines, and the products manufactured in the Tokyo plant were sold principally to diesel engine builders in Japan.The net1970 U.S. Tax Ct. LEXIS 51">54 pretax profit earned by the petitioner for 1963 as a percentage of its total sales was 13.5 percent. The net pretax profit earned by the petitioner's Aircraft Controls Division for 1963 as a percentage of its total sales was 17.6 percent.The NATO Starfighter ProgramPrior to 1959, the Lockheed Aircraft Corp. (Lockheed) developed a fighter-interceptor bomber known as the F104 Starfighter (the Starfighter). The Starfighter was selected by the North Atlantic Treaty Organization (NATO) for use in the development and maintenance 55 T.C. 56">58 of its military potential. Thereafter, NATO initiated a program under which production of the Starfighter airframe (excluding the powerplant and its parts and accessories) was licensed by Lockheed to various construction firms in West Germany, the Netherlands, Belgium, and Italy. At approximately the same time, Lockheed granted similar licenses in Japan and Canada.The Starfighter was powered by an engine developed by the General Electric Co. (GE) and designated by GE as the J-79 gas turbine engine (the J-79 engine). Production of the J-79 engine was licensed by GE to various firms in West Germany, Belgium, Italy, Japan, and Canada. The J-791970 U.S. Tax Ct. LEXIS 51">55 engines manufactured by such firms were incorporated into the Starfighter airframes.Development and Selection of the 1307In 1952, the petitioner began to develop the Type 1307 main fuel control (the 1307) for use in aircraft gas turbine engines. The 1307 is an extremely sophisticated and complex fuel control. Its function is to control the flow of fuel to the aircraft gas turbine engine under all conditions of altitude, attitude, temperature, acceleration, deceleration, and steady speed.On January 7, 1955, the 1307 was selected by GE as the alternate main fuel control for use in the J-79 engine. At that time, the primary main fuel control was manufactured by the Bendix Corp. (Bendix). In 1957, the 1307 was selected by GE as the primary main fuel control to be used in its J-79 engine and thus replaced the fuel control manufactured by Bendix as the primary fuel control.Petitioner's General Pricing Policy and ProcedureThe petitioner's first step in arriving at a list price for a product in production quantities is to determine the total manufacturing cost of the product according to its internal cost-accounting procedures. After the total manufacturing costs of the 1970 U.S. Tax Ct. LEXIS 51">56 product is determined, the petitioner's next step is to arrive at a net price for the product by adding a profit margin to its total manufacturing cost. Many factors are considered in determining the profit margin, including the market potential, the risk involved, and special circumstances (e.g., special tooling, special test equipment). The net price is used by the petitioner as the selling price when there is only one customer for the product.When there are several classes of customers, the petitioner determines a list price and the appropriate discounts from list price to be allowed to its customers for the product. These discounts are based upon the petitioner's analysis of industry practices and vary as between 55 T.C. 56">59 the petitioner's different product lines. For example, the largest or prime discount allowed by the petitioner in its industrial engine and turbine product line is 35 percent, whereas the prime discount allowed by the petitioner in its aircraft product line is 50 percent. Within each product line, the discounts vary according to customer classification, with the prime discounts allowed to so-called "original equipment manufacturers."The final step in arriving1970 U.S. Tax Ct. LEXIS 51">57 at the list price of the product is to add to the net price an appropriate markup so that sales at the list price less prime discount will yield the net price. For example, in the industrial engine and turbine product line in which the petitioner's prime discount is 35 percent, the list price is determined by dividing the net price by 65, the complement of the prime discount, and multiplying by 100. Similarly, in the aircraft produced line in which the prime discount is 50 percent, the list price is determined by dividing the net price by 50, and multiplying by 100.Sales of 1307's to GEThe petitioner's first sales of 1307's to GE were of prototype units. The petitioner began to sell 1307's to GE in production quantities in 1957 after GE had selected the 1307 as the primary main fuel control for the J-79 engine, and these sales continued throughout the taxable year in issue and thereafter on a regular and continuing basis.The petitioner's initial sales of 1307's in production quantities to GE were at net prices, which included the total manufacturing cost thereof plus a profit margin. However, prior to 1961, the petitioner developed a list price for the 1307, and in accordance1970 U.S. Tax Ct. LEXIS 51">58 with its general pricing policy, established discounts for the different classes of customers. According to this policy, the 1307's were sold to domestic original equipment manufacturers, and to the U.S. Government, at list price less a 50-percent discount; to foreign manufacturers and foreign governments, at list price less a 35-percent discount; to certain distributors and repair shops, at list price less a 25-percent discount; and to ultimate consumers, at the full list price. Since the establishment of the list price for the 1307's, all sales of such controls to GE have been at the list price less a 50-percent discount.In accordance with its general overall pricing policy of allowing no quantity discounts, the petitioner's allowance of a 50-percent discount from list price to GE for 1307's was not based on the volume or prospective volume of 1307 sales to GE. All 1307's sold to GE were priced f.o.b. Rockford, Ill. The petitioner's trademark was affixed to all 1307's sold to GE. In connection with its sales of 1307's to GE, the 55 T.C. 56">60 petitioner required GE to indemnify it against all liability arising from the testing or use of 1307's.The total volume of the petitioner's1970 U.S. Tax Ct. LEXIS 51">59 sales to GE in the taxable year in issue was $ 12,349,000, of which $ 11,158,000 consisted of sales of 1307's. During such taxable year, 75 percent of the profits of the aircraft product line division was derived from the sale of 1307's to GE; some of the sales of that division during that year were of development products on which there was little or no profit.The petitioner was not controlled, directly or indirectly, by GE; nor was GE controlled, directly or indirectly, by the petitioner.Sales and Service of 1307's by GEBeginning in 1957, GE offered for sale and sold all parts and accessories for the J-79 engine, including 1307's, to those firms licensed to produce the J-79 engine. However, GE's license agreements with its licensees did not require the licensees to purchase the parts and accessories from it.GE performed extensive selling activities through its sales apparatus with regard to parts and accessories for the J-79 engine, including 1307's. GE provided warranties against defects in materials and workmanship for all 1307's sold by it.Aircraft Sales to Other CustomersCanada required that a certain percentage of the components of J-79 engines manufactured1970 U.S. Tax Ct. LEXIS 51">60 by Orenda Engines Ltd., GE's Canadian licensee, had to be manufactured in Canada. The petitioner considered itself obligated to support GE's J-79 program in Canada by making it possible for 1307's to be manufactured to the required extent in Canada. For that reason, on December 2, 1959, the petitioner entered into a technical assistance agreement with Aviation Electric Ltd. (AEL), an unrelated Canadian subsidiary of Bendix. Under this agreement, the petitioner agreed (1) to sell to AEL certain 1307 parts or components and (2) to furnish AEL with the manufacturing know-how necessary to enable AEL to manufacture 1307's and certain spare parts therefor in its plant in Canada for use on Canadian-built J-79 engines for Canadian-built Starfighters. The agreement also provided that the petitioner would receive a royalty for its know-how and that it would sell the parts and components to AEL at list less a 50-percent discount.The petitioner sold other products in its aircraft product line to other original equipment manufacturers at list price less a 50-percent discount or at net prices which were the equivalent of list price less a 55 T.C. 56">61 50-percent discount in accordance with its1970 U.S. Tax Ct. LEXIS 51">61 standard pricing policy. For example, the petitioner sold propellor governors and related equipment to Cessna Aircraft Co., Beech Aircraft Corp., and Piper Aircraft Corp. at list price less a 50-percent discount. The petitioner also sold propellor governors and related equipment to the Hamilton Standard Division of United Aircraft Corp. and gas turbine fuel controls to Westinghouse Electric Corp. at net prices which were equal to list price less a 50-percent discount.Formation of GmbHPrior to April 22, 1961, the petitioner made no sales of 1307's directly to GE's European licensees for the J-79 engine. All sales of 1307's had been made directly to GE, which, in turn, resold them to its J-79 licensees.In 1961, the petitioner decided to enter into the European market for its 1307 controls through a wholly owned foreign subsidiary. Accordingly, on April 22, 1961, the petitioner organized Woodward Governor GmbH (GmbH) under the laws of the Swiss Confederation as a wholly owned subsidiary. GmbH's domicile was in Lucerne, Switzerland. The petitioner's initial investment for all quotas (equivalent to shares of stock in a domestic corporation) in GmbH was $ 23,255.81.Operations1970 U.S. Tax Ct. LEXIS 51">62 of GmbHFollowing its formation, GmbH (1) purchased 1307's from the petitioner for resale to GE's European licensees for the J-79 engine, and (2) sold in Europe, the Middle East, and Africa, on a commission basis, industrial engine and turbine controls manufactured in the petitioner's United States, Slough, and Schiphol plants. Prior to the formation of GmbH, the sales of the industrial engine and turbine controls were performed by employees of the petitioner's Slough and Schiphol plants.GmbH reimbursed the petitioner for any accounting services and other services that may have been performed on its behalf by the petitioner.Sales of 1307's to GmbHFollowing the formation of GmbH, the petitioner decided to sell 1307's to GmbH at list price less a 50-percent discount, the same price at which they were sold to GE.The petitioner began selling 1307's to GmbH shortly after the formation of GmbH, and these sales continued throughout the taxable year in issue and thereafter on a regular and continuing basis. The terms and conditions of the petitioner's sales of 1307's to GmbH were 55 T.C. 56">62 the same as the terms and conditions of its sales of 1307's to GE. The petitioner's trademark1970 U.S. Tax Ct. LEXIS 51">63 was affixed to all 1307's sold to and by GmbH.At the time of GmbH's formation, the petitioner also had to decide upon a commission rate to be paid to GmbH with regard to sales of industrial engine and turbine controls consummated as a result of GmbH's selling activities. The petitioner decided that a commission equal to 6 percent of the net selling price of such controls represented a fair compensation to GmbH for its selling activities. This conclusion was based on the selling expenses with regard to similar sales in the United States, which slightly exceeded 5 percent of the net sales price of these products.Sales and Service of 1307's by GmbHHaving purchased 1307's from the petitioner at list price less a 50-percent discount, GmbH offered 1307's for sale to GE's European licensees for the J-79 engine at the petitioner's list price less a discount of approximately 35 percent.GmbH performed sales and service activities with regard to 1307's. These activities included personal visits to customers and potential customers; assistance in setting up test stands for 1307's for customers; training of customers' technicians as to overhauling, operating, and servicing 1307's; advising1970 U.S. Tax Ct. LEXIS 51">64 customers as to the types of spare parts inventories they should keep; advising customers as to the types of tools they needed; answering trouble-shooting calls; providing training films and cutaway governors; and performing crash investigations involving Starfighter aircraft.GmbH and GE were in direct competition with each other for the sale of 1307's to GE's licensees in Europe. For example, GmbH attempted to make sales to the J-79 licensees of GE who were buying 1307's from GE. Similarly, GE attempted to sell 1307's to GmbH's principal customer for 1307's.The first order received by GmbH was for seventy-three 1307's from Fabrique Nationale d'Armes de Guerre, S. A. (Fabrique Nationale), Belgium, a licensee of GE for the J-79 engine. This order was received by GmbH from Fabrique Nationale in May 1961, approximately 1 month after GmbH was organized. The negotiations with Fabrique Nationale with regard to this order took place prior to the formation of GmbH and were carried out by W. J. Whitehead, who at that time was the petitioner's vice president in charge of foreign operations. Mr. Whitehead advised Fabrique Nationale that it was the petitioner's intention to form a European1970 U.S. Tax Ct. LEXIS 51">65 subsidiary to handle all European sales of 1307's. Fabrique Nationale's order for the seventy-three 1307's was accepted and completed by GmbH. Delivery of such controls was 55 T.C. 56">63 scheduled for 1962, prior to the beginning of the taxable year in issue. Fabrique Nationale was GmbH's principal customer for 1307's from the time of its formation throughout the taxable year in issue.During the taxable year in issue, GmbH negotiated the conditions of sale, price, delivery date, and other terms of sale with regard to 1307's sold by it. All purchase orders for 1307's obtained through the sales efforts of GmbH were accepted by GmbH itself. GmbH passed title to, and assumed full risk of loss for, all 1307's sold by it, and it provided its customers with warranties against defects in materials and workmanship. GmbH assumed sole responsibility for patent infringement suits against GmbH or the petitioner arising out of sales of 1307's by GmbH and agreed to indemnify the petitioner against all liability arising from the testing or use of 1307's.Subsequent to 1963, GmbH sold 1307's to Mitsui in Japan, but the record does not reveal the circumstances surrounding the sales and service of1970 U.S. Tax Ct. LEXIS 51">66 such controls.GmbH provided no postsales service or warranties with respect to its sales of nonaircraft controls as the agent of the petitioner.Set forth below is an income statement for GmbH for its fiscal year ending September 30, 1963:Sales (type 1307 fuel controls)$ 1,868,446Less: Cost of sales1,470,554397,892Sales commissions on diesel governors:6% of $ 1,037,14662,229460,121Selling, service, and administrative expenses122,219337,902Miscellaneous income0 Net income337,902OPINIONThe issue for decision is whether the respondent was authorized under section 482 to reallocate certain income from GmbH to its parent company, the petitioner.Section 482 provides:SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS.In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, 55 T.C. 56">64 the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or 1970 U.S. Tax Ct. LEXIS 51">67 businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.The purpose of section 482, as interpreted by the respondent, is set forth in section 1.482-1(b)(1) of the Income Tax Regulations:(b) Scope and purpose. (1) The purpose of section 482 is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer, the true taxable income from the property and business of a controlled taxpayer. The interests controlling a group of controlled taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the taxable income from the property and business of each of the controlled taxpayers. If, however, this has not been done, and the taxable incomes are thereby understated, the district director shall intervene, and, by making such distributions, apportionments, or allocations as he may deem necessary of gross income, deductions, credits, or allowances, 1970 U.S. Tax Ct. LEXIS 51">68 or of any item or element affecting taxable income, between or among the controlled taxpayers constituting the group, shall determine the true taxable income of each controlled taxpayer. The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.See Local Finance Corporation v. Commissioner, 407 F.2d 629 (C.A. 7, 1969), affirming 48 T.C. 773">48 T.C. 773 (1967). The petitioner invites us to hold that regulation invalid and to apply a test other than the arm's-length standard. However, in view of our conclusions in the case, it is unnecessary for us to deal with that argument -- we shall apply the arm's-length standard.In situations involving sales of tangible property between members of the same controlled group, three specific pricing methods are provided by the regulations to determine arm's-length price: The comparable uncontrolled price method; the resale price method; and the cost plus method. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. If comparable uncontrolled sales exist, the regulations provide that the comparable uncontrolled price method must1970 U.S. Tax Ct. LEXIS 51">69 be utilized in determining the arm's-length price, "because it is the method likely to result in the most accurate estimate of an arm's length price." Sec. 1.482-2(e)(1)(ii). If no comparable uncontrolled sales exist, the resale price method must be used, if applicable, since it is considered more desirable than the cost plus method. Finally, if the resale price method is not applicable, the cost plus method must be used. If none of the three tests can reasonably be applied, "some [other] appropriate method of pricing * * * can be used." Sec. 1.482-2(e)(1)(iii).The respondent takes the position that the sales to GE were not comparable to, and did not establish an arm's-length price for, the 55 T.C. 56">65 sales to GmbH. He determined that in connection with the sales of the 1307's, GmbH acted merely as a commission agent, although he recognizes that it should receive a larger commission in connection with such sales than it received for its sales of the industrial engine and turbine controls. In his determination, he recomputed the income of GmbH by allowing it a 7-percent commission on such sales, and he reallocated to the petitioner the balance of the income shown by GmbH in connection1970 U.S. Tax Ct. LEXIS 51">70 with its sales of 1307's.Section 482, by its terms, gives the respondent unlimited authority to reallocate income and other items when necessary to prevent tax evasion or to reflect income clearly. When his reallocation is challenged, the courts have upheld his action unless it is shown that he acted arbitrarily, unreasonably, or without justification. Ballentine Motor Co. v. Commissioner, 321 F.2d 796 (C.A. 4, 1963), affirming 39 T.C. 348">39 T.C. 348 (1962); Hall v. Commissioner, 294 F.2d 82 (C.A. 5, 1961), affirming 32 T.C. 390">32 T.C. 390 (1959); Grenada Industries, Inc., 17 T.C. 231">17 T.C. 231 (1951), affd. 202 F.2d 873 (C.A. 5, 1953), certiorari denied 346 U.S. 819">346 U.S. 819 (1953). However, his action will not be upheld when it is found that there is no rational justification for such action. Nat Harrison Associates, Inc., 42 T.C. 601">42 T.C. 601 (1964).From the record before us, we have concluded that the evidence does not support the respondent's determination. The respondent claims to1970 U.S. Tax Ct. LEXIS 51">71 have applied the resale price method described in section 1.482-2(e)(3) of the Income Tax Regulations; he refers to the provision in subdivision (vii) thereof indicating that the method may be applied when the reseller performs services similar to those of a sales agent. However, he takes that provision out of context. It is clear that the resale price method described in the regulations is not applicable to this situation. The objective of that pricing method is to determine the arm's-length price for controlled sales to a person who resells the product by reducing the resale price by the markup earned by resellers in uncontrolled purchases and sales. The method can only be applied when there are uncontrolled purchases and resales by the same reseller or a similar reseller. Similarly, although the method can be applied when the reseller is acting merely as a sales agent who receives a commission for its services, the commission must be established by reference to uncontrolled transactions. In this case, the respondent based his determination on the commissions charged by GmbH for its sales of industrial engine and turbine controls, but those sales did not involve uncontrolled1970 U.S. Tax Ct. LEXIS 51">72 transactions. The commissions were established by the petitioner, which controlled GmbH, and therefore, they do not provide a basis for applying the resale price method.Even more importantly, the activities of GmbH in connection with the sales of the industrial engine and turbine controls and the sales of 55 T.C. 56">66 the 1307's were significantly different. In its sales of 1307's, GmbH took title to the controls and in turn sold them to the engine manufacturers. Accordingly, GmbH assumed the warranties of a seller and incurred the credit risks. In addition, by its contract with the petitioner, it undertook to indemnify the petitioner against any tort liability. It also incurred the responsibility of furnishing services subsequent to the sale of the 1307's. The respondent points out that the petitioner, not GmbH, arranged for the first sale of the 1307's to Fabrique Nationale and questions whether GmbH performed the selling and servicing activities in connection with the sales of 1307's to Mitsui. However, the initial sale to Fabrique Nationale occurred prior to the beginning of the taxable year in issue, and the sales to Mitsui occurred subsequent to such year. Whether the price1970 U.S. Tax Ct. LEXIS 51">73 charged GmbH for those sales was an arm's-length price is not in issue in this case. Moreover, although the respondent has raised some doubts in connection with the sales to Mitsui, there is no evidence that GmbH did not perform the customary selling and servicing activities.In view of the very significant differences between the nature and extent of GmbH's responsibilities in connection with the sales of the industrial engine and turbine controls and the sales of the 1307's, we find and hold that the respondent acted unreasonably and without justification in his determination.On the other hand, the petitioner has convinced us that the comparable-price method is applicable in this case and that its sales of 1307's to GE established an arm's-length price for its sales to GmbH. When the petitioner decided to enter the European market for 1307's, it was not oblivious of the fact that it could thereby earn and retain a greater profit on the sale of such controls. The profit earned by GmbH was, after all, the profit of the petitioner. That inducement to enter the European market does not affect the issue before us. Our only interest is in determining whether the sales to GmbH were1970 U.S. Tax Ct. LEXIS 51">74 at an arm's-length price so that the petitioner realized, and subjected to United States taxation, an appropriate portion of the profits on the ultimate sales to the European manufacturers.Under the comparable-price method, the arm's-length price is determined by reference to comparable sales to uncontrolled persons. GE was clearly an uncontrolled person, but the respondent contends that the sales of 1307's to it were not comparable. The respondent vigorously argues that under the petitioner's pricing policy, the prime discount was allowed only to domestic original equipment manufacturers and to the U.S. Government and that the petitioner favored GmbH by allowing it the prime discount. When it became necessary for the petitioner to establish the price to be charged GmbH for 1307's, the 55 T.C. 56">67 petitioner decided to allow it the prime discount since it would be selling in competition with GE. No doubt, GmbH was not an original equipment manufacturer, but since it would be selling in competition with GE, the price charged it would have to be equal or close to that charged GE, if it was to realize any profit on the resale of 1307's.Although GE was an original equipment manufacturer, 1970 U.S. Tax Ct. LEXIS 51">75 it was acting as a distributor in dealing with its European licensees -- it was purchasing the 1307's from the petitioner and reselling them to those licensees. The sales to GmbH were clearly comparable to those transactions. Under the Income Tax Regulations, sec. 1.482-2(e)(2), for a sale to be comparable, both the property and the circumstances of the sale must be identical. One of the circumstances to be considered is the level of the market. When we consider the sales to the ultimate purchasers, the European manufacturers of the J-79 engines, the sales of 1307's to GE and to GmbH were at the same market level. Moreover, both GE and GmbH performed comparable selling and servicing activities in connection with such sales. Both GE and GmbH were soliciting the European manufacturers of the J-79 engines and attempting to sell them the 1307's. Both warranted their products and stood ready to furnish postsales services. The evidence convinces us that GmbH furnished as much postsales services as did GE.For the sales to be comparable, the terms of sale must be the same. In form, the terms of the sales to GE and to GmbH were the same, but the respondent urges us to look back of1970 U.S. Tax Ct. LEXIS 51">76 the form and conclude that in substance they were not comparable. Both GE and GmbH undertook to indemnify the petitioner against any tort liability, but the respondent contends that the promise by GmbH was not comparable in substance. In connection with the purposes for establishing GmbH, we were told that the petitioner was concerned about possible tort liability. There was some fear that a Starfighter might come down in a heavily populated area, causing extensive damage and resulting in substantial tort claims, especially if it were carrying nuclear weapons. However, we have no evidence as to the likelihood of such a tragedy occurring, nor as to the extent of the petitioner's possible liability. There was some indication that the petitioner had some insurance against such liability, and it is not clear as to what would be the petitioner's liability under European law. The respondent asks us to assume that the promise of GE was worth substantially more than that of GmbH; yet, we have no evidence as to GE's financial soundness. So far as we know, it may be as reliable as the Rock of Gibraltar, but recent events have demonstrated that not all business giants are financially 1970 U.S. Tax Ct. LEXIS 51">77 sound. It sometimes requires a very sophisticated analysis of a financial report to determine the financial soundness of the business. 55 T.C. 56">68 What the respondent is asking us to do is to speculate as to the occurrence and amount of such tort liability and as to the financial reliability of GE and GmbH. Since the petitioner has proved that the terms of the sales of 1307's to GE and GmbH were the same, it seems to us that if the respondent wishes to establish that those sales differed in substance, he must do more than merely raise questions and ask us to speculate as to their answers. Under these circumstances, we are satisfied that the terms of sale were comparable.In considering whether the sales to GE were comparable and established an appropriate arm's-length price for the sales to GmbH, it should be remembered that the sales of 1307's to GE produced very satisfactory profits for the petitioner. Although its overall profits, expressed as a percentage of sales, were only 13 percent, it realized 17 percent from the sales in the aircraft product line. The petitioner was unable to furnish information as to its profits on the sales of 1307's, but sales of 1307's to GE constituted1970 U.S. Tax Ct. LEXIS 51">78 approximately 75 percent of the business done in the aircraft product line. Since some of the business in that product line was performed at little or no profit, it appears that the sales of 1307's to GE must have yielded 17 percent or more. Thus, this is not a situation in which a price was established by reference to sales in which there was little or no profit. Eli Lilly & Co. v. United States, 372 F.2d 990 (Ct. Cl. 1967). The sales to GE were producing satisfactory profits, and there was no reason to attempt to earn more on the sales to GmbH.Although the respondent asserts that the petitioner would not have sold the 1307's to an independent company situated similarly to GmbH, there is no evidence to support that assertion. There is no evidence that the petitioner charged more for 1307's in sales to persons situated similarly to GmbH. In fact, aside from the sales to GE, the other most comparable sales were those to AEL. Parts for the 1307's were sold to AEL at the same prime discount -- list less 50 percent, even though it, like GmbH, was not an original equipment manufacturer in the United States. It was a Canadian corporation; yet, 1970 U.S. Tax Ct. LEXIS 51">79 it received the prime discount.Under all the circumstances, we find and hold that the respondent acted arbitrarily in treating GmbH as a mere sales agency entitled to a commission on its sales of 1307's and that the petitioner has proved that the sales of 1307's to GE and GmbH were comparable.In order to reflect other ajustments,Decision will be entered under Rule 50. 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/4623353/	Leslie Q. Coupe and Maybelle Coupe, Petitioners v. Commissioner of Internal Revenue, RespondentCoupe v. Comm'rDocket No. 861-65United States Tax Court52 T.C. 394; 1969 U.S. Tax Ct. LEXIS 116; June 11, 1969, Filed 116 Decision will be entered under Rule 50. Petitioners contracted to sell their farm (Elk Grove), which included about 2 acres immediately surrounding their residence, to S.P. for $ 2,500 per acre in a series of conveyances. S.P. contracted to pay interest on all deferred payments. Subsequently petitioners and S.P. reformed their contract so that petitioners exchanged parcels of Elk Grove with third parties for (respectively) property of like kind, a deed-of-trust note, a new residence, and cash. Said third parties included petitioners' attorneys, who purchased the exchange properties in their own names. Simultaneously the third parties conveyed Elk Grove to S.P. for $ 2,500 per acre. Held:1. Petitioners exchanges of Elk Grove property for property of like kind qualified as currently nontaxable transactions under sec. 1031 of the Code. Their exchange for the deed of trust note was not, inter alia, an exchange for like property and did not qualify under that section.2. Petitioners received $ 2,500 per acre for the 1.936 acres which constituted their residence; consequently, only $ 4,840 qualified for nonrecognition of gain on replacement of the residence under sec. 1034.3. A portion 117 of the cash petitioners received represented interest income.4. A $ 5,000 attorney's fee paid by petitioners in 1960 is allocated 20 percent as a selling expense of Elk Grove (either deductible, or as an adjustment to basis dependent upon time of recognition) and 80 percent to acquisition of properties.5. The amount of $ 6,000 received by petitioners' attorneys in 1961 was not a profit realized by them but was a fee from petitioners; represented a part of petitioners' receipts from the Elk Grove disposition, and 80 percent of such amount constituted currently nondeductible attorneys' fees paid in connection with the acquisition of property. The remaining 20 percent was a selling expense of Elk Grove, either deductible, or as an adjustment to basis dependent upon time of recognition.6. Certain selling expenses allocated to taxable and nontaxable transactions. Lee M. Galloway, for the petitioners.Gordon B. Cutler, for the respondent. Forrester, Judge. Drennen, J., dissents. Simpson, J., concurring. Raum, J., dissenting. Tietjens and Withey, JJ., agree with this dissent. FORRESTER394 Respondent has determined deficiencies in petitioners' Federal income taxes for the calendar years 118 1960 and 1961 in the amounts of $ 16,807.34 and $ 47,453.81, respectively.The issues for decision are:Whether the taxpayers sold their entire farm for cash, or whether they exchanged part of it for property of like kind. If there was an exchange, the amount of the unrecognized gross sales price attributable to petitioners' exchange must be determined.395 The amount which petitioners received for the sale of their residence located on the farm.Whether any amount of cash received in connection with the sale of the farm represented interest income to petitioners.Whether $ 5,000 and $ 6,000 amounts received by petitioners' attorneys during 1960 and 1961, respectively, in connection with the farm sale, represented income to petitioners and, if so, whether such amounts also constituted deductible expenditures.The correct allocation and deductibility of selling expenses which petitioners incurred in the sale of their farm.FINDINGS OF FACTSome of the facts are stipulated and they are so found.Petitioners Leslie Q. Coupe and Maybelle Coupe (hereinafter sometimes called the Coupes or Leslie and Maybelle, respectively), husband and wife, resided in Galt, Calif., at the time the petition in the 119 instant case was filed. Their joint Federal income tax returns for the calendar years 1960 and 1961 were filed with the district director of internal revenue at San Francisco, Calif.Leslie and Maybelle are farmers. In 1945 they purchased 188.943 acres of farmland near Elk Grove, Calif. (hereinafter sometimes called the Elk Grove property). During all pertinent times the land was farmed continuously and primarily held for the purpose of farming.In 1958 and 1959 Leslie and Maybelle received two unsolicited offers from a neighbor to buy the Elk Grove property for first $ 250 per acre and then $ 800 per acre. They refused both offers. On March 12, 1960, the Coupes granted an option to Malcolm K. Grant (hereinafter sometimes referred to as Grant), a real estate broker, to purchase the farm for $ 2,250 per acre. This option eventually led to a contract between the Coupes and Southern Pacific Co. (hereinafter sometimes referred to as S.P.), which called for the Coupes to sell the Elk Grove property for $ 2,500 per acre. The relevant provisions of this agreement are reproduced below:This Agreement, made this 1st day of June, 1960, by and between LESLIE QUENTIN COUPE and MAYBELLE COUPE, 120 husband and wife, Sellers, and SOUTHERN PACIFIC COMPANY, a corporation, Buyer;Witnesseth:Sellers hereby agree to sell and Buyer agrees to buy, subject to terms hereof, that real property situate, lying and being in the County of Sacramento, State of California, described as follows: * * 1. Sellers, at their expense, will cause said property to be surveyed by a registered civil engineer who shall furnish a mutually satisfactory and simplified metes and bounds description of the property, and who shall determine the number of acres in said property. The metes and bounds description shall replace the above description for all purposes hereunder.396 2. Purchase price of the land or any part or parcel thereof shall be Two Thousand, Five Hundred (2,500) Dollars per acre acreage to be determined by the aforementioned survey.3. Buyer shall acquire title to, and Sellers shall convey said property in parcels, as follows:(a) Upon execution of this agreement, Buyer shall deposit the sum of Twenty-five Thousand (25,000) Dollars in escrow; Sellers shall as soon as practicable convey to Buyer a portion or parcel with area equal to twenty-nine (29) per cent of the total area of said land, the location 121 of said portion to be mutually agreed by the parties. At the time of such conveyance Buyer will pay the balance of the purchase price of said twenty-nine (29) per cent portion over and above the initial payment of Twenty-Five Thousand (25,000) Dollars, and this first escrow shall close. It is understood the portions herein referred to are not undivided interests in the whole of said land, but rather parcels within said land.(b) Buyer shall acquire at least twenty-five (25) per cent of the remainder of the area of said land in each of the four (4) years following the conveyance set forth in (a) above, paying therefor at the rate herein specified, provided, that Buyer may accelerate acquisition in any manner it desires after one (1) year from the conveyance set forth in (a), and provided further that payment may be made by an exchange transaction as hereafter described.4. Buyer shall pay interest at the rate of six (6) per cent per annum on unpaid portions of the total purchase price for all the land.5. Buyer shall have the right to pay for any acquisition covered in 3(b) hereof by a conveyance of property, hereafter called "exchange property", of value equal to or less than the price 122 of the parcel being acquired. If the value of such exchange property is less than the price of the parcel acquired, Buyer shall pay the difference in cash. It is understood, however, Buyer shall pay by means of exchange property only if at the time of such transaction a purchaser stands ready, willing and able to buy such exchange property from Sellers. The value of the exchange property to Sellers shall be measured by the price offered by such purchaser.6. After execution of this agreement Sellers shall remain in possession of all of the property without rental or other payment to Buyer for a period of one hundred eighty (180) days. Thereafter Buyer shall have possession of all of the property without rental or other payment to Sellers, and together with all rights incident thereto, including the right to lease, to receive rental, and to conduct operations of every sort.7. Sellers shall make all conveyances hereunder by good and sufficient grant deed, free and clear of all encumbrances except easements of record.8. Sellers shall provide and pay for policy or policies of title insurance for Buyer. Sellers shall pay for all revenue stamps and any broker's or other commissions due 123 on this transaction. Current taxes shall be pro-rated as of the date first herein written. Buyer shall pay all recording fees. Other expenses shall be in accordance with usual practice in Sacramento County, California.9 This agreement shall inure to the benefit of and be binding upon the successors and assigns of the Sellers and the assigns of Buyer.In Witness Whereof, Sellers and Buyers have executed these presents the day and year first herein written.(S) Leslie Quentin Coupe(S) Maybelle CoupeSouthern Pacific Company.By [Illegible], Vice PresidentAttest:[Illegible], Assistant Secretary397 In a separate agreement, the Coupes agreed to pay Grant a commission of 10 percent of the sales price, payable one-half at the close of the first escrow under paragraph 3(a), and the balance at the close of the escrow under paragraph 3(b).After signing the above agreement, the Coupes went over its provisions and noticed that while paragraph 3 called for a series of conveyances for cash, paragraph 5 provided for the possibility of an exchange of properties rather than a cash payment by S.P. for all conveyances after the first one. Since the Coupes wished to continue to farm after they had disposed 124 of the Elk Grove property, they contacted Edwin B. Polhemus (hereinafter sometimes referred to as Polhemus), an attorney, with regard to arranging an exchange whereby they could receive farm property for the Elk Grove property. Prior to contacting Polhemus, the Coupes had not been represented by counsel.Polhemus advised the Coupes that it would be possible for them to delay paying a capital gains tax on the sale of the Elk Grove property if they exchanged it for property of like kind. After reviewing the above agreement he informed the Coupes that he thought it would be possible to have S.P. acquire properties which it could then use for an exchange under paragraph 5. This type of arrangement was agreeable to the Coupes and they authorized Polhemus to see if he could find suitable properties and arrange the exchange. Shortly thereafter Polhemus was joined by another attorney, John L. Brannely (hereinafter sometimes referred to as Brannely), for the purpose of arranging and transacting the exchanges.Polhemus attempted to persuade S.P. to modify the sales agreements' terms to provide for S.P.'s purchase of suitable exchange properties, and during the same period of time he made arrangements 125 for the purchase of two parcels of farmland which the Coupes had chosen for the exchanges.On July 7, 1960, Polhemus and Brannely, acting as "trustees and agents for an undisclosed principal," obtained an option on a farm owned by Paul and Jessie McEnerney (hereinafter referred to as the McEnerney property). The option called for a cash downpayment of $ 19,800 on a total purchase price of $ 66,000. The remaining $ 46,200 was to be secured by a note and deed of trust on the McEnerney property. At the time Polhemus and Brannely executed the agreement, they intended that the undisclosed principal would be S.P. and not the Coupes.On July 15, Brannely made an offer to Polhemus to purchase farmland from the Estate of Elizabeth Sala, deceased (hereinafter referred to as the Sala property), for $ 55,000. The offer was made to Polhemus, as he was administrator of the estate, and was accepted by him subject 398 to court approval. Polhemus had recommended the property to the Coupes, but informed them that, under the provisions of the California law, he as administrator could exchange it only for cash. A sale of the property to Brannely for cash and Brannely's sale of the property to S.P. for 126 exchange of the property with the Coupes was thus agreed upon as the most practical course to pursue. Though Brannely agreed to purchase the property for purposes of the exchange, he was not acting as agent for the Coupes in the purchase and was willing to retain the property if an exchange with the Coupes or sale to S.P. did not materialize.Polhemus attempted but failed to have S.P. agree to take title in its name to either the McEnerney or Sala property for purposes of exchanging property for the Elk Grove property, however, he was able to persuade S.P. to allow the Coupes to exchange an Elk Grove parcel of land for the McEnerney and Sala properties with third parties and then have S.P. purchase the Elk Grove parcels from those third parties.Under the June 1 sales agreement between S.P. and the Coupes, supra, the Elk Grove property was to be conveyed in a series of transactions. Under paragraph 3(a), 29 percent of the Elk Grove property was to be transferred to S.P. for cash as soon as practicable and the balance a minimum of 1 year thereafter. Pursuant to the provisions of that agreement, on August 2, 1960, S.P. placed $ 111,982.50 in escrow with the Alameda County-East Bay Title 127 Co. (hereinafter referred to as East Bay), which amount added to a prior $ 25,000 deposit called for by the agreement totaled $ 136,982.50 in full satisfaction of S.P.'s obligation under paragraph 3(a). The escrow instructions were in accord with the June 1 agreement, with the exception that the instructions provided that the escrow amount was to be paid to the Elk Groveowners of record rather than to the Coupes. That paragraph reads as follows:We have been informed that the Coupes desire to convey the property described in Item #3 in exchange for other property they desire and that this party or parties will convey to Alameda County-East Bay Title Company. Therefore, you are instructed to cause the total sum of $ 136,982.50, which includes the $ 25,000 now on deposit with Western Title Guaranty Company, to be paid to owners of record when property outlined in Item #3 above is conveyed to Alameda County-East Bay Title Company for account of Southern Pacific Company under usual form of holding agreement and Western Title Guaranty Company is prepared to issue its standard form of policy of title insurance in amount $ 136,982.50 showing title vested in Alameda County-East Bay Title 128 Company, free and clear of all encumbrances except easements of record and taxes for fiscal year 1960-61 a lien not yet due and payable.Between August 2 and 8, 1960, escrows were established with instructions furnished to the Western Title Guaranty Co. by S.P. or 399 East Bay, the Coupes, the McEnerneys, and John Brannely, which resulted in the following grant deeds being recorded simultaneously on August 9, 1960, and escrows closed as of that date:"Transaction"PropertyGrantorGranteeASalaPolhemus, asadministrator Brannely.ASalaBrannely (and wife)Petitioners.A22.00 acres of Elk GroveFarm PetitionersBrannely.A22.00 acres of Elk GroveFarm Brannely (and wife)S.P. (nominee).BMcEnerneyMcEnerneysPetitioners.B17.92 acres of Elk GroveFarm PetitionersMcEnerneys.B7.92 acres of Elk GroveFarm McEnerneysS.P. (nominee).C24.873 acres of Elk GroveFarm PetitionersS.P. (nominee).As a result of these transactions, the $ 136,982.50 paid to East Bay by S.P. was distributed as follows: Estate of Sala, $ 55,000; Paul and Jessie McEnerney, $ 19,800; Leslie and Maybelle Coupe, 129 $ 62,182.50. From the Coupes' $ 62,182.50 the following expenses were deducted by the escrow agent as charges against the various escrows as follows:Charged to parcel of Elk Grove FarmExpenseFromFromFromSala farmMcEnerneypetitionersexchangeexchangeto S.P.(22 acres)(7.92 acres)(24.873 acres)Grant's commission$ 5,500.00$ 6,600.00$ 11,517.88Title insurance314.00164.00346.00Revenue stamps1 121.0022.0068.75Recording fees1 4.002 4.002.80Insurance prorate13.05130.75Attorneys' fee -- Polhemus & Brannely5,000.00Land survey1,577.80Taxes pro rata271.975,952.056,920.7518,785.20Balance to petitioners, $ 30,524.50.On December 28, 1960, S.P. instructed the East Bay Title Co. that it was completing the Elk Grove property purchase and that, inter alia, East Bay was to pay $ 335,375 plus interest of $ 7,657.73 in accordance with the terms of the June 1, 1960, agreement. As in the instructions for the transfer of the 29-percent interest, reference was made to the owners of record of the Elk Grove property rather than to the Coupes for purposes of title transfer and payment of expenses. The instructions specified that the transaction 130 was to be completed on or before January 3, 1961.Though the June 1 agreement provided that the final purchase of the Elk Grove property was not to occur until 1 year from the completion of the first escrow, the Coupes were amenable to an early completion of the agreement. In the meantime two other parcels of farmland had been found which petitioners wished to obtain. For 400 convenience these properties will be referred to as the Schauer and the Bettencourt property, respectively. In an attempt to further reduce the Coupes' currently taxable capital gain, Polhemus also felt that an exchange of Elk Grove property for the $ 46,200 deed of trust note on the McEnerney property plus the interest thereon would qualify for nonrecognition treatment. In addition he decided that if the Coupes sold the 1.936 acres, which constituted their residence, separately for $ 20,000, rather than for the $ 2,500 per acre called for by the June 1 agreement, they would be able to further postpone part of this gain under section 1034 of the Code, 1 which provides for nonrecognition of gain on the sale of a residence to the extent that it is replaced by a residence of equal or greater value within 1 year of 131 the date of sale.In order to accomplish the above objectives, prior to any transactions involving the proposed 1961 transactions, the Coupes agreed with Polhemus and Brannely that the latter would no longer be the Coupes' attorneys. Any services performed by them for the Coupes' benefit would be merely as an accommodation. Instead of attorneys' fees being paid to them, it was intended that the attorneys realize a $ 6,000 profit in regards to the proposed exchanges. In fact, however, in the following transactions and negotiations, Polhemus prepared a number of escrow instructions for the Coupes and at times represented himself to others as the Coupes' attorney.Between December 22, 1960, and January 3, 1961, various escrows were established and instructions submitted, and on January 10, 1961, the following grant deeds were recorded: PropertyGrantorGranteeSchauerSchauersBrannely and Polhemus(and wives). SchauerBrannely and PolhemusPetitioners.(and wives). BettencourtBettencourt1132 Brannely and Polhemus (and wives). BettencourtBrannely and PolhemusPetitioners.(and wives). 1.936 acres of ElkPetitionersBrannely and PolhemusGrove Farm. (and wives). 132.214 acres of ElkPetitionersBrannely and PolhemusGrove Farm. (and wives). Above two parcels ofBrannely and PolhemusS.P. (nominee).Elk Grove Farm. (and wives). 401 In addition the $ 46,200 McEnerney property deed of trust and note was assigned to Brannely (and wife), who in turn assigned their interest to petitioners.The $ 343,032.73 paid by S.P. was distributed by the escrow agent as follows:RecipientAmountPetitioners for residence$ 20,000.00Petitioners for balance of Elk Grove Farm115,646.93Farmers & Merchants Bank for assignment (deed-of-trust2note plus interest) 47,385.80Schauers for property75,000,00Bettencourt for property79,000.00Balance to Polhemus & Brannely1 6,000.00343,032.73The $ 135,646.93 which petitioners received was distributed as follows:DisbursementAmountGrant's commission$ 23,617.88Title insurance1,202.00Revenue stamps370.15Recording fees -- deeds and assignment20.00Interest on McEnerney note61.60Title fee on assignment of McEnerney deed of trust114.40Balance to petitioners110,260.90Total 135,646.93On November 1, 1960, the Coupes 133 moved their household goods to their new residence on the McEnerney property. Their livestock stayed on the Elk Grove property until early in 1961. At the date of trial the Coupes continued to live on the McEnerney property and raise beef cattle and hay. They also continued to own the other properties received in the 1960 and 1961 transactions. The Sala property was leased to a dairy for $ 2,400 per year and used in connection with the dairy business; the Bettencourt property was sharecropped for one-third of the seed produced; and the Schauer property was leased for $ 3,600 a year and used to grow crops.On their Federal income tax return for the calendar year 1960, the Coupes reported the 1960 transaction as follows: 402 Parcel of Elk Grove Farm7.92 acres22 acres24.873 acresSales price$ 19,800$ 55,000$ 62,1831134 Less: cost sale expenses 4751,3201,4927,5137,94615,783Gain2 11,8122 45,73444,908On their Federal income tax return for the calendar year 1961, the Coupes reported the 1961 transaction as follows:Parcel of Elk Grove FarmResidence132.214 acres(1.936 acres)Sales price$ 20,000$ 323,033Less:Cost (less depreciation) 2,60317,0783Sale expenses 1,50329,821Gain15,894276,134Tax free1 14,3472 131,633Taxable1,547144,501In his statutory notice of deficiency, respondent determined the Coupes' capital gain on the sale of the Elk Grove property as follows, accompanied by the following explanations:On your 1960 income tax return you reported the exchange of 7.92 acres of your farm, the exchange of 22 acres of your farm, and the sale of 24,873 acres of your farm. You considered the exchanges 135 as tax free and reported a long-term capital gain on the sale. It has been determined that all this property was sold; therefore, the gain is all taxable as long-term capital gain. In the computation of the gain claimed expenses have been reduced from $ 31,242.00 to $ 15,137.86. This is based on allowing 10% sales commission, survey costs based on an allocation of the entire cost on an acreage basis, and allowing title insurance, revenue stamps and recording expenses only on the final transfer of the property. The payment of $ 5,000.00 to Polhemus and Brannely is not an allowable expense of sale. 403 1960 SALESales price, 54.793 acres at $ 2,500 an acre$ 136,982.50Less: Cost, as reported$ 3,287.00Sales expenses: Grant's commission, 10 percent of sales price $ 13,698.25Title insurance, as reported 824.00Revenue stamps: 22.00 acres $ 60.507.92 acres 22.0024.873 acres 68.75151.25Recording fees: 22.00 acres $ 2.007.92 acres 2.0024.873 acres 2.806.80Land survey, 54.793/188.943 x $ 1577.80457.5615,137.8618,424.86Capital gain118,557.64On your 1961 income tax return you reported the sale of your residence for $ 20,000.00 and the sale and exchange 136 of 132.214 acres of your farm for $ 323,033.00. You reported only a portion of the gain on these two transactions as taxable long-term capital gains based on your purchase of a new residence and based on your contention that you received two other properties in exchange for a portion of the reported sales price. It has been determined that you sold the entire property of 134.150 acres for $ 2,500.00 per acre for a total of $ 335,375.00 and that you received taxable interest income of $ 7,657.73 on the transaction. $ 4,840.00 of the sales price is allocated to the residence property of 1.936 acres and, as you purchased a new residence for an amount in excess of $ 4,840.00, no taxable gain results on the residence portion of the sale. The gain on the balance of the property (132.214 acres) is all taxable to you as long-term capital gain. Expenses are allowed in the computation of the gain based on 10% sales commission, a pro rata share of the survey expenses, and title insurance, revenue stamps and recording expenses incurred in the final transfer of the property. The amount of $ 6,000.00 received by Polhemus and Brannely is not an allowable expense of sale.1961 SALEResidenceBalance(1.936 acres)(132.214 acres)Sales price, at $ 2500 an acre$ 4,840.00$ 330,535.00Less: Adjusted cost, as reported2,603.0017,078.00Sales expenses: Grant's commission, 10 percent of sales price 484.0033,053.50Title insurance, pro rata 17.351,184.65Revenue stamps, pro rata 5.34364.81Recording fees, pro rata .2919.71Land survey ($ 1,577.80 less $ 457.56 applicable to 1960) 16.171,104.07Capital gain1,713.85277,730.26137 404 OPINIONOn June 1, 1960, petitioners entered into an agreement with Southern Pacific Co. (S.P.) to sell S.P. their 188.943-acre farm (Elk Grove property) for $ 2,500 per acre, plus interest. S.P. made an initial $ 25,000 deposit. Thereafter in two separate escrow transactions (terminating on August 9, 1960, and January 10, 1961, respectively), S.P. paid in the amounts of $ 111,982.50 and $ 343,032.73, respectively, with the instruction that such amounts were to be paid to the title holders of the Elk Grove property. The latter amount included $ 7,657.73 in interest. S.P. thereafter received Elk Grove parcels of 54.793 acres and 134.150 acres in 1960 and 1961, respectively.Rather than simply transferring title in the Elk Grove property to S.P. and receiving cash, however, petitioners arranged to have it transferred to S.P. after they had entered into certain exchanges for said property, simultaneously with the closing of the two escrows with S.P. After the exchanges were completed they had received title to four parcels of property, called the McEnerney, Sala, Schauer, and Bettencourt properties, respectively. In addition they received cash and a note secured by a deed of trust 138 on the McEnerney property.On their Federal income tax return for the years 1960 and 1961, petitioners reported their transfers of the Elk Grove property, in part, as tax-free exchanges of property for property of like kind under section 1031 3 of the Code, in part as a partially tax-free sale of their residence for $ 20,000, and its replacement by another residence costing $ 18,000, under section 1034 4140 of the Code, and the balance as a currently taxable sale of property to S.P., upon which they reported their gain as shown in the Findings of Fact. Petitioners are now also contending that their transfer of part of the Elk Grove property for the McEnerney deed-of-trust note also constituted a tax-free exchange under section 1031. In his statutory notice of deficiency, respondent determined the amount of petitioners' capital gains arising from the two transactions and, with the exception of the transfer 405 of 1.936 Elk Grove acres for the McEnerney residence, further determined that the gains constituted currently taxable income to petitioners in 1960 and 1961. Assigning a sales price of $ 4,840 for the Elk Grove residence (1.936 acres at $ 2,500 per acre), respondent determined that 139 petitioners' capital gain from its sale qualified for nonrecognition treatment under section 1034 of the Code, as petitioners had replaced their residence with one of an equal or greater cost than the $ 4,840 sales price. Respondent also determined that petitioners received $ 7,657.73 in interest income in 1961. In his statutory notice, respondent allowed certain selling expenses to be deducted from the sales price received by petitioner on the determined taxable transactions. In so doing he disallowed certain expenses and reallocated others which petitioner had deducted from the gross sales price of the various parcels in determining their gain.It is now well settled that when a taxpayer who is holding property for productive use in a trade or business enters into an agreement to sell the property for cash, but before there is substantial implementation of the transaction, arranges to exchange the property for other property of like kind, he receives the nonrecognition benefits of section 1031. Coastal Terminals, Inc. v. United States, 320 F. 2d 333 (C.A. 4, 1963); James Alderson, 38 T.C. 215">38 T.C. 215 (1962), reversed on other grounds 141 317 F. 2d 790 (C.A. 9, 1963); Carlton v. United States, 385 F. 2d 238 (C.A. 5, 1967). Of crucial importance in such an exchange is the requirement that title to the parcel transferred by the taxpayer in fact be transferred in consideration for property received. See Carlton v. United States, supra.In the instant case, petitioners arranged to have their Elk Grove property exchanged in a variation of a so-called 4-way exchange. Involved in this type of exchange is a taxpayer desiring to exchange property, a prospective purchaser of the taxpayer's property, a prospective seller of the property the taxpayer wishes to receive in exchange, and a fourth party. In a simultaneously executed transaction (usually done through escrow) the fourth party receives the taxpayer's property and sells that property to the prospective purchaser. With the funds he receives, he purchases the prospective seller's property and then transfers that property to the taxpayer. When the smoke has cleared, the taxpayer has exchanged his property in a so-called 1031 transaction, the prospective purchaser has the taxpayer's property, the prospective seller has cash, and the fourth party, with the exception of 142 agreed compensation, nothing. See Mercantile Trust Co. of Baltimore et al., Executors, 32 B.T.A. 82">32 B.T.A. 82 (1935).The instant transactions involved, in addition to petitioners, S.P. as the prospective purchaser of the taxpayer's property, the owners of the McEnerney, Sala, Bettencourt, and Schauer properties as the 406 prospective sellers, and Polhemus and Brannely as the fourth party. With the exception of the McEnerney property, petitioners transferred Elk Grove property to Polhemus and/or Brannely, who transferred the property to S.P. 5143 for cash. With the cash Polhemus and/or Brannely purchased the above properties and transferred them to petitioners. In the case of the 1960 McEnerney transaction, petitioners exchanged the Elk Grove property with the McEnerneys for the McEnerney property and the McEnerneys transferred the Elk Grove property to S.P. for cash. Since the net result of the transactions was petitioners' receipt of property for property of like kind, petitioners contend that they have met the requirements of section 1031. Respondent contends that the above actions were little more than a transparent attempt on petitioners part to restructure a taxable transaction into a nontaxable one. The fact remains, however, that when it came time to transfer title to the Elk Grove property, petitioners did not transfer it to S.P., but to other individuals, and insofar as the consideration which they received for the transfer constituted title to property of like kind, they had exchanged their property in tax-free exchanges under section 1031. The deed-of-trust note and the cash they received will be discussed infra.We have not overlooked the fact that with the exception of the McEnerney exchange, the exchanges in issue were with Polhemus and Brannely. Respondent strenuously argues that at all times these men were petitioners' attorneys. From this he concludes that they were also their agents in all of the transactions. He argues that since title in an agent is the equivalent of title in the principal, there could have been no exchange of property between petitioners and Polhemus and Brannely; and that the sale to S.P. by Polhemus and Brannely as petitioners' agents was simply a 144 sale by petitioners.We agree that the exchange would be meaningless for purposes of section 1031 if Polhemus and Brannely were petitioners' agents for purposes of carrying out the transactions. See Mercantile Trust Co. of Baltimore, et al., Executors, supra at 85. But the undisputed evidence establishes that, for the purpose of carrying out the exchanges, Polhemus and Brannely did not intend to be and were not petitioners' agents, but were effectively acting as agents for and on behalf of S.P.To uphold respondent's position, we would have to find that Polhemus and Brannely entered into the various agreements to purchase the exchange properties and receive title thereto on behalf of the petitioners. The evidence establishes, however, that in fact Polhemus 407 and Brannely first attempted to have S.P. obtain title to the exchange properties, but when that failed, to have title vest solely in themselves. Being fully aware of the consequences of having title vest in petitioners, they deliberately structured all transactions so that petitioners could not obtain even a vestige of title, legal or equitable, to the exchange properties by virtue of any agreements Polheums and Brannely entered 145 into. Thus, all transactions prior to the actual exchange of Elk Grove property for the exchange properties were in the names of Polhemus and Brannely, as agents for an undisclosed principal (intended to be S.P.) and at no time prior to the final conveyances, intended to be the petitioners.Though the evidence shows that S.P. refused to take title to the properties in its own name, it also shows that S.P. was willing to allow Polhemus and Brannely to accept and convey title to the exchange properties on behalf of and in place of S.P. It agreed to accept conveyances from the title holders of Elk Grove rather than from petitioners, and when the 1960 and 1961 escrow transactions were consummated, Polhemus, Brannely, and McEnerneys did accept and convey title to the various parcels for S.P. and, in accord with the understanding with S.P., conveyed the Elk Grove parcels to it. We find and hold from this entire record, for the tax consequences flowing therefrom, that Polhemus, Brannely, and the McEnerneys were S.P.'s agents for the various transactions here considered.Whether S.P. itself acquired legal or equitable title to any of the exchange properties we need not decide, for it is clear 146 that in the instant case petitioners first obtained title to the exchange properties as a result of the simultaneous escrow exchanges of August 9, 1960, and January 10, 1961. Polhemus 6 and the petitioners both testified that for purposes of the exchanges they agreed that any title in the exchange properties vesting in Polhemus and Brannely was not to convey any title, legal or equitable, to the petitioners. In fact, if the proposed exchanges had not taken place Polhemus and Brannely were willing to and did take the risk of being left with title to the properties in their own names, and having to hold them for investment.Such an arrangement was perfectly valid. Even if Polhemus and Brannely stood in a fiduciary relationship with petitioners, under California law one who stands in a fiduciary relationship with another may engage in an activity adverse or potentially adverse to that of his principal if he makes full disclosure to and receives the consent of his principal, see 2 Cal. Jur. 2d, Agency, sec. 108. Polhemus and Brannely specifically satisfied this requirement so that there could be, and was, no agency between themselves and petitioners 147 even though they maintained an attorney-client relationship.408 There is also no question but that when Polhemus and Brannely entered into agreements to purchase property in their own names or as agents for an undisclosed principal, under California law they became personally liable under the agreements, because the agreements under those circumstances are considered to be theirs for purposes of affixing liability under them. See 2 Cal. Jur. 2d, Agency, sec. 139.To say that Polhemus and Brannely were petitioners' agents when they entered into the various agreements would be in direct contradiction to the fact that they had agreed not to be such, and were in fact de facto agents of S.P., obtaining title to the properties for that company, not petitioners. The only juristic facts in the instant case involve bona fide exchanges of Elk Grove properties and the exchange properties between petitioners, Polhemus and Brannely and the McEnerneys. With respect to the exchange properties, there was no sale for cash under California law between S.P. and the petitioners and we so find and hold. To hold otherwise would be to create a legal fiction which did not occur and substitute it for the substantive 148 facts which did. As we pointed out in Mercantile Trust Co. of Baltimore et al., Executors, supra at 86-87:Respondent admits that the transaction was carried out in a legal manner, and that no fraud was perpetrated. We cannot find that it was a mere device, essentially fictitious. The several agreements and deeds executed, and the cash payments made by the four interested parties were not simulated transactions. They were intended to and did constitute juristic facts -- not fictions. The agreements created fixed liabilities. The deeds transferred legal title. The cash payments were real. Petitioners actually conveyed the Baltimore Street property to the Title Co. They likewise received from that company, in exchange, the Lexington Street property and $ 33,000. These real transactions must here be given their normal effect. So, our single inquiry is whether these facts bring the petitioners in the pending transaction within the scope of the quoted statutory provisions. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; Royal Marcher, 32 B.T.A. 76">32 B.T.A. 76.The obvious purpose and effect of these provisions, as well as their predecessors, in the Revenue Act of 1921, section 202(c)(1), n2 (d)(1), n3 149 and (e), n4 and the amendment of the Act of March 4, 1923, was to permit the postponement of recognition of taxable gain or loss upon an exchange there described until the disposition of the property received in the exchange. In the ultimate analysis of the present transaction, this was all petitioners intended or accomplished.The present exchange was not connected with a corporate reorganization. Neither in the last-quoted provisions nor in their successors, here applicable, does there appear any express or implied indication of a legislative intent to premise the nonrecognition of gain or loss there provided upon any other condition than that stated specifically therein. Compare Gregory v. Helvering, supra, which construed subsections (g) and (i)(1)(B) of the same section (112) and Revenue Act (1928) here under consideration. Nonrecognition of gain or loss 409 does not depend here upon the impossibility of a sale of the property by the taxpayer. The only condition precedent to that nonrecognition is the actual exchange of property held for investment for like property to be held for investment, with or without so-called "boot." Cf. John S. Garvan, 23 B.T.A. 817">23 B.T.A. 817; George E. Hamilton, 30 B.T.A. 160">30 B.T.A. 160; 150 Loughborough Development Corporation, 29 B.T.A. 95">29 B.T.A. 95; W. H. Hartman Co., 20 B.T.A. 302">20 B.T.A. 302; Sarther Grocery Co., 22 B.T.A. 1273">22 B.T.A. 1273.In the cited case of Gregory v. Helvering, supra, the Supreme Court determined the taxable status of the questioned transaction "by what actually occurred" -- the receipt of the taxed stock by the taxpayer. To sustain respondent upon the present record, we would be compelled to ignore the exchange that actually occurred, and tax, as received by the taxpayers, money never, in fact, received by or for them, in a sale that did not occur. We cannot here thus substitute fiction for fact.[Footnotes omitted.]Respondent next contends that by the time the exchanges took place Elk Grove property title was effectively in S.P. and petitioners no longer had the requisite economic interest to convey to either Polhemus, Brannely, or the McEnerneys. In this regard, respondent makes the following argument:Although federal law determines the tax consequences of a taxpayer's interest in property, the nature of that interest is determined by state law. Aquilino v. United States, 363 U.S. 509">363 U.S. 509 (1960); Commissioner. v. Crichton, 122 F. 2d 181 (5th Cir. 1941). Under applicable California151 law, the execution of the Sales Contract by petitioners effectively disposed of their Elk Grove Farm: SP became the equitable owner of the property, and petitioners were vested with a contractual right to receive the sales proceeds, coupled with a vendor's security title subject to divestment upon performance of the Sales Contract. 50 Cal. Jur. 2d, Vendor and Purchaser, secs. 92-94, 118; 18 Cal. Jur. 2d, Equitable Conversion, sec. 12. Hence, petitioners' rights under the Sales Contract were a chose in action, a right to cash, the subsequent exchange of which would not qualify as like kind of property under section 1031. Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260 (1958). [Emphasis supplied.] 7As was pointed out in Coastal Terminals, Inc. v. United States, supra at 337, the transactions in this area are viewed as a whole and are not to be broken down into their components for the purpose of examining the quality of the interests in the various properties at any given time. The statute only requires that as the end 152 result of an agreement, property be received as consideration for property transferred by the taxpayer without his receipt of, or control over, cash. All that is required is that taxpayer retain his bundle of rights in the property until the exchange takes place. If the statute were to be interpreted as respondent contends, all agreements which in the first instance call for cash as consideration for the transfer of property, even if followed by a bona fide exchange, would fail to qualify for section 1031 treatment, 410 as the taxpayer would have no more than a chose in action at the time of the exchange in those cases also.That the statute is not to be interpreted as respondent contends is shown by the decision in Coastal Terminals, Inc., supra, where a sales agreement followed by the substitution of property for a promise to pay cash was upheld as a valid 1031 exchange, since in the final analysis only property was received for property. It is to be noted that in that case the property to be exchanged was not even in existence at the time the agreement was entered into.Our opinion in John M. Rogers, 44 T.C. 126 (1965), affd. 377 F. 2d 534 (C.A. 9, 1967), though using language similar 153 to that in respondent's brief, is inapposite. In that case, Standard Oil exercised an option to purchase taxpayer's property, deposited cash for the taxpayer's account in escrow, and demanded title to the property on December 26. It was not until the following January 19, that the taxpayer exchanged title with a third party and that party transferred title to Standard Oil. By that time, however, there was nothing for the taxpayer to convey or receive, as the cash paid for the property was at the taxpayer's disposal and only Standard Oil had the right to title to the property. In the instant case, in the 1960 transaction, S.P. specifically agreed to allow petitioner to exchange Elk Grove parcels prior to its receiving title to the Elk Grove property and instructed the escrow agent to pay cash to the title holder (rather than to the petitioners) when the property was placed in escrow. This arrangement, as performed by the parties, resulted in a modification of the original agreement, Cal. Civ. Code secs. 1698, 1700 (West 1954); James Alderson, supra at 221, and we find and hold that it was sufficient to recast the agreement between S.P. and petitioners so that petitioners did transfer 154 title to the owners of the exchange properties.The 1961 transactions were also the result of a modification of the original sales agreement, which allowed petitioners to exchange Elk Grove property for property of like kind rather than for cash. Respondent contends that S.P., in its escrow instructions for that transaction, did not agree to substitute anybody for petitioners as sellers of the Elk Grove property and consequently did not agree to purchase the property from anyone else. But no matter what S.P.'s escrow instructions, the transaction by which S.P. obtained title to Elk Grove was that property's conveyance by Polhemus and Brannely to S.P. on January 10, 1961. Since the June 1 sales agreement did not give S.P. the right to the Elk Grove property until 1 year after the August 9, 1960, conveyance, S.P. could not have demanded title from petitioners for approximately 8 more months without the modification of the agreement as performed. Unlike the situation in Rogers, S.P. had no right to title in the Elk Grove property even after it placed the purchase 411 price in escrow and unlike the taxpayers in Rogers, petitioners had valid title to convey to Polhemus and Brannely. As 155 in the 1960 transaction, Brannely and Polhemus' title had substance and their transfer of Elk Grove title to S.P. was not the meaningless formality that it was in Rogers.At the time of the agreement with S.P., the Elk Grove property was held for productive use in the farming business and the property received when the exchange took place was of like kind. The property petitioners received was in exchange for the Elk Grove property. Thus we find and hold that petitioners' 1960 exchange of their Elk Grove property for the McEnerney property and the Sala properties, and the 1961 exchange of their Elk Grove property for the Schauer and Bettencourt properties, satisfied the provisions of section 1031.With the exception of an adjustment as to allowance of a deduction for attorneys' fees, we hold for respondent on the remaining issues.Petitioners' claim that their exchange of Elk Grove property for the McEnerney deed-of-trust note was a tax-free exchange under section 1031 must fail, as section 1031 specifically excludes exchanges of notes from nonrecognition treatment. Indeed, even if exchanges of notes were not excluded by the statute, the exchange in the instant case was not an exchange 156 of notes, but was an exchange of land for a note and therefore did not constitute an exchange of property for property of like kind. See Imperator Realty Co., 24 B.T.A. 1010 (1931). We therefore hold that the exchange for the deed-of-trust note constituted a taxable transaction.Petitioners' attempts to structure the 1961 transaction so that they would receive $ 20,000 for their residence, and not recognize the $ 7,657.73 interest payment by S.P. or the $ 6,000 "profit" by Polhemus and Brannely from the amount S.P. paid into escrow are without substance.The evidence presented by petitioners clearly established that these transactions were structured as they were primarily for tax-avoidance purposes. Since section 1031 requires only that property of like kind be exchanged, we upheld petitioners' exchanges with Polhemus and Brannely as nontaxable. However, in light of the close relationship existing between those men and the petitioners, the intricate planning on the part of Polhemus for petitioners' benefit, and the lack of any substantial adverse interest in their negotiations, their dealings cannot be described as "arm's length." If there is substance to the transaction, the form 157 specifically prescribed by the statute controls. Herman Glazer, 44 T.C. 541">44 T.C. 541, 545 (1965); Victor H. Heyn, 39 T.C. 719">39 T.C. 719 (1963).We do not find a rational basis to support petitioners' attempt to attach a $ 20,000 sales price to their residence located on 1.936 acres 412 of the Elk Grove property. At the time they transferred their property to Brannely and Polhemus, petitioners had agreed to sell their Elk Grove property for $ 2,500 per acre, no matter what structures were on any particular parcel. Consequently, all they could expect to receive was $ 4,840 (either in cash, or exchange property) for the 1.936-acre parcel containing their residence. Polhemus and Brannely were well aware that they had no choice other than to convey that parcel to S.P. upon receiving it and that they would receive $ 4,840 from S.P. for the parcel.The $ 15,160 difference which petitioners received was simply a part of the funds to which they were entitled for conveying the balance of the Elk Grove property at $ 2,500 per acre. Consequently, we have upheld respondent's determination that petitioners received $ 4,840 for the residence and could use only that figure for purposes of computing the nonrecognized gain 158 under section 1034 of the Code. For similar reasons, we also find that the sales price of each Elk Grove acre transferred was $ 2,500.We similarly reject the contention that Polhemus and Brannely made a $ 6,000 "profit" on the 1961 transaction rather than earning a legal fee. Though Polhemus and Brannely did accept certain risks in receiving and conveying title to the property, we find that that figure was the amount which Polhemus and Brannely were to receive for their efforts in arranging the 1961 transactions for petitioners' benefit. To consider that amount to be "profit" to Polhemus and Brannely on a judicious purchase of realty when the ultimate sales price was known to all parties, and the holding period of fleeting length, would ignore the tremendous efforts which they spent in arranging the various transactions as petitioners' attorneys. Thus, we find that the $ 6,000 amount was in fact a legal fee paid out of petitioners' proceeds from selling its Elk Grove property. It was not a reduction of the Elk Grove property's sales price. Consequently, we find and hold that that amount is to be considered as part of the sales price received by petitioners.Petitioners' attempt 159 to avoid reporting the $ 7,657.73 in interest paid by S.P. pursuant to the June 1 agreement and received by petitioners does not have any basis in form. That amount represents interest accruing on S.P.'s obligation to purchase the Elk Grove property under paragraph 4 of the June 1, 1960, agreement. Though petitioners transferred record title to the Elk Grove property to Polhemus and Brannely, there is not one scintilla of evidence to show that petitioners ever transferred their right to receive the interest to them. Consequently, at all times, petitioners retained the right to collect $ 7,657.73 in interest from S.P. Polhemus and Brannely's receipt 413 of the amount through the escrow process meant nothing more than that they were conduits for petitioners and their conveyance of such amount to petitioners was in no way connected with any exchange of any properties. We thus find and hold that petitioners had and received $ 7,657.73 in interest income in 1961.Having determined the nature of the transactions surrounding petitioners' disposition of their Elk Grove property, the only issue remaining is the allowable expenses petitioners may claim in regard to the presently taxable transfers 160 of their Elk Grove property, i.e., 24.873 acres in 1960 and 70.614 acres in 1961. Since the McEnerney, Sala, Bettencourt, and Schauer transactions, along with petitioners' sale of their old residence and replacement with a new one, were tax-deferred transactions, and expenses pertaining to the related Elk Grove property dispositions were not currently deductible, we need not and do not decide the amount of the unrecognized gain on those transactions. Consequently, the following pertains only to those items affecting the currently taxable transactions.In his statutory notice of deficiency, respondent allocated petitioners total sales commissions to Grant and total survey costs of the Elk Grove property equally over each of the 188.943 acres and allowed them as selling expenses in the year the various parcels were sold. He also allocated the 1961 title insurance, revenue stamps, and recording expenses equally to each acre transferred by petitioners. Petitioners offer no serious objection to these allocations and, in light of the lack of any evidence in support of a different allocation, we find them to be entirely proper. See Wellesley A. Ayling, 32 T.C. 704">32 T.C. 704 (1959); Fairfield Plaza, Inc., 39 T.C. 706">39 T.C. 706 (1963). 161 Petitioners' escrow statements for 1960 in regard to the 24.873 acres transferred to S.P. show charges of $ 346, $ 68.75, and $ 2.80 for title insurance, revenue stamps, and recording fees, respectively. Respondent allowed these amounts as deductible expenses and we find that the escrow statements accurately reflected the cost of transferring that parcel. Thus, we allow the above-stated costs as deductible selling expenses.Respondent disallowed any deduction as a selling expense of the $ 5,000 and $ 6,000 payments to Brannely and Polhemus in 1960 and 1961, respectively. Respondent also disallowed the $ 114.40 payment constituting the cost of the title fee in connection with McEnerney note transaction. Respondent determined all three of these items to be expenses incurred in the acquisition of property.We uphold respondent's disallowance of the $ 114.40 title fee in connection with the McEnerney note as a selling expense, as it is clear that that expenditure was for the purpose of perfecting petitioners' title in the McEnerney property. It was not a cost of disposing of the Elk Grove property.414 Respondent's disallowance of the $ 5,000 and $ 6,000 amounts received by Brannely and 162 Polhemus in 1960 and 1961 finds support in Polhemus' testimony that both he and Brannely were hired for, and their efforts were almost entirely directed toward arranging the exchange of the properties. Respondent contends that under such circumstances any portion of either payment considered to be for petitioners' disposition of Elk Grove property is negligible and should be disregarded. The record, however, does indicate that Polhemus spent a substantial amount of time in preparing the necessary documents required for the disposition of Elk Grove, and we find and hold that of the amounts received by Polhemus and Brannely during 1960 and 1961, $ 1,000 and $ 1,200, respectively, represent selling expenses pertaining to the dispositions of Elk Grove property; the $ 1,000 amount to be allocated equally over the 54.793 acres transferred in 1960 and the $ 1,200 amount to be allocated equally over the 134.150 acres transferred in 1961. Cohan v. Commissioner, 39 F. 2d 540. The balance of the amounts ($ 4,000 in 1960 and $ 4,800 in 1961) was paid in connection with the acquisition of the Sala, McEnerney, Bettencourt, and Schauer properties and as such are currently nondeductible expenditures. 163 Petitioners would have us separately allow a portion of the $ 5,000 and $ 6,000 payments as currently deductible fees incurred in obtaining tax advice, but both fees pertain to a capital transaction and can therefore only represent a part of the basis of the property acquired, or a selling expense of the property sold. Cf. Rev. Rule 67-125, 1 C.B. 31">1967-1 C.B. 31.Decision will be entered under Rule 50. SIMPSONSimpson, J., concurring: I agree with the results of the majority opinion, but my reasons are somewhat different.Occasionally, the tax consequences of a transaction are governed by the form in which it is cast. Commissioner v. Lester, 366 U.S. 299">366 U.S. 299 (1961); Chester L. Tinsman, 47 T.C. 560">47 T.C. 560 (1967). However, generally, tax consequences turn upon substance. Taxpayers are not permitted to circumvent the restrictions in the law by mere formal compliance; nor should they be deprived of a tax benefit when in substance they are entitled to it merely because they accidentally or unwisely chose the wrong form. If tax consequences were based upon form, the results would be a capricious application of the tax law. Relying upon substance results in a more equitable application of the law.In my 164 opinion, the substance of the transactions in this case is that the petitioners exchanged business property which they desired to relinquish for other business property which they wished to operate. 415 I see no reason for reading the statute restrictively and limiting it to a bilateral exchange of properties. The petitioners desired to transfer their property and found a purchaser who wished to acquire it. However, the purchaser owned no property suitable for an exchange and did not wish to take title to any such property merely for the purpose of trading it. Thus, the petitioners paid their attorneys to find other property which they could accept in exchange, and the attorneys effected the necessary exchanges. In summary, the petitioners were the moving force; it was through their planning and efforts that the exchanges were arranged. In my view, it should make no difference whether the traded property was first transferred to the agents of S. P. so that S. P.'s agents could effect a bilateral exchange with the petitioners. To hold that section 1031 applies when the traded property is first transferred to S. P. or their agent, but not otherwise, places a premium on formal compliance 165 with the law. So long as the ultimate effect of the several exchanges of property is that the petitioners have transferred business property and acquired like business property, I believe section 1031 should apply.If the petitioners had sustained a loss as a result of the transactions and were arguing that it should be recognized, I would not be beguiled by all that took place in this case; I would hold that the step transaction doctrine should be applied, that in substance there was an exchange of business property for business property, and that the loss is not allowable. In my judgment, an even-handed application of the law calls for us also to apply the step-transaction doctrine when the taxpayer realizes a gain. RAUMRaum, J., dissenting: I cannot agree that there was an "exchange" of property in this case. Plainly, there is no "exchange" under section 1031 where the seller of property merely uses the proceeds of sale to purchase other like property, cf. Trenton Cotton Oil Co. v. Commissioner, 147 F. 2d 33, 36 (C.A. 6); John M. Rogers, 44 T.C. 126">44 T.C. 126, affirmed per curiam 377 F. 2d 534 (C.A. 9), notwithstanding that there may be an "exchange" where the seller persuades the purchaser 166 to acquire other property desired by the seller and to substitute such other property for the purchase price, cf. Coastal Terminals, Inc. v. United States, 320 F. 2d 333 (C.A. 4). The difficulty here is that the purchaser, Southern Pacific Co., was unwilling in turn to purchase other properties to be used in "exchange" for the Elk Grove property that it was purchasing from petitioners. The majority opinion gets around this difficulty by concluding that Polhemus and Brannely, petitioners' attorneys who purchased the other properties, were acting as agents for Southern Pacific, a conclusion that appears to me to be wholly 416 unsupported. Polhemus and Brannely were not agents for Southern Pacific, and there was no "exchange" of like properties between petitioners and Southern Pacific.Nor is there any support for the theory suggested in the concurring opinion, relying "upon substance" to achieve "a more equitable application of the law." Concededly, the statute as written does not apply where the seller merely uses the proceeds of the sale to buy other property. And that is all that occurred here. The fact that an exchange could theoretically have been arranged so as to make the statute *167 applicable may be unfortunate for petitioners, but that unhappy result is brought about by Southern Pacific's unwillingness to participate in such manner. I can see no reason for rewriting the statute; its terms are specific. See Trenton Cotton Oil Co. v. Commissioner, 147 F. 2d at 36. Where Congress wanted to permit nonrecognition upon the reinvestment of proceeds, it expressly did so in the case of the sale of a residence in the closely related provisions of section 1034. Footnotes1. In addition petitioners gave to McEnerneys a note and purchase-money deed of trust on McEnerney's property securing same for $ 46,200.↩1. Covered two deeds.↩2. Covered petitioners' deed to McEnerneys and vice versa.↩1. All references are to the Internal Revenue Code of 1954.↩1. An option in the hands of a third party to purchase the Bettencourt property also was assigned to Brannely and Polhemus (and wives).2. We assume that the excess of $ 1,185.80 over the face amount of this note represents accrued interest.↩1. Of this amount, Polhemus received $ 5,000 and Brannely $ 1,000.↩1. The reported sale expenses correspond with those shown as deducted by the escrow agent, supra, except that the proration of the taxes and insurance charged to the Coupes was not included and that the $ 5,000 attorneys' fee charged to the sale to S.P. was allocated to the three parcels on an acreage basis.2. Tax-free exchange.↩3. The reported sale expenses totaling $ 31,324 (1503+29,821) consisted of the following:↩Grant's commission$ 23,617.88Title insurance1,202.00Revenue stamps370.15Recording fees20.00Title fee114.40Attorneys' fee6,000.00Total 31,324.431. Purchased new residence within 1 year for $ 18,053: $ 18,053/$ 20,000 x $ 15,894 = $ 14,347.↩2. Tax-free exchange of properties:Bettencourt property$ 79,000Schauer property75,000Total 154,000$ 154,000/$ 323,033 x $ 376,134 = $ 131,633.↩3. SEC. 1031. EXCHANGE OF PROPERTY HELD FOR PRODUCTIVE USE OR INVESTMENT.(a) Nonrecognition of Gain or Loss From Exchanges Solely in Kind. -- No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.↩4. SEC. 1034. SALE OR EXCHANGE OF RESIDENCE.(a) Nonrecognition of Gain. -- If property (in this section called "old residence") used by the taxpayer as his principal residence is sold by him after December 31, 1953, and, within a period beginning 1 year before the date of such sale and ending 1 year after such date, property (in this section called "new residence") is purchased and used by the taxpayer as his principal residence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer's adjusted sales price (as defined in subsection (b) of the old residence exceeds the taxpayer's cost of purchasing the new residence.5. The deeds actually named S.P.'s nominee, the Alameda East Bay Title Co. For sake of simplification, we have grouped S.P. transactions and East Bay transactions as being S.P. transactions.6. At the time of trial Brannely was deceased.↩7. It is noted that petitioners did not have "a right to cash" under the June 1, 1960, agreement with S.P. since S.P. had the right to pay in part with "exchange property."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623354/	HENRY E. AND DOROTHY ENGLER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEngler v. CommissionerDocket No. 39538-87United States Tax CourtT.C. Memo 1995-338; 1995 Tax Ct. Memo LEXIS 342; 70 T.C.M. (CCH) 172; July 26, 1995, Filed 342 Decision will be entered for respondent except as to the additions to tax for negligence. 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 and 1983 as follows: Additions to Tax Sec.Sec.Sec.Sec. Sec. YearDeficiency6653(a) 6653(a)(1)6653(a)(2)6659(a)6661(a) 1980$ 2,730.00$ 136.50-- --$ 819-- 198311,589.20-- $ 579.461 $ 2,2562 $ 1,017.30343 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); (3) an addition to tax for a substantial understatement of income tax for the taxable year 1983; and (4) 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 Elyria, Ohio. Petitioner Henry E. Engler (petitioner) is a high school graduate who has taken some college courses dealing mainly with job-related subjects. Mrs. Engler is also a high school graduate. During the years in issue, petitioner was employed as a supervisory air traffic control specialist at the Cleveland Air Traffic Control Center. During the years in issue, Mrs. Engler was a housewife. Petitioners344 have no specialized training in either accounting or taxation. In 1982 or early 1983, petitioner began considering ways by which to ensure his family's financial security upon his retirement. Petitioner considered various investment options, including the possibility of investing in stocks and bonds. He spoke with several brokers and attended a few seminars in an effort to educate himself on the topic. Petitioner also spoke with his colleagues about his financial concerns. Some of petitioner's colleagues suggested that he consult with Graham & Associates, Inc. (Graham & Associates) regarding long-term investment packages. Prior to 1983, petitioners had made no financial investments. Petitioner met with John Hootman (Hootman) and John Graham of Graham & Associates for the first time on July 26, 1983 (the first meeting). Thomas Graham (Graham), the president of Graham & Associates, was not present at the first meeting. Petitioner's purpose in attending the first meeting was to find out "what all these financial investments was all about and how they operated and what they were offering". Petitioner was impressed by the operations of Graham & Associates, by the apparent professionalism345 of the staff, and by Graham's credentials. At the first meeting, petitioner was advised that some of the investments 2 offered by Graham & Associates were tax shelters. In subsequent meetings with petitioners, Graham outlined a long-term investment strategy for petitioners. This long-term strategy included several investments, including Saxon Energy Corp. (Saxon). Petitioners first learned of Saxon through Graham & Associates. Saxon was a corporation formed in 1981 to lease energy management systems to the public. See Schillinger v. Commissioner, T.C. Memo 1990-640">T.C. Memo. 1990-640, affd. per order 1 F.3d 954">1 F.3d 954 (9th Cir. 1993) (discussing the Saxon Energy program in some detail). Petitioners had no experience or knowledge with respect to the acquisition, lease, production, installation, marketing, or use of energy management systems during the years in issue. Petitioner was, however, 346 aware of what he described as "a frenzy all across the country initiated by the United States Congress and the Executive Department to save energy". Graham & Associates provided petitioners with several documents relating to Saxon, including a copy of the Saxon Energy Corp. Energy Brain/Fuel Optimiser Equipment Leasing Program Information Memorandum (the Information Memorandum); a document entitled "Frequently Asked Questions About the Energy Brain/Fuel Optimiser Equipment Leasing Program", and a copy of a document entitled "Fair Market Value of Equipment $ 205,000". These 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. Petitioners also received from Graham & Associates a copy of a 1-1/2 page letter from Charles Taylor (Taylor) to Saxon indicating Taylor's opinion that the fair market value of the Energy Brain System was $ 205,000. The letter, dated June 13, 1983, included a "vita criteria" providing limited information regarding Taylor's credentials. Prior to investing in Saxon, petitioners reviewed each of the documents347 provided to them by Graham & Associates. After the first meeting, petitioner also took other steps in an effort to decide whether to engage Graham & Associates as his financial adviser. First, petitioner investigated whether Graham & Associates was a legitimate company. He telephoned the Better Business Bureau in Cleveland to inquire whether it had collected any negative information regarding Graham & Associates. Petitioner was advised that no negative information had been recorded. Petitioner posed similar questions regarding Graham & Associates to the Securities and Exchange Commission in Washington, D.C., and was similarly advised that no negative information regarding Graham & Associates had been recorded. Next, petitioner attempted to determine whether the advice he had received from Graham & Associates was reliable. Petitioner telephoned the Internal Revenue Service (IRS), asked for a tax shelter specialist, explained the Saxon Energy program, and elicited the IRS representative's views on the legality of the program. Petitioner understood the IRS representative to indicate that the program did not violate any tax laws. Petitioner also contacted the accountant who had prepared348 his income tax returns for prior years and a tax attorney in Elyria. He explained the Saxon Energy program to each of these professionals and asked whether the program was legal from a tax standpoint. He understood both professionals to reply in the affirmative. After petitioner was satisfied that he could rely on the advice of Graham & Associates, he engaged that firm as his financial adviser. On December 13, 1983, petitioner completed a document entitled "Lessee's Qualification Questionnaire". On that same date, Graham completed a document entitled "Business Advisor's Questionnaire", which was countersigned by petitioners. An Agreement of Lease (the lease) was entered into on December 13, 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. A Certificate of Insurance for the Energy Brain System named Saxon as the insured. The policy expiration date was December 1, 1984. 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, 1983349 through December 31, 1984 in the amount of $ 6,750 for their one-half interest in the Energy Brain System. Petitioners did not negotiate the amount of the lease payment to Saxon. After petitioners made this payment, they and a Saxon representative executed an Election to Pass Investment Tax Credits from Lessor to Lessee. Petitioners never intended to use the Energy Brain System themselves. Instead, petitioners planned to engage a management company, which would locate an end-user. The end-user would pay for the Energy Brain System by sharing equally the amount of energy savings with the lessees. 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. Petitioners relied upon Graham & Associates to select ALH Energy Management Corp. (ALH) as the management company for the Energy Brain System. Petitioners received a letter dated December 22, 1983, from ALH indicating that petitioners had expressed an interest in utilizing ALH as the management company for the Energy Brain System. Enclosed with the letter from ALH were350 two copies of ALH's standard form of management agreement, which petitioners were instructed to sign and return with a check in the amount of $ 675. Petitioners executed a Service Agreement with ALH, but that agreement, dated December 13, 1983, was not signed on behalf of ALH. A Management Agreement between petitioners and ALH was also drafted. That Management Agreement, also dated December 13, 1983, was neither signed by ALH nor by petitioners. By check dated December 13, 1983, petitioners paid ALH $ 337.50 (one-half of the $ 675 requested by ALH). By letter dated June 28, 1984, K. M. Fereg (Fereg) of ALH notified petitioners that the Energy Brain System had been placed in service in December 1983. The location of the Energy Brain System was identified in that letter as Sawa's Old Warsaw Restaurant at 9200 West Cermak Road in Broadview, Illinois. On February 12, 1985, petitioners wrote to Fereg, enclosing a check for $ 150 to pay for continued insurance of the Energy Brain System. In that letter, petitioners also requested that ALH provide them with "a financial report as to the status of the installation and operation of the system and the gross receipts derived therefrom". This351 check was returned by Fereg to petitioners, with an accompanying letter dated May 14, 1984. The letter indicated that ALH had been unable to obtain a group insurance policy covering the Energy Brain System and that petitioners should attempt to obtain coverage privately. Between February 22, 1985 and October 1985 petitioners received several pieces of correspondence from Graham & Associates relating to the IRS examination of Saxon and those who had invested in the investments that Saxon promoted. These letters also assured petitioners of the continued viability of their investment. On several occasions, petitioner spoke with Graham, who assured him that Graham & Associates was managing the Energy Brain System, ensuring that such systems were installed and operating properly. 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 352 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 other 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 adopt them as our own. See Schillinger v. Commissioner, T.C. Memo. 1990-640. During 1982 and 1983, there were many products comparable to the Energy Brain System being marketed because of the nation's energy conservation353 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 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 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 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. 3354 Petitioners also attached a Schedule C in respect of their Saxon investment to 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 an investment credit carryback pertaining to their Saxon investment to the taxable year 1980 in the amount of $ 2,730. As previously indicated, petitioners concede the deficiencies in income tax for the 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; (3) an addition to tax for a substantial understatement of income tax for 1983; and (4) 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). NegligenceWe begin with the addition to tax for negligence, 355 which is the primary issue in this case. Section 6653(a) for 1980 and section 6653(a)(1) for 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 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">60 T.C. 728, 740 (1973). Within this framework, petitioners may prevail if they reasonably relied on competent professional advice. Freytag v. Commissioner, 501 U.S. 868 (1991). When considering356 the negligence addition, we evaluate the particular facts of each case, judging the relative sophistication of the taxpayers as well as the manner in which the taxpayers approached their investment. In this case, petitioners contend that their actions, particularly their reliance on Graham & Associates, were reasonable, pointing in particular to their advance inquiries concerning: (1) Alternative investment opportunities; (2) Graham & Associates; and (3) the legality of tax shelters. Petitioner's testimony at trial was credible and provides the evidentiary basis for our conclusion that petitioners are not liable for the additions to tax for negligence. Neither petitioner received an educational degree beyond the high school level nor did either have any investment experience prior to 1983. By investigating alternative forms of investments, by attending seminars, by meeting with several brokers, by consulting with his colleagues, by meeting with representatives of Graham & Associates on several occasions in order to discuss his financial situation and potential investments, and by reviewing the information provided to him by Graham & Associates, petitioner made a good faith effort357 to identify a long-term investment that would provide his family with an increased level of financial security. By consulting a tax shelter specialist at the IRS, by consulting an accountant who had previously prepared his income tax returns, and by consulting a tax attorney, petitioner made a good faith effort to ascertain whether the type of investment being proposed by Graham & Associates was an appropriate type to be considered. By telephoning the local office of the Better Business Bureau and the Securities and Exchange Commission in Washington, D.C., petitioner also made a good faith effort to ensure that the financial adviser he selected could be relied upon. Petitioners subjectively intended to achieve an economic profit from their investment. Aware of the increasing governmental interest in energy conservation, petitioner subjectively believed that the Energy Brain System had, as indicated by Graham & Associates, the potential to produce an economic profit. Petitioners attempted to monitor their investment, both by contacting ALH and by maintaining continued contact with Graham & Associates. Although slightly more sophisticated investors would likely have taken steps 358 different from those taken by petitioners to ensure the viability of an investment upon which they intended to earn an economic profit, we are persuaded that petitioners' actions with regard to the Energy Brain System, under the specific facts and circumstances presented in this case, were reasonable. Therefore, we do not sustain respondent's determination with respect to the additions to tax for negligence. OvervaluationWe turn now to the additions 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 250 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 valuation359 overstatements. Sec. 6659(a); Todd v. Commissioner, 862 F.2d 540">862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912">89 T.C. 912 (1987). 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 $ 9,030 of that amount to reduce their reported income tax liability for 1983 (exclusive of the alternative minimum tax) 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 an investment credit carryback pertaining to their Saxon investment to the taxable year 1980 in the amount of $ 2,730. On the basis of the 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. We must now decide whether the deficiency in income tax for each of the taxable years in issue is attributable to360 such overstatement. 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; Urbanski v. Commissioner, T.C. Memo. 1994-384. 4In this instance, the deficiency determined by respondent for 1980 resulted from the disallowed carryback of investment credit from 1983 pertaining to petitioners' Saxon investment. Accordingly, we sustain respondent's application of the addition to tax under section 6659(a) to the361 entire underpayment for the taxable year 1980. We also sustain respondent's determination with respect to that part of the underpayment for the taxable year 1983 that is attributable to the valuation overstatement, specifically the amount relating to the investment tax credit. Because petitioners reported and paid alternative minimum tax due on their original 1983 income tax return, the amount attributable to the valuation overstatement in 1983 is $ 7,520 rather than $ 9,030. Understatement of Tax LiabilityWe turn next to the addition to tax for substantial understatement of income tax under section 6661(a) for 1983. Section 6661(a) imposes an addition to tax equal to 25 percent of the amount attributable to a substantial understatement. 5362 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)(A). 6In determining the amount of the addition to tax for which taxpayers are liable, section 6661(b)(3) provides: "there shall not be taken into account that portion of the substantial understatement on which a penalty is imposed under section 6659". "The portion of the understatement on which the penalty under section 6659 has been imposed is taken into account, however, in determining whether there is a substantial understatement of tax." Sec. 1.6661-2(f)(1), (2), Income Tax Regs. (emphasis added). Because the understatement for 1983, which petitioners have conceded, exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000, the addition to tax under section 6661(a) applies. Sec. 6661(b)(1)(A). We therefore sustain respondent's determination that363 the addition to tax under section 6661(a) applies to that portion of the understatement not subject to the addition to tax under section 6659, i.e., $ 4,069 ($ 11,589 - $ 7,520). Increased Rate of InterestFinally, 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), 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 petitioner was liable for the increased rate of interest because the underpayments for the years in issue are attributable to a tax-motivated transaction. Section 6621(c)(3)(A)(i) provides that the term tax-motivated transaction includes "any valuation overstatement (within the meaning of section 6659(c))". Accordingly, 364 in light of our conclusion that a valuation overstatement exists for 1980 and 1983, we are bound to sustain respondent's determination under section 6621(c) with respect to the deficiency in each of those years that relates to the valuation overstatement. In addition, section 6621(c)(3)(A)(v) provides that the term tax-motivated transaction includes "any sham or fraudulent transaction". Economic shams, or transactions which lack economic substance, fall within the ambit of section 6621(c)(3)(A)(v). Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1128-1129 (1987), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 865">868 F.2d 865 (6th Cir. 1989), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186 (4th Cir. 1988). The presence of a subjective profit motive does not preclude the conclusion that a transaction lacks economic substance and is therefore, a sham. Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986 (1987).365 Petitioners introduced no evidence that the Saxon transaction was not an economic sham. Accordingly, we sustain respondent's determination that petitioners are liable for the increased rate of interest under section 6621(c) with respect to the deficiencies for both of the years in issue. ConclusionIn order to reflect our disposition of the disputed issues, as well as petitioners' concessions, Decision will be entered for respondent except as to the additions to tax for negligence. 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, i.e., $ 11,589.20.↩2. Respondent amended her answer to plead, in the alternative, that in the event that the Court concludes that the addition to tax under section 6659 does not apply, the addition to tax under section 6661 should be increased to $ 2,897.30, or 25 percent of the entire deficiency, rather than 25 percent of the portion of the deficiency not attributable to an overvaluation of property.↩2. We use the term "invest" and all of its derivatives solely for the sake of convenience.↩3. Of this amount, petitioners utilized $ 9,030 on their 1983 return in order to reduce their reported income tax liability for that year (exclusive of the alternative minimum tax) to zero.↩4. 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) is "attributable to" the adjustments in the later year, sec. 6659 may be applied to taxable years prior to 1981. Nielsen v. Commissioner, 87 T.C. 779">87 T.C. 779↩ (1986).5. Having concluded that petitioners are subject to the addition to tax for a valuation overstatement under sec. 6659(a), we need not address respondent's alternative argument, advanced in her amended answer, that sec. 6661(a) should apply to the entire deficiency for 1983.↩6. An understatement will be reduced to the extent that it is: (1) Based on substantial authority or (2) adequately disclosed in the return or in a statement attached to the return. Sec. 6661(b)(2)(B). In this case, the understatement for 1983 was neither based upon substantial authority nor adequately disclosed.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4476056/	OPINION. Arundell, Judge: These proceedings involve the question of basis with respect to gas properties that were sold by the petitioner in 1943, and incidentally some that were sold in 1941 and 1942 because of loss carry-overs from those years to 1943. In 1929 the petitioner corporation acquired 194 operating gas properties, of which 62 were acquired by purchase from individuals and partnerships and 132 through the liquidation of 8 corporations whose stocks it had purchased. Of the total of $1,300,000 paid by the petitioner, the respondent has determined that $435,500 represents the cost, and basis, of 62 properties purchased. He has further determined that $132,000, or $1,000 for each of the other 132 properties, is the depreciated cost to the 8 former corporate owners and the basis to the petitioner. The respondent’s position is that section 141 of the Bevenue Act of 1928 required as a condition of the privilege of filing consolidated returns that all members of the affiliated group consent to the consolidated return regulations prescribed by the Commissioner, with the approval of the Secretary, and that those regulations, and similar regulations subsequently promulgated, require the petitioner to use the basis of the 8 transferor corporations. Both parties quote from Regulations 75, which were applicable to the taxable year 1929 and subsequent years, as follows: Art. 37. — Dissolutions—Recognition of Gain or Loss. (a) During Consolidated Return Period. Gain or loss shall not be recognized upon a distribution during a consolidated return period, by a member of an affiliated group to another member of such group, in cancellation or redemption of all or any portion of its stock; and any such distribution shall be considered an intercompany transaction. Art. 38. — Basis of Property. (a) General Rule. Subject to the provisions of paragraph (6), the basis during a consolidated return period for determining the gain or loss from the sale or other disposition of property, or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed, shall be determined and adjusted in the same manner as if the corporations were not affiliated (see sections 111 to 115, inclusive, of the Act), whether such property was acquired before or during a consolidated return period. Such basis immediately after a consolidated return period (whether the affiliation has been broken or whether the privilege to file a consolidated return is not exercised) shall be the same as immediately prior to close of such period. (b) Intercompany Transactions. The basis prescribed in paragraph (a) shall not be affected by reason of a transfer during a consolidated return period (whether by sale, gift, dividend, upon dissolution, or otherwise) from a member of the affiliated group to another member of such group. The respondent further quotes from Internal Revenue Code section 113 (a) (11), which provides in material part that: The basis in case of property acquired by a corporation during any period, in the taxable year 1929 or any subsequent taxable year, in respect of which a consolidated return is made by such corporation under section 141 of. * * * the Revenue Act of 1928, * * * shall be determined in accordance with regulations prescribed under section 141(b) of * * * the Revenue Act of 1928 * * * The petitioner’s position is that it was the intended objective of Chase & Gilbert, Inc., to acquire all of 194 operating properties and place them in one corporation, and that the preceding transactions were interrelated and interdependent steps in a unitary plan. It says that where such facts exist the intended and attained objective of a series of transactions should be given that effect for tax purposes which the plan and objective require when viewed as a whole; that the several steps should not be treated as independent transactions at the cost of distorting the clear effect of the plan. There are many decisions which, in the abstract, support the petitioner’s argument. See, for example, Schumacher Wall Board Corporation, 33 B. T. A. 1211, where the question of basis depended on whether there was control in the same persons before and immediately after the transfer of assets. Control did exist in an investment banking house, but at the time it received the stock it was bound by contract to convey it to others. In holding for the taxpayer in that case, we said, quoting from Wilbur F. Burns, 30 B. T. A. 163, that “the question of control is to be determined by the situation existing at the time of the completion of the plan rather than at the time of fulfillment of one of the intermediate steps.” The language was quoted with approval by the Ninth Circuit Court of Appeals in affirming our decision at 93 F. 2d 79. The Circuit Court in that case also quoted the rule often announced by the Supreme Court that in matters of taxation it recognized the “importance of regarding matters of substance and disregarding forms * * ." See United States v. Phellis, 257 U. S. 156. In the application of such general rules, proper regard must he had for the provisions of the particular statute and regulations under consideration and the facts of the case being decided compared with those in which the rules were announced. When this is done here, we think the issue in these proceedings must be decided for the respondent. Under Revenue Acts prior to that of 1928, affiliated corporations were either required or permitted to file consolidated returns. However, none of the prior acts required consent to the regulations prescribed for the filing of such returns, nor specifically delegated to administrative officers the authority to prescribe such regulations as they might deem necessary in order to determine the tax liability of the group and of each corporation in the group both during and after the period of affiliation. Section 141 of the Revenue Act of 1928 required such consent and granted such authority. The provisions of section 141 were given careful consideration by the Congress in the enactment of the Revenue Act of 1928. The Senate Finance Committee, after referring to the history of consolidated return provisions under prior acts, said in part (S. Rept. No. 960, 70th Cong., 1st sess., p. 15; 1939-1 C. B. (Part 2) 409, 419): Many difficult and complicated problems, however, have arisen in the administration of the provisions permitting the filing of consolidated returns. It is, obviously, of utmost importance that these questions be answered with certainty and a definite rule be prescribed. Frequently, the particular policy is comparatively immaterial, so long as the rule to be applied is known. The committee believes it to be impracticable to attempt by legislation to prescribe the various detailed and complicated rules necessary to meet the many differing and complicated situations. Accordingly, it has found it necessary to delegate power to the Commissioner to prescribe regulations legislative in character covering them. The standard prescribed by the section keeps the delegation from being a delegation of pure legislative power, and is well within the rules established by the Supreme Court. (See Hampton, Jr., & Co. v. United States, decided by the Supreme Court on April 9, 1928, and eases there cited.) Furthermore, the section requires that all the corporations joining in the filing of a consolidated return must consent to the regulations prescribed prior to the date on which the return is filed. Among the regulations which it is expected that the Commissioner will prescribe are: (1) The extent to which gain or loss shall be recognized upon the sale by a member of the affiliated group of stock issued by any other member of the affiliated group or upon the dissolution (whether partial or complete) of a member of the group; (2) the basis of property (including property included in an inventory) acquired, during the period of affiliation, by a member of the affiliated group, including the basis of such property after such period of affiliation; * * The House agreed with the proposed section 141, as presented by the. Senate Committee on Finance, with a clarifying amendment as to insurance companies, Amendment No. 91, H. Rept. No. 1882, 70th Cong., 1st sess., p. 16, 1939-1 C. B. (Part 2) 444, 448. In view of such specific delegation of power to administrative ofiicers to promulgate regulations, and which has been continued in successive revenue acts, a clear showing must be made of authority to cut across such regulations and to reach a result other than that spelled out by the regulations. General rules which under some facts and some statutes might permit the disregard of intermediate steps in a so-called step plan are not sufficient to permit the disregard of any step in a case like this where the regulation is specific and the power to make it is as specific as it is in the Revenue Act of 1928. The cases cited by the petitioner are not persuasive authority for its position. A case strongly relied on by the petitioner is Muskegon Motor Specialties Co., 35 B. T. A. 851. In that case, a Delaware corporation organized late in 1928 acquired the stock of two existing Michigan corporations. It was contemplated by the organizers and the bankers that the Delaware corporation would as soon as practicable acquire the assets of the Michigan corporations. The transfer of assets took place on January 23, 1929. All three corporations filed separate income tax returns for the year 1929. In each of the three returns it was stated that it was not a consolidated return. Upon the foregoing facts, we held that the basis of the depreciable assets acquired by the Delaware corporation from the Michigan corporations was not limited to the latters’ basis. We said in part: The filing of a consolidated return is a matter of election by affiliated corporations. Oklahoma Contracting Corporation, 35 B. T. A. 232, 237. The regulations lay down detailed instructions as to the formalities to be complied with by corporations seeking the privilege of making a consolidated return. Among other things, the consolidated return must be made by the parent for the group. The parent must prepare and file form 851 and the subsidiaries must prepare and file form 1122 consenting to the regulations and authorizing the parent to file for them. These formalities were not met. Each corporation filed its own return and neither form 851 nor form 1122 was filed. What is more important is that according to the evidence these matters were considered and a deliberate election was made not to file a consolidated return and not to meet the conditions which were necessary to the filing of such a return. On the contrary, it was intended that separate returns be filed and that was done. Consequently, it can not be held that a consolidated return was filed. We also discussed in the opinion arguments as to whether the dissolution of the old companies and the acquisition of their assets by the new was part of the original plan, but the real basis for our holding is in the language above quoted. The fact that in the Muskegon case no consolidated return was filed, and there was a deliberate election not to file such a return, readily distinguishes that case from the present one. The case of Ruth M. Cullen, 14 T. C. 368, is not in point as it did not involve either affiliated corporations or consolidated return. In that case, the individual holders of a minority of corporate stock purchased the stock of other stockholders and liquidated the corporation. The questions for decision concerned only the realization of gain or loss by the individuals on the liquidation. The case of Kimbell-Diamond Milling Co., 14 T. C. 74, affd. per curiam, 187 F. 2d 718, likewise did not involve any question growing out of affiliation or consolidated returns. There the taxpayer, following an involuntary conversion, with intent to acquire the assets of another corporation, purchased all of its stock and within a few days liquidated it. It sought a stepped-up basis for the depreciable assets under the provisions of Code sections 112 (b) (6) and 113 (a) (15). Of the cases cited, the one that is most nearly like the present one on the facts is Commissioner v. Ashland Oil & Refining Co., 99 F. 2d 588, which reversed the holding in Swiss Oil Corporation, 32 B. T. A. 777. In that case, Swiss in 1924 obtained an option to purchase all of the stock of Union Gas & Oil Company for cash and notes. The stock was placed in escrow pending the making of certain cash payments. The last required payment was made late in 1925, the escrowed stock was delivered on January 2, 1926, to Swiss which thereupon liquidated Union and acquired its properties. Swiss, Union, and another corporation filed a consolidated return for the year 1925 which included income and deductions of Union for the period February 2, 1925, to December 31, 1925. One of the questions in that case was whether Swiss realized a gain on the liquidation of Union in 1926. The Circuit Court held that it did not on the ground that the entire transaction between the corporations was essentially one for the acquisition of property, and the intervening steps should not be separately regarded either at the instance of the taxpayer or the taxing authority. It also held that the filing of a consolidated return for the year 1925 was unimportant, and for this proposition it cited Muskegon Motor Specialties Co., supra. For the year in suit in the Ashland case, whatever regulations there were as to the filing of consolidated returns did not have the statutory sanction that was given to them by section 141 of the Revenue Act of 1928. It may be that for that reason the Court felt it proper to disregard intervening steps. At any rate, we think that the absence of legislation on the subj ct in 1926 is an effective distinction between the Ashland case and the me before us. The petitioner further contends that the consents filed by the 8 corporations whose stock was acquired by the petitioner had no legal effect. This is based on its view that the transfers of properties should be given effect as of August 1, 1929, in the case of Laurel Development Company and as of June 1, in the case of the other 7 corporations. It says that after those dates the 8 corporations could have no income or deductions to be included in a consolidated return. We think that this contention is based on too light a consideration of the existence of the 8 corporations and their continued ownership of properties. All of them continued their corporate existence throughout the year 1929. They continued to be the owners of their properties until December 19, 1929, when they were transferred to the petitioner. During that time, they had income from and expenses with respect to their properties. While such income and expenses became those of the petitioner, that was by reason of contract, and the income and expenses were initially those of the 8 corporations. Accordingly, we cannot say that the consents filed should not be given effect. Finally, the petitioner contends that if its basis as to the 132 operating properties is limited to that of the eight corporations, then its basis as to the 62 properties acquired from individuals and partnerships must be increased. It develops on brief a set of figures, and arrives at an amount of $46,124.84 which it says was the portion of Anderson Development Company’s profits that is allocable to the 62 properties. The petitioner’s position on this point is not based on proof. We do not know what Anderson Development Company agreed to pay for the 62 properties, but what is more important we do not know how much the petitioner paid for them. Certainly we cannot say that the petitioner’s basis was greater than cost. An agent of the respondent attempted to ascertain how the total of $1,300,000 should be distributed. On the basis of what records were available, he determined that $740,000 was the cost of the stock of the 8 corporations and $435,500 was the cost of the 62 properties. The remainder of $124,500 he reported to be unidentified. On the record before us, we cannot determine what portion, if any, of the $124,500 should be allocated to the 62 properties as part of their cost to the petitioner. Reviewed by the Court. Decision will he entered for the respondent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623355/	Estate of Maggie M. Holding, Deceased, Willis A. Holding, Sr., and Mildred Holding Stockard, Executors, Petitioner, v. Commissioner of Internal Revenue, RespondentEstate of Holding v. CommissionerDocket No. 65341United States Tax Court30 T.C. 988; 1958 U.S. Tax Ct. LEXIS 115; July 31, 1958, Filed 115 Decision will be entered under Rule 50. Decedent, Maggie M. Holding, in 1952 and for several years prior thereto, owned some valuable unimproved land near the city of Raleigh, North Carolina. She sold it that year at what she considered an advantageous price. She gave part of the proceeds of the sale to her children, grandchildren, and a daughter-in-law who had remarried subsequent to her husband's death. Although the donor was 87 years of age she was in good health at the time the gifts were made and the dominant motive of the donor in making the gifts was the satisfaction of seeing her children, grandchildren, and daughter-in-law enjoy the money given them while she was living rather than that they should come into possession of it after her death. Decedent's death, which occurred in September 1953 after an illness of about 3 months' duration, was from cancer, unknown to decedent or her physician at the time the gifts were made. Held, the gifts were not made in contemplation of death or as a substitute for a testamentary disposition of the amounts of money included in the gifts. The value of the gifts is not includible in decedent's gross estate as the Commissioner116 has determined. Daniel R. Dixon, Esq., for the petitioner.Thomas E. Tyre, Esq., for the respondent. Black, Judge. BLACK988 The Commissioner has determined a deficiency in the estate tax of the Estate of Maggie M. Holding of $ 15,645.55. The deficiency is due to the addition to the estate reported on the return of $ 61,000 explained in the deficiency notice, as follows:Explanation of AdjustmentsSchedule GGifts made in 1952 and 1953 toReturnedDeterminedWillis Holding, Jr$ 0.00$ 11,000.00Bernice Y. Holding0.003,000.00John N. Holding0.0011,000.00Doris M. Holding0.003,000.00H. Jerome Stockard0.0011,000.00Gene M. Stockard, Jr0.003,000.00Mildred H. Stockard0.009,000.00H. Jerome Stockard, Sr0.003,000.00Bessie Price0.006,000.00Willis Holding, Sr0.001,000.00Total$ 0.00$ 61,000.00117 The transfers listed above are included in decedent's gross estate pursuant to Section 811 (c) of the Internal Revenue Code, as amended, as gifts made in contemplation of death or in lieu of a testamentary disposition of a part of her estate.989 Petitioner, the Estate of Maggie M. Holding, deceased, contests the foregoing adjustment by an appropriate assignment of error. At the hearing petitioner, in an amendment to petition, assigned an additional error as follows:(5) Respondent erred by failing to allow as an additional deduction from the gross estate of the decedent those expenses and costs incurred by the petitioners for attorney's fees and other expenses in defending said estate against the assessment of additional federal estate taxes and state inheritance taxes.FINDINGS OF FACT.Part of the facts have been stipulated and are incorporated herein by this reference.The decedent, Maggie M. Holding was born on November 4, 1865, and for the last 50 years preceding her death lived in the family residence in Raleigh, North Carolina.Decedent's United States estate tax return was filed with the district director of internal revenue, Greensboro, North Carolina, on December118 13, 1954. This return showed a net estate of $ 34,655.54, after deducting the specific exemption of $ 60,000, and an estate tax due of $ 3,838.In 1952 and prior thereto, decedent owned some acres of farmland in Wake County, North Carolina, just outside the city of Raleigh. This land was sold in August 1952 to J. W. York, et al. The date of the conveyance was August 18, 1952. At the time it was sold this farmland was not profitable or income producing. It was known to be valuable property, however, because of its proximity to the city of Raleigh. The decedent acquired the land in question as a result of a foreclosure under a mortgage and sale of such property in 1936. The land had been owned by her son, Hubert R. Holding, Sr., who died in 1922. The decedent had purchased the farm for her son, Hubert, Sr., and took the mortgage on the property as security. The sale of the land owned by decedent (64.07 acres) to York et al. was contingent upon York et al. acquiring the contiguous tracts owned by decedent's son, Willis A. Holding, Sr., and her grandson, Hubert R. Holding, Jr. The land was sold for $ 2,000 per acre, the gross proceeds being received as follows:Number ofAmountacresMaggie M. Holding (decedent)$ 128,14064.07Willis A. Holding, Sr. (son)25,90012.95Hubert R. Holding, Jr. (grandson)19,0009.50Total173,040119 The land sold to J. W. York et al. by Hubert R. Holding, Jr., through his guardian was inherited by him from his father, Hubert R. Holding, Sr. These acres were inadvertently omitted from the mortgage executed to decedent by Hubert R. Holding, Sr., on June 1, 990 1922. The mortgage was purportedly to cover all of the land owned by Hubert R. Holding, Sr. As a result of the inadvertent omission, the subsequent foreclosure by decedent did not include the 9.50 acres which were consequently inherited by Hubert, Jr. In making the subsequent gifts to her grandchildren, decedent took this factor into consideration and made no gifts to Hubert R. Holding, Jr. The omission of these properties took place in 1936 but was not discovered until the time the land was sold in 1952 and title papers were being prepared.The gross proceeds from the sale of land received by the decedent in the amount of $ 128,140 were deposited in her account at Wachovia Bank and Trust Company, Raleigh, North Carolina, on August 21, 1952.In September and October of 1952 and in February of 1953, decedent made 17 gifts of cash to her children, grandchildren, and the widow of a deceased son who had remarried, 120 through the medium of checks drawn on her account at the Wachovia Bank and Trust Company, Raleigh. The checks were in the handwriting of the decedent and were made payable to the donees, and bore the dates and amounts as indicated in the following listing:Date of checkPayeeMarkingAmountSept. 10, 1952Mildred H. Stockard(From corpus)$ 6,000Sept. 10, 1952Mildred H. Stockard(General)3,000Sept. 10, 1952H. J. Stockard, Sr3,000Sept. 10, 1952John N. Holding(From corpus)6,000Sept. 10, 1952John N. Holding(General)3,000Sept. 10, 1952Doris Holding(General)3,000Sept. 10, 1952Willis A. Holding, Jr(From corpus)6,000Sept. 10, 1952Willis A. Holding, Jr(General)3,000Sept. 10, 1952Bernice Holding(General)3,000Sept. 9, 1952H. J. Stockard, Jr(From corpus)6,000Sept. 9, 1952H. J. Stockard, Jr(General)3,000Sept. 10, 1952Eugenia M. Stockard(General)3,000Oct. 14, 1952Bessie L. Price(Corpus)6,000Total for 195254,000Feb. 6, 1953H. J. Stockard, Jr(For Jerry -- birthday)2,000Feb. 12, 1953Willis A. Holding, Sr(Birthday)1,000Feb. 14, 1953John N. Holding(House)2,000Feb. 14, 1953Willis Holding, Jr(House)2,0007,000Total for 1952 and 195361,000121 The relationship of the various donees to the donor-decedent is as follows: Mildred H. Stockard is the daughter of the decedent; H. J. Stockard, Sr., is the husband of Mildred H. Stockard; Willis A. Holding, Sr., is the son of the decedent; Willis A. Holding, Jr., is a grandson of the decedent; Bernice Holding is the wife of Willis A. Holding, Jr.; John N. Holding is a grandson of the decedent and is a son of Willis A. Holding, Sr.; Doris Holding is the wife of John N. Holding; H. J. Stockard, Jr., is a grandson of the decedent; Eugenia M. Stockard is the wife of H. J. Stockard, Jr.; and Bessie L. Price, 991 formerly Bessie Holding, is the surviving wife of Hubert Holding, Sr., who is a deceased son of the decedent, Maggie M. Holding.A Federal gift tax return, Form 709, was filed by decedent for the year 1952 on February 24, 1953, with the office of the now district director of internal revenue, Greensboro, North Carolina, disclosing gifts of $ 54,000. From this total of $ 54,000 in gifts, nine exclusions of $ 3,000 each, totaling $ 27,000 were taken. This left "Total included amount of gifts for year $ 27,000.00." From this $ 27,000 was deducted "Specific exemption claimed, 122 $ 27,000.00." This resulted in "Amount of net gifts for year, None." Therefore, no gift tax was paid for 1952. The record does not disclose the filing of any gift tax return for 1953.Decedent prepared her holographic last will and testament on August 20, 1952. She died on September 16, 1953, at the age of 87. The primary beneficiaries under the decedent's will were her two surviving children, Willis A. Holding, Sr., and Mildred Holding Stockard. The estate was distributed under the will as follows:Mildred Holding Stockard (daughter)$ 34,589.02Willis A. Holding, Sr. (son)41,992.12Willis A. Holding, Jr. (grandson)3,149.22John N. Holding (grandson)3,149.23Hubert R. Holding, Jr. (grandson)3,149.22H. Jerome Stockard, Jr. (grandson)3,149.23Arthur Newton Holding (grandson)4,877.50Others600.00Total94,655.54The assets and liabilities constituting the adjusted gross estate of the decedent as shown on the estate tax return were as follows:Real estate$ 45,800.00Bonds4,877.50Cash in banks44,770.74Other property1,000.00Gross estate96,448.24Liabilities1,792.70Adjusted gross estate94,655.54During her last123 illness decedent was treated at Rex Hospital, Raleigh, North Carolina. Decedent was admitted to Rex Hospital on July 19, 1953, and was discharged therefrom on August 26, 1953. Petitioner died shortly thereafter on September 16, 1953. The first noticeable symptoms of decedent's last illness occurred within a period of approximately 1 month prior to her admission to Rex Hospital on July 19, 1953, in the form of nausea, vomiting, and indigestion. Decedent did not consider these symptoms as indicative of a serious illness and objected to being hospitalized. However, her family physician insisted that she go into the hospital for observation and treatment and she did so.992 Prior to her last illness decedent had enjoyed excellent health for many years. Petitioner was an unusually active and vigorous person for one of her age, both mentally and physically. She could read without her glasses and continued to conduct her business and personal affairs and work in her home and yard until her last illness. During the last 8 to 10 years of her life decedent's family physician gave her a periodic checkup at irregular intervals of about twice a year and occasionally treated her for124 minor ailments. These checkups disclosed no serious illness and members of decedent's family and her family physician were unaware of any serious illness until she was ordered to go to the hospital on or about July 17, 1953, by her physician. Upon admission to Rex Hospital on July 19, 1953, decedent was subsequently found to be suffering from an incurable malignancy which resulted in her death on September 16, 1953.At the time the gifts were made in September and October of 1952 and in February of 1953, the decedent was enjoying good health. At these times, the malignancy was either nonexistent or had not manifested any symptoms. The first knowledge of any symptoms of illness appeared approximately 1 month before admission to Rex Hospital.Decedent made a practice of giving substantial gifts of money to her children and grandchildren and their spouses on frequent occasions. Decedent, on birthdays, holidays, Christmas, and other occasions would make money gifts of $ 25 to $ 100 to each of them. On special occasions these gifts were as large as $ 500 or $ 1,000. The gift made to Jerry in 1953 in the amount of $ 2,000 was made on his birthday, and the check by which the gift 125 was made was marked "(For Jerry -- Birthday)" by the decedent. The gift made to Willis, Sr., in 1953 in the amount of $ 1,000 was made on his birthday and the check was marked "(Birthday)" by the decedent. Decedent also paid a large and substantial portion of the expenses her grandchildren incurred in acquiring their respective college educations.At the time of her death, decedent had an independent annual gross income of approximately $ 10,000 and a net taxable income of approximately $ 6,000. Decedent was receiving approximately $ 4,400 annually in dividends from a trust fund at her death and approximately $ 6,000 annually in gross rentals from various properties at the time of her death.At the time of her death decedent owned $ 44,770.74 in cash in the form of bank deposits.Decedent made a practice of frequently rewriting her will without legal assistance and in her own handwriting whenever an occasion would seem to justify such action. She had followed this practice for many years before her death.Decedent was advised on several occasions by her tax adviser not to sell the land in question for the reason that said sale would result in 993 incurring high income tax126 for both Federal and State income tax purposes. He also advised her not to sell for the further reason that because of her advanced years an estate tax problem would also be created if she gave away the proceeds of sale and died within 3 years thereafter.Decedent proceeded to sell the land against the advice of her tax adviser. Petitioner paid income tax to the Federal Government for 1952 in the total amount of $ 30,148.01. Of this amount, $ 29,353.67 was attributable to the gain on the sale of the land which was sold. Petitioner paid income tax to the State of North Carolina for 1952 in the total amount of $ 7,974.83. Of this amount, approximately $ 7,826.31 was attributable to the sale of the land. Accordingly, decedent paid a total of $ 37,179.98 in income taxes on the land sale.Decedent deplored the practice of some of her associates of keeping their wealth until they died. She believed in sharing what she had with her descendants while she was alive to see them enjoy it and she practiced that belief.None of the gifts made by decedent in 1952 and 1953 aggregating the sum of $ 61,000 was made by decedent in contemplation of death or in lieu of testamentary disposition. 127 The dominant motive which prompted decedent to make the several gifts in question to her children, grandchildren, and daughter-in-law was to see them enjoy the use of the money given to them while she was yet living.OPINION.The Commissioner, in his determination of the estate tax deficiency against the Estate of Maggie M. Holding, deceased, has determined that gifts which she made to her children, grandchildren, and daughter-in-law in 1952 and 1953 were made in contemplation of death or in lieu of a testamentary disposition of a part of her estate and therefore are includible in decedent's gross estate under section 811 (c), I. R. C. 1939, as amended. The applicable statute is printed in the margin. 1128 994 The petitioner estate fully realizes that there is not only a general presumption that the determination of the Commissioner is correct but there is also a special statutory provision which says that gifts made within 3 years prior to decedent's death "shall, unless shown to the contrary, be deemed to have been made in contemplation of death." Petitioner has taken upon itself the burden of showing "to the contrary." Regulations 105, section 81.16 (as amended by T. D. 6071, June 11, 1954), provide, among other things, as follows:The phrase "contemplation of death," as used in the statute, does not mean, on the one hand that general expectation of death such as all persons entertain, nor, on the other, is its meaning restricted to an apprehension that death is imminent or near. A transfer in contemplation of death is a disposition of property prompted by the thought of death (though it need not be solely so prompted). A transfer is prompted by the thought of death if it is made with the purpose of avoiding the tax, or as a substitute for a testamentary disposition of the property, or for any other motive associated with death. The bodily and 129 mental condition of the decedent and all other attendant facts and circumstances are to be scrutinized to determine whether or not such thought prompted the disposition.A stipulation of facts has been filed and in addition thereto much other evidence has been received bearing upon the issue we have to decide. It will be noted that the foregoing regulation provides that "[the] bodily and mental condition of the decedent and all other attendant facts and circumstances are to be scrutinized to determine whether or not such thought prompted the disposition." We have done that, in the light of the evidence which is before us, and have reached the conclusion that the transfers in question were not made in contemplation of death nor were they made as a substitute for a testamentary disposition of the property in question, but were made from motives associated with life rather than death.Respondent, in his brief, lays much stress on the fact that decedent was 87 years of age when the gifts were made and argues therefore, considering all the circumstances, we should find that they were made in contemplation of death. Of course, it is undoubtedly true that when an individual reaches the 130 age that decedent had reached when she made the gifts he knows that he is "nearing the journey's end," but that alone does not mean that gifts of the kind which decedent made in the instant case were made in contemplation of death or as a substitute for a testamentary disposition. Notwithstanding the age of the donor, the dominant motive for such gifts may be associated with life rather than with death.The leading case dealing with the contemplation of death transfers is United States v. Wells, 283 U.S. 102">283 U.S. 102. In that case, in speaking of the statutory presumption that gifts made within a certain time prior to death (in the Wells case, 2 years prior to death) were made in contemplation of death, the Supreme Court said:995 But this presumption, by the statute before us, is expressly stated to be a rebuttable one, and the mere fact that death ensues even shortly after the gift does not determine absolutely that it is in contemplation of death. The question, necessarily, is as to the state of mind of the donor.We have in the instant case much evidence as to the state of mind of the donor, Maggie M. Holding, at the time the gifts were made. 131 The testimony was to the effect that she had always been a remarkably healthy woman, energetic and active, and very much interested in the welfare of her children and grandchildren. She had frequently made them gifts from time to time at Christmas, on their birthdays, and in helping to educate her grandchildren, as shown in our Findings of Fact. In 1952, an opportunity came to make a sale, at an advantageous price, of some unimproved real estate which she owned and which was situated near the city of Raleigh. She made the sale and out of part of the proceeds, made gifts to her children, grandchildren, and daughter-in-law (who had remarried) of the amounts shown in our Findings of Fact. The evidence shows that she was in good health at the time these gifts were made and convinces us that the dominant motive which prompted her in making the gifts was associated with life, rather than death. She wanted to see the recipients of such gifts enjoy the money which she was giving them while she was living rather than that they should receive it after her death. The fact that she died not many months after the gifts were made does not convince us that the gifts were made in contemplation132 of death or as a substitute for testamentary disposition. The fact that decedent was 87 years of age when she made the gifts is an important factor, of course, to be considered but it is not, within itself, determinative of the issue.The case of Bradley v. Smith, 114 F. 2d 161 (C. A. 7, 1940), involved a donor who made gifts at the age of 85 which were held to be not in contemplation of death even though made within 4 months of his death. The case of Levi v. United States, 14 F. Supp. 513">14 F. Supp. 513 (Ct. Cl. 1936), is similar in some of its facts to the instant case. Decedent there was a man of 75 years of age when he made certain gifts. At the time of the gifts he was apparently in good health. Death was caused by cancer 2 months after the gifts were made and such gifts were held not in contemplation of death.We are aware, of course, that the issue we have here to decide depends in each case upon its own facts. It is with full knowledge of this rule that we have decided the issue involved in favor of petitioner. Notwithstanding the decision of this issue in favor of petitioner, a Rule 50 computation will be necessary133 in order to dispose of the deduction of additional expenses and attorney's fees incurred by decedent's estate in the prosecution of this proceeding. See Rule 51, Rules of Practice, Tax Court of the United States.Decision will be entered under Rule 50. Footnotes1. SEC. 811. GROSS ESTATE.The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside of the United States -- * * (c) Transfers in Contemplation of, or Taking Effect at, Death. -- (1) General rule. -- To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise -- (A) in contemplation of his death; or * * (1) Contemplation of Death. -- If the decedent within a period of three years ending with the date of his death (except in case of a bona fide sale for an adequate and full consideration in money or money's worth) transferred an interest in property, relinquished a power, or exercised or released a power of appointment, such transfer, relinquishment, exercise, or release shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of subsections (c), (d), and (f); * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623357/	LUTHER D. HYDE, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, RespondentHyde v. Comm'rDocket No. 4640-76. United States Tax CourtT.C. Memo 1981-480; 1981 Tax Ct. Memo LEXIS 258; 42 T.C.M. (CCH) 954; T.C.M. (RIA) 81480; September 2, 1981. 258 Held: (1) Deduction for casualty loss of automobile disallowed where record did not support the view that petitioner was the owners of the automobile. (2) Support payments made to spouse pursuant to deed of separation were periodic and therefore deductible, as under North Carolina law such payments were contingent on the wife's remarriage. Payments made to spouse pursuant to a division of property between husband and wife are not in the nature of support and thus not deductible under section 215. (3) Home office deduction disallowed where business use of home office was incidental. (4) (a) Expenses for travel away from home disallowed for failure to meet substantiation requirements of section 274(d). (b) Deductions disallowed for depreciation of automobile used for travels away from home for failure to show that travels were predominantly business related. (5) (a) Depreciation deduction on 1967 automobile disallowed where petitioner was not the owner of the automobile and had no investment in the property. (b) Depreciation deduction on 1973 automobile disallowed where petitioner failed to prove actual depreciation on automobile exceeded the depreciation allowance built in to 259 reimbursed expenses. (c) Depreciation deduction of employment contract disallowed where contract was acquired at no cost. Costs of obtaining a college education cannot be viewed as depreciable costs of obtaining a contract. Cf. Sharon v. Commissioner, 66 T.C. 515">66 T.C. 515 (1976), affd. 591 F.2d 1273">591 F.2d 1273 (9th Cir. 1978), cert. denied 442 U.S. 941">442 U.S. 941 (1979). (6) (a) Investment credit on 1967 automobile owned by petitioner's brother disallowed. (b) Investment credit disallowed on 1973 automobile and office furniture as those properties were not section 38 property. (7) Deductions for meals and lodging expenses disallowed for failure to meet substantiation requirements of section 274(d). (8) Payment of premium for accident insurance does not qualify for a medical expense deduction. (9) Deductions for taxes in excess of amount allowed by respondent disallowed for lack of proof. (10) Charitable contributions in excess of amount allowed by respondent not proved. (11) Dependency exemption claimed by petitioner for his mother disallowed where multiple support agreement was invalid and petitioner could not otherwise show that he provided over half of his mother's support. (12) Expenses for professional 260 tax advice disallowed for failure to produce any evidence. (13) Since petitioner was still married at the end of the year in issue, had no dependents living with him, and did not maintain the household in which his mother lived, he cannot qualify for head to household rates and must file as a married individual filing a separate return. (14) Credit for political contributions disallowed for failure to substantiate claimed expenditure. Luther D. Hyde, pro se. Edwina L. Link, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: Respondent determined a deficiency of $ 2,135.23 in petitioner's 1973 Federal income tax. After concessions the issues presented for our determination are: (1) Whether petitioner is entitled to a casualty loss resulting from the demolition of a 1967 Pontiac Firebird automobile and if so, the amount of the casualty loss; (2) Whether payments allegedly made to or on behalf of petitioner's wife qualify as periodic alimony, so as to be deductible under section 2151; (3) Whether petitioner is entitled to a deduction for 261 home office expenses (including depreciation of office furniture); (4) Whether petitioner is entitled to a deduction for automobile expenses incurred between September 5, 1973 and December 31, 1973; (5) Whether petitioner's deductions for depreciation on automobiles, and an employment contract for the taxable year are allowable; (6) Whether petitioner is entitled to an investment credit against tax for the taxable year 1973 for the purchase of a 1967 Pontiac Firebird, a 1973 Oldsmobile Cutlass, and office furniture and if so the amount of the credit; (7) Whether meals and lodging expenses allegedly incurred by petitioner while away from home for the period between September 5, 1973 and December 31, 1973 are deductible; (8) Whether petitioner is entitled to a medical and dental expenses deduction in excess of $ 109; (9) Whether a deduction for taxes in excess of $ 798 is allowable to petitioner; (10) Whether petitioner is entitled to a deduction for charitable contributions in excess of $ 50; (11) Whether petitioner may be allowed a depedency exemption for his mother for the taxable year 1973; (12) Whether petitioner is entitled to a deduction of $ 67.40 for professional tax advice; 262 (13) Whether petitioner qualifies for head of household status for the taxable year 1973; (14) Whether petitioner is entitled to a credit against tax in 1973 for political contributions. FINDINGS OF FACT Some of the facts have been stipulated. These facts, together with the exhibits attached thereto, are incorporated herein by this reference. Petitioner Luther D. Hyde was a resident of Washington, D.C. when his petition in this case was filed. For the taxable year 1973, petitioner filed a Federal income tax return with the Internal Revenue Service Center, Memphis, Tennessee. On August 7, 1972 petitioner's brother, Barnell Hyde, purchased a 1967 Pontiac automobile from Mr. James Earl McGaha. An assignment of title to the automobile was executed to Mr. McGaha to Barnell Hyde which was immediately filed at the North Carolina Division of Motor Vehicles. Aetna Casualty and Surety Company insured the 1967 Pontiac, in the name of Barnell Hyde. In November of 1973, the 1967 Pontiac, with Barnell driving, was wrecked as a result of a collision with another automobile. The accident report listed Barnell as the sole owner of the car. The value of the 1967 Pontiac at the time of its 263 demolition was $ 1,050. No insurance recovery was ever had respecting the automobile. At the time of the acquisition of the Pontiac, petitioner was the sole owner of one automobile and a joint owner of another. Subsequently, petitioner also acquired a 1973 Oldsmobile. This purchase occurred after petitioner agreed to transfer at least one of his older cars to his estranged spouse pursuant to a deed of separation. On his return for 1973, petitioner claimed a casualty loss deduction with respect to the wrecked Pontiac in the amount of $ 750. Respondent, in his notice of deficiency, disallowed the entire deduction. OPINION - CASUALTY LOSS Section 165(a) allows the taxpayer a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(c)2264 in limiting the losses allowable to an individual provides in pertinent part at section 165(c)(3) that losses or property not connected with a trade or business qualify for a deduction only if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. A casualty loss deduction is authorized only when the claimant was the owner of the property with respect to which the loss is claimed. Rink v. Commissioner, 51 T.C. 746 (1969); Draper v. Commissioner, 135">15 T.C. 135 (1950). The issue of an automobile as the subject of a casualty loss 265 is specifically addressed in section 1.165-7(a)(3), Income Tax Regs. The relevant portion of that section provides: (3) Damage to automobiles. An automobile owned by the taxpayer whether used for business purposes or maintained for recreation or pleasure, may be the subject of a casualty loss * * . (Emphasis added.) Petitioner claims a $ 750 casualty loss deduction as a result of the demolition of the 1967 Pontiac. He alleges, despite all the evidentiary matter indicating that his brother Barnell was the record owner of the automobile, that he paid the entire purchase price of the car ($ 1,595) in January of 1973 and allowed his brother to borrow the car periodically. Thus, he argues that he is the beneficial owner of the auto and should be entitled to the casualty loss deduction. Our findings of fact expressly state that Barnell Hyde purchased the automobile. Petitioner, at the time of acquisition of the car, was in possession of two other automobiles. The certificate of title and insurance policy on the auto cited Barnell as the owner. All factors, although not individually conclusive, point to the fact that petitioner was not the owner of the automobile. Nothing in the 266 record other than petitioner's own testimony supports ownership of the automobile by petitioner. Accordingly, petitioner is not entitled to a casualty loss on the 1967 Pontiac. FINDINGS OF FACT - ALIMONY DEDUCTION Petitioner and his former wife, Wanda Lee Hyde, were married on or about January 30, 1970. A deed of separation was executed by petitioner and his former spouse on November 14, 1972. Paragraphs four and six of the deed provided as follows: 4. The Husband agrees to pay unto the Wife the sum of Three Hundred Dollars Ninety-eight cents ($ 300.98) per month, the first of said payments being due the 1st day of December, 1972, and a like amount each and every month thereafter for a period of twelve (12) months; and providing that the Husband has met each and every payment in accordance with this schedule, the Wife does hereby release and forever discharge the Husband from any further obligation of support. 6. It is agreed between the parties that the Wife shall have all the household and kitchen furnishings located in their apartment at 400-D Ridge Townhouse Apartments, except that the Husband shall have a certain stereo set as his own separate property, free and clear of 267 any claims of the Wife. Some of the household and kitchen furnishings that the deed granted to the wife were purchased with funds borrowed by petitioner and his former spouse. They were jointly and severally liable on the indebtedness. Petitioner, in an effort to comply with paragraph 6 of the deed of separation, continued to make monthly payments respecting certain household furnishings. Specifically, petitioner made payments of $ 465.23 per month, as principal, to Wachovia Bank and Trust Company during the first 9 months of 1973. In addition to the payments set forth above, petitioner made 11 monthly payments totaling $ 3,311 in 1973 to his former spouse pursuant to paragraph 4 of the deed of separation. In his 1973 return, petitioner claimed a deduction for alimony in the amount of $ 6,000. The $ 6,000 was composed of the monthly payments made directly to Wanda and a portion of the payments in the amount of $ 465.23 made during the first 9 months of 1973 in repayment of the loan made to petitioner and his former spouse. Respondent, in his notice of deficiency, disallowed the entire alimony deduction. OPINION - ALIMONY DEDUCTION Section 215 allows a husband a deduction for 268 alimony payments that are taxable to the wife under section 71 and paid to her during the husband's taxable year. Section 71(a)(2) provides: SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS. (a) General Rule.-- (2) Written separation agreement.--If a wife is separated from her husband and there is a written separation agreement executed after the date of the enactment of this title, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such agreement is executed which are made under such agreement and because of the marital or family relationship (or which are attributable to property transferred, in trust or otherwise, under such agreement and because of such relationship). This paragraph shall not apply if the husband and wife make a single return jointly.Section 71(c) provides that installment payments on a lump sum obligation specified in the decree or written instrument shall not be treated as periodic payments unless they are payable over a period in excess of 10 years. However, installments payable over a period of 10 years or less may still qualify as periodic if they come within the guidelines cited in section 1.71-1(d)(3)(i), Income Tax Regs.269 which provides: (i) Where payments under a decree, instrument, or agreement are to be paid over a period ending 10 years or less from the date of such decree, instrument, or agreement, such payments are not installment payments discharging a part of an obligation the principal sum of which is, in terms of money or property, specified in the decree, instrument, or agreement (and are considered periodic payments for the purposes of section 71(a)) only if such payments meet the following two conditions: (a) Such payments are subject to any one or more of the contingencies of death of either spouse, remarriage of the wife, or change in the economic status of either spouse, and (b) Such payments are in the nature of alimony or an allowance for support. Furthermore, section 1.71-1(d)(3)(ii) states that payments will be considered periodic regardless of whether the contingencies set forth above are imposed by local law or by the terms of the decree, instrument, or agreement. We first address the 11 monthly installments paid by petitioner to his former spouse pursuant to paragraph 4 of the deed of separation. Since the instrument provides that the payments are to be made over a 1-year period, 270 the payments could be periodic only if they are in the nature of support and are subject to any of the contingencies set forth in the regulations. The language of the deed of separation, which makes it abundantly clear that the monthly payments by petitioner to Wanda were in the nature of support, does not address itself to any of the contingencies noted in the regulations. Respondent submits that under North Carolina law alimony payments are subject only to contingencies set forth in N.C. Gen. Stat. sec. 50-16.9. 3271 He reasons that because that statute provides for modification of an order of a court, separation agreements voluntarily executed are not subject to any contingencies. While we agree that the North Carolina statute is inapplicable to separation agreements not incorporated into any decree, we believe, despite the lack of abundant case law on the matter, that the payments were subject to the contingencies of death and remarriage. Questions relating to the construction of a separation agreement between a husband and wife are governed in general by the rules and provisions applicable in the case of other contracts generally. The intention of the parties is to be gleaned from the language of the contract, the subject matter, the end in view and the situation of the parties at the time. Bowles v. Bowles, 237 N.C. 462">237 N.C. 462, 75 S.E.2d 413">75 S.E.2d 413 (1953); 24 Am. Jr. 2d 1026 (1966). Unless 272 a contrary intention is expressed, a wife's remarriage terminates the husband's obligation to make payments in the nature of support under a separation agreement which is silent on the question of the wife's remarriage. Medders v. Medders40 N.C. App. 681">40 N.C. App. 681, 254 S.E.2d 44">254 S.E.2d 44 (1979). 4 The deed of separation obligated petitioner to make payments in the nature of support in the amount of $ 300.98 per month for 12 months. Nowhere in the agreement can we ascertain that the parties intended continued payments in the event of divorce and a subsequent remarriage of the wife. Although we are acutely 273 aware of the fact that these occurrences were unlikely considering the duration of payments in this case, we nonetheless must hold that the contingency existed and thus rendered the payments periodic within the purview of section 1.71-1(d)(3)(i), Income Tax Regs. Therefore petitioner is entitled to deduct $ 3,311 in monthly payments made to his then spouse Wanda. We next address the payments made by petitioner in repayment of borrowed funds used in part to purchase certain household furnishings. Petitioner and his former spouse borrowed these moneys and were jointly and severally liable on them. The deed of separation executed by petitioner and his former spouse mandated that all kitchen and household furnishings shall belong to the wife. Petitioner, believing that the agreement contemplated a conveyance free of any encumbrance, made 9 monthly payments during 1973 of $ 465.23 each in repayment of the borrowed money.Where payments are made pursuant to a division of property between husband and wife the payments are capital in nature and are neither includable by the recipient under section 71 nor deductible by the payor under section 215. Wright v. Commissioner, 62 T.C. 377">62 T.C. 377, 389 (1974), 274 affd. 543 F.2d 593">543 F.2d 593 (7th Cir. 1976); Hesse v. Commissioner, 60 T.C. 685">60 T.C. 685, 691 (1973), affd. per order (3rd Cir. Mar. 10, 1975). We think it evident that paragraph 6 of the agreement granting all household and kitchen furnishings to the wife and the stereo to the petitioner represented a division of property. Paragraph 4 of the deed specifically provided for the payment of monthly support and lucidly stated that compliance with its terms would effect petitioner's release from any further obligation of support. Thus, we are hard pressed to find that the agreement resulting in a transfer of furnishings to the wife and a stereo set to petitioner is anything but a property settlement. The fact that petitioner made monthly payments with respect to the loan with which some furnishings were purchased does not cause the transfer of the furnishings to the wife to be anything other than a division of property in settlement of a property right. Cf. Van Orman v. Commissioner, 418 F.2d 170 (7th Cir. 1969). 5However, even if we view petitioner's payments with respect to the furnishings as in the 275 nature of support, petitioner would not be entitled to deduct the payments made with respect to the encumbered furnishings. Section 71(a) applies only to payments made to a spouse or former spouse because of the family or marital relationship in recognition of the general obligation of support which is made specific by a decree or written agreement or instrument. Section 1.71-1(b)(4), Income Tax Regs.; Herring v. Commissioner, 66 T.C. 308">66 T.C. 308 (1976). Nowhere in the deed of separation is it stated explicitly that petitioner was required to satisfy the outstanding indebtedness resulting from the loan both he and his former spouse procured. It is therefore apparent that these expenditures were not made pursuant to the written agreement between husband and wife and therefore do not fall within the ambit of section 71(a)(2) and section 215. Furthermore, petitioner has not shown, with the required specificity either the exact nature of the furnishings purchased or the amount of money so expended. For the above reasons petitioner is not entitled under section 215 to deduct any of the 9 monthly payments of $ 465.23 made in repayment of a loan. FINDINGS OF FACT - HOME OFFICE EXPENSES During 276 1973 petitioner was employed as a planning consultant by the Region B Planning and Development Commission of North Carolina whose headquarters were in Skyland, North Carolina. At that time petitioner resided in a rented five room house in Buncombe County, North Carolina. Commission offices were located in a building situated over a fire department and were adjacent to the community center. Activity from both the fire department and community center created brief disruptions in the conduct of normal daily business at the commission. As a result, petitioner designated two rooms in his five room house to be used for office space. Petitioner claims that the institution of this home office was at the request of the commission's secretary. One room of petitioner's home office was equipped with an L-shaped desk, typewriter, bookcases, planning reports and telephone. The second room consisted of a large conference table, six conference chairs, a telephone, drafting papers and other materials germane to petitioner's business. Petitioner continued to make use of the commission offices in Skyland, but whenever petitioner was disrupted by noise levels from the fire department he would 277 retreat to his home office. On rare occasions some of petitioner's business associates would meet at petitioner's home office to prepare plans for Federal and State grant applications. Between September 5, 1973 and the end of that year petitioner was not employed and consequently his home office was not utilized during this period. Petitioner paid $ 1,560 in 1973 for rent of his five room house. Due to difficulties in locating proper documentation petitioner has been unable to indicate the exact amount of his 1973 utility costs. Yet petitioner has shown that his monthly telephone bill approximated $ 50, and his monthly electric bill was approximately $ 20. Additionally, petitioner made one payment for home fuel oil in the amount of $ 50 in April of 1973. On his 1973 return, petitioner claimed a deduction for home office expenses in the amount of $ 920 6278 based on a claim that 40 percent of the total space in his residence was used exclusively as an office. Respondent, in his notice of deficiency, disallowed the entire deduction. OPINION Petitioner's $ 920 home office deduction was disallowed by respondent on the ground that petitioner failed to establish that the amount deducted was a business expense within the meaning of section 162(a). 7 Respondent asserts that the expenses were nondeductible personal expenses within the purview of section 262. While it is true that the term "ordinary and necessary" in section 162(a) has been interpreted to mean "appropriate and helpful," Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 113 (1933), this court commented in Sharon v. Commissioner, 66 T.C. 515">66 T.C. 515 (1976), affd. 591 F.2d 1273">591 F.2d 1273 (9th Cir. 1978), cert. denied 279 442 U.S. 941">442 U.S. 941 (1979): The "appropriate and helpful" concept is not a litmus test. Where there is a mixture of personal and business considerations, that test, like the statutory "ordinary and necessary" test, requires a weighing and balancing of all the facts so that they may be given the proper order of importance, bearing in mind the precedence of section 262, which denies deductions for personal expenses, over section 162, which allows deductions for business expenses. * * [66 T.C. at 524] Thus, our attention now focuses on section 1.262-1(b)(3), Income Tax Regs. which provides: Expenses of maintaining a household, including amounts paid for rent, water, utilities, domestic service, and the like, are not deductible. A taxpayer who rents a property for residential purposes, but incidentally conducts business there (his place of business being elsewhere) shall not deduct any part of the rent. If, however, he uses part of the house as his place of business, such portion of the rent and other similar expenses as is properly attributable to such place of business is deductible as a business expense. Petitioner bears the burden of proving that respondent's determination on this issue 280 is incorrect. Welch v. Helvering, supra; Rule 142(a), Tax Court Rules of Practice and Procedure. We believe petitioner has failed to meet the burden on this issue. Petitioner asserted that noise levels from the fire department located beneath the offices of the Region B Planning and Development Commission made it "absolutely impossible to work." Specifically petitioner points to disturbances which occurred whenever "they took the [fire] engines in and out" and to disruptions from afternoon training maneuvers at the fire department. First, we cannot comprehend how the movement of fire engines and equipment can produce anything greater than a momentary commotion. Second, the Region B Commission meetings were held at these offices at the time of fire department maneuvers and never were the meetings interrupted by the alleged tumult from the training maneuvers. Thus we conclude that nises from the operation of the fire department could not have been so disruptive so as to make it absolutely necessary for petitioner to institute a home office. It is therefore apparent that petitioner's home office was a place where petitioner incidentally conducted business for reasons other then 281 employment exigencies. See Meehan v. Commissioner, 66 T.C. 794 (1976). Petitioner argues further that he was required to maintain a home office pursuant to a direction from the secretary of the commission. He also stated that several colleagues in the commission used his home office to draw up plans for grant applications. Yet petitioner did not introduce any witness who testified to the necessity and importance of petitioner's home office. We are left only with petitioner's own testimony as to the required nature and significance of his own home office. Under these circumstances we must view his testimony as solely self-serving and we therefore cannot allow a deduction where no corroborative ground for its allowance exists. Alternatively, petitioner argues that under section 167(a)8 he is entitled to an allowance for depreciation of his office furniture. Petitioner has not convinced us that use of his home office ascends to the level of use in a trade or business. Rather, we are inclined to think that his infrequent business use of the office cannot alter the fact that its use was predominantly personal. A large conference table with six chairs may easily be converted into 282 a large dining room table for six. Absent any evidence to establish that petitioner's home office furnishings were used in a trade or business we must hold that all the expenses of the office including depreciation are personal and thus nondeductible pursuant to section 262. Cf. Meehan v. Commissioner, supra; Sharon v. Commissioner, supra.Furthermore, other than petitioner's self-serving testimony, petitioner has not firmly established the cost basis of the furnishings. With an unknown depreciable basis, we are unable to comply with the mandate of section 167(g)9283 and thus a depreciation deduction is not allowable on petitioner's office furniture. FINDINGS OF FACT - AUTOMOBILE EXPENSES FOR THE PERIOD SEPTEMBER 5, 1973 - DECEMBER 31, 1973 Petitioner purchased a new 1973 Oldsmobile Cutlass in March of 1973 at a price of $ 5,078.82. After petitioner left the employ of the Region B Planning and Development Commission on September 5, 1973, petitioner undertook to find employment as a planning consultant. He made several automobile trips to destinations including Knoxville, Tallahassee, and Raleigh whose alleged purpose was employment seeking. Although no employment opportunities resulted from these trips, petitioner visited several law school campuses in his travels in order to inquire about the possibility of attending law school. On his return for 1973, petitioner, using the rate of $ .12 per mile, deducted $ 1,200 in automobile expenses contending that from September 5, 1973 until the end of that year he traveled 10,000 miles in pursuit of business away from his home. In his notice of deficiency respondent disallowed the entire deduction. OPINION Section 162 allows a deduction for traveling expenses incurred while away from home in pursuit of a trade 284 or business. However, section 274(d) conditions the deduction on the taxpayer's ability to substantiate the expenditure. More specifically, the relevant portion of section 1.274-5(b)(2), Income Tax Regs. provides: (2) Travel. The elements to be proved with respect to an expenditure for travel are-- (i) Amount. Amount of each separate expenditure for traveling away from home, such as cost of transportation or lodging, * ; (ii) Time. Dates of departure and return for each trip away from home, and number of days away from home spent on business; (iii) Place. Destinations or locality of travel, described by name of city or town or other similar designation; and (iv) Business purpose. Business reason for travel or nature of the business benefit derived or expected to be derived as a result of travel. Petitioner has not presented us with any detailed records supporting the claimed expenditure. Other than the vague recollections of petitioner, we have no clue as to the distance of his trips, their duration and their exact business purpose. Petitioner's failure to produce an account book or diary, with entries made therein contemporaneous with or near the date of each expenditure, 285 is crucial. Section 1.274-5(c), Income Tax Regs. Therefore, respondent's determination on this issue is sustained. Petitioner alternatively argues that if a deduction for travel is not allowed then he is entitled to a depreciation allowance on his automobile for the period September 5, 1973 until the end of that year. We hold that petitioner is not so entitled.Petitioner bears the burden of proving that the Commissioner's determination is incorrect. Welch v. Helvering, supra; Rule 142(a), Tax Court Rules of Practice and Procedure.Petitioner testified that during the period of September 5, 1973 until the end of that year he registered 12,000 miles on his automobile. He further asserts that 10,000 of these miles were for business travel. Unfortunately for petitioner, we believe that in order to sustain a deduction in this case, something more than the unsubstantiated testimony of petitioner is necessary. Furthermore, petitioner readily admits that in his travels he visited the campuses of two law schools seeking information concerning admittance into law school and at least in one case he spoke with a dean. Thus, without sufficient proof to the contrary, these journeys appear 286 to be personal in nature rather than primarily business related. Petitioner's assertion that "approximately 98 percent of the mileage put on the car was for business miles" is unconvincing in light of the dearth of corroborative evidence and thus an allocation of expense between business and nonbusiness use is not possible in this case. Cf. International Artists, Ltd. v. Commissioner, 55 T.C. 94 (1970). Accordingly, we hold that petitioner has not met his burden of proof on this issue. In light of the above holding on this issue, we consider it unnecessary to address respondent's final argument alleging that even if petitioner had substantiated his search for employment, he was not engaged in a trade or business during the last 4 months of 1973. FINDINGS OF FACT - DEPRECIATION ON AUTOMOBILES For over 8 months in 1973, petitioner was the executive director of the Region B Planning and Development Commission of North Carolina. His employment mandated that he make numerous trips to cities within North Carolina and to Washington, D.C. Most often petitioner drove an automobile to these destinations and then requested reimbursement for the mileage traveled. Pursuant to his request, 287 petitioner would receive warrants for reimbursement from the North Carolina Department of Administration. Petitioner received over $ 800 for reimbursement of automobile expenses. Petitioner's salary at the commission was from two sources. He was paid by the North Carolina Department of Administration while the Region B Commission supplemented his income with local funds. This supplement was proffered by the local commission because petitioner was previously the executive director of another commission where he had been receiving a salary in excess of pay levels at the North Carolina Department of Administration. Petitioner's combined salary was $ 14,527 and this is the figure reported on his return. Nowhere on his return has petitioner included in income any reimbursement for expenses. For January, February, and part of March of 1973 petitioner used his brother's 1967 Pontiac Firebird in his business travels. In March petitioner purchased a new Oldsmobile Cutlass for $ 5,078.82 which petitioner used in his capacity as executive director of the Planning Commission. Both automobiles were also utilized for petitioner's nonbusiness affairs. Petitioner, in an amended petition, 288 claims that for 1973 he is entitled to an allowance for depreciation for the use of the Pontiac and Oldsmobile. OPINION Respondent argues that petitioner is not authorized to claim an allowance for depreciation of the 1967 Pontiac because petitioner was not the owner of the automobile. Having already discussed the issue of ownership of this automobile in connection with its casualty, we need only repeat that petitioner's brother Barnell Hyde was the owner of the car. The depreciation deduction is predicated upon an investment in property. The benefits of a depreciation allowance should inure to those who would suffer an economic loss caused by wear and exhaustion of business property. Mayerson v. Commissioner, 47 T.C. 340">47 T.C. 340, 350 (1966); Blake v. Commissioner, 20 T.C. 721">20 T.C. 721 (1953). We are not persuaded that petitioner had any investment in the 1967 Pontiac and therefore he is not entitled to a deduction for depreciation of the automobile. With respect to the Oldsmobile purchased by petitioner in March of 1973, we believe that petitioner has not borne his burden to prove his entitlement to a depreciation deduction. First we note that petitioner received allowances for travel expenses 289 from the North Carolina Department of Administration. An automobile allowance, although expressed in terms of mileage, may be, and generally is, fixed so as to include an estimated share of depreciation. Petitioner has failed to show that this was not the case here and we cannot find otherwise. Such a mileage allowance may be subject to a wide margin of error, but the burden rests with the taxpayer who seeks a greater depreciation deduction, to show that depreciation attributable to his employment exceeded the reimbursed amount. Geer v. Commissioner, 28 T.C. 994">28 T.C. 994, 996 (1957). The record is barren of evidence necessary to support the view that the amount of actual depreciation of petitioner's automobile did indeed exceed the apparent built-in depreciation allowance reflected in the reimbursements. Furthermore, petitioner admits that the automobile was put to personal use as well as business use. Except for business mileage for which petitioner was reimbursed by the Department of Administration, we are presented with no proof that any other business mileage was registered on the automobile between January 1 and September 5, 1973.Thus the total mileage involved and the comparative 290 amounts of business and personal use are wholly unproved. See Thompson v. Commissioner, 15 T.C. 609">15 T.C. 609 (1950). Therefore we must uphold respondent's determination that petitioner is not entitled to any automobile depreciation deduction. FINDINGS OF FACT - DEPRECIATION OF EMPLOYMENT CONTRACT Petitioner entered into a 1-year contract with the Region B Development and Planning commission to render services during 1973 as executive director of the commission. To acquire the position it was required that an applicant have a diploma from a 4-year college and 3 years of experience, preferably in planning. The commission breached its contract with petitioner in September of 1973 when the commission asked petitioner to resign from his office. In an amended petition, petitioner claims that he is entitled to a depreciation deduction on his employment contract which was prematurely terminated on September 5, 1973. OPINION Section 1.167(a)-3, Income Tax Regs. provide in pertinent part: If an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy, 291 such an intangible asset may be the subject of a depreciation allowance. * * * Depreciation allowances permit the taxpayer to recover, tax free, the total cost of assets used in a trade or business. Massey Motors v. United States, 364 U.S. 92">364 U.S. 92 (1960). If a taxpayer has no capital investment in property, then depreciation or amortization deductions with respect to the property are not allowable. Fromm Laboratories, Inc. v. Commissioner, 295 F.2d 726">295 F.2d 726, 729-730 (7th Cir. 1961), affg. a Memorandum Opinion of this Court; Miller v. Commissioner, 68 T.C. 767">68 T.C. 767, 775 (1977).Petitioner claims that although he incurred no costs at the time he acquired the contract, costs for his college education provide the basis for his investment in the contract.Petitioner attempts to justify this assertion by citing the employment requirement that he have a 4-year college education. There is no merit to petitioner's claim. We have held that the costs of obtaining a general college education may not be amortized. Sharon v. Commissioner, supra (costs of obtaining license to practice law including costs of college and law school not amortizable); Denman v. Commissioner, 48 T.C. 439">48 T.C. 439 (1967) (costs of obtaining 292 an engineering degree not amortizable). See Carroll v. Commissioner, 51 T.C. 213">51 T.C. 213, 216 (1968), affd. 418 F.2d 91">418 F.2d 91 (7th Cir. 1969). These expenses are personal in nature and must be deemed nondeductible within the purview of section 262. Furthermore, petitioner's college expenses fall within section 1.162-5(b) (2), 10293 Income Tax Regs., which declares that education expenditures made by an individual for education which is required of him in order to meet the minimum educational requirements for qualification in his employment are not deductible. We note that in a technical sense petitioner is seeking to amortize the cost of acquiring his employment contract under section 167294 and is not focusing on the deduction of education expenditures under section 162. However in Sharon (66 T.C. at 526) we stated our disapproval of this distinction as follows: * * the petitioner attempts to distinguish our opinion in Denman by asserting that he is not attempting to capitalize his educational costs, but rather, the cost of his license to practice law. Despite the label which petitioner would apply to such costs, they nonetheless constitute the costs of his education, which are personal and nondeductible. Therefore, we hold that petitioner is not entitled to an amortization deduction with respect to his employment contract. Accordingly, we need not address respondent's argument concerning the impossibility of amortizing a 1-year contract. FINDINGS OF FACT - INVESTMENT CREDIT As noted earlier, a 1967 Pontiac automobile was purchased by petitioner's brother Barnell Hyde in 1972 and was borrowed by petitioner for the first 2 months of 1973 for his employment at the Region B Planning and Development Commission and for personal purposes. Petitioner purchase a new 1973 Oldsmobile on March 6, 1973 for $ 5,078. In 1973, this automobile was used by petitioner for personal 295 endeavors and in his employment at the Region B Planning Commission for 6 months beginning in March of 1973. On September 5, 1973 petitioner's employment at the commission was terminated. After that date petitioner made several automobile trips to southeastern cities, none of which has been established as being primarily related to business. Petitioner obtained no further employment for the duration of 1973. Petitioner, in an amended petition, 11 claims an investment credit for both automobiles for 1973 as well as for the desk, conference table, and chairs placed by petitioner in his home office. OPINION - INVESTMENT CREDIT Sections 38 and 46 allow as a credit against tax a specified percentage of the taxpayer's qualified investment for the taxable year. 12296 297 With regard to used section 38 property, section 48(c)(1) provides: SEC. 48. DEFINITIONS; SPECIAL RULES. (c) Used Section 38 Property.-- (1) In general.--For purposes of this subpart, the term "used section 38 property" means section 38 property acquired by purchase after December 31, 1961, which is not new section 38 property. Property shall not be treated as "used section 38 property" if, after its acquisition by the taxpayer, it is used by a person who used such property before such acquisition (or by a person who bears a relationship described in section 179(d)(2)(A) or (B) to a person who used such property before such acquisition). We have found that petitioner's brother owned the 1967 Pontiac which was borrowed by petitioner for the first 2 months of 1973. Petitioner had no investment in the property and thus his temporary use of the automobile cannot justify the allowance of an investment credit. Furthermore, since depreciation is not allowable to petitioner on the automobile and neither has petitioner shown that the 6-year old Pontiac had a useful life 298 of more than 3 years upon its acquisition, the automobile is not section 38 property as defined in section 48(a) 13 and as such is not subject to the investment credit. Next, we consider petitioner's claim for an investment credit on his new 1973 Oldsmobile. Petitioner did use this automobile in his business as an employee at the Region B Planning and Development Commission until September 5, 1973 when his employment at the commission was terminated. In this regard, section 1.46-3(a)(2) provides in pertinent part: (2) The basis (or cost) of section 38 property placed in service during a taxable year shall not be taken into account in determining qualified investment for such year if such property is disposed of or otherwise ceases to be section 38 property during such year * * . Section 38 property includes only property which is subject to the allowance for depreciation. Thus it is clear that property whose use has been eliminated from a trade or business or income producing activity in the same taxable year as its insertion in service, is not a qualified investment and thus not subject to the credit. Accordingly petitioner's entitlement to the credit hinges 299 upon whether his automobile was depreciable between September 5, 1973 and the end of that year.Unfortunately for petitioner, we have held that he was not entitled to a depreciation allowance on his 1973 Oldsmobile for the last 4 months of 1973. That holding was premised on our conclusion that petitioner has not adequately established that his journeys to Southeastern United States cities were primarily related to business. Accordingly, we must find the petitioner's automobile ceased to be section 38 property and is therefore not property which is subject to the investment credit. Similarly, we have determined that petitioner's office furniture was not subject to a depreciation allowance. Therefore it is not section 38 property and petitioner's claim for an investment credit thereon must be denied. FINDINGS OF FACT - MEALS AND LODGING EXPENSE Petitioner incurred expenses for meals and lodgings while away from home between September 5, 1973 and the end of that year.In an amended petition, petitioner alleges that he is entitled to deduct $ 650 for meals and lodging which were incurred in his capacity as a professional planning consultant. OPINION Respondent asserts that petitioner 300 has failed to satisfy the substantiation requirements of section 274(d). We agree.Under section 274(d) no deduction for traveling expenses (including meals and lodging while away from home) is allowed unless the amount, time, place, and business purpose of the expenditure areestablished by adequate record or by sufficient evidence corroborating the taxpayer's statement. The only evidence presented by petitioner relating to the period in question are a few credit card vouchers, none of which detail the business purpose of the expenses or their duration. We therefore hold that these vouchers fall far short of adequate corroboration, and thus petitioner's claim for a deduction for meals and lodging expenses is disallowed. See Rutz v. Commissioner, 66 T.C. 879">66 T.C. 879 (1976); Nicholls, North, Buse Co. v. Commissioner, 56 T.C. 1225">56 T.C. 1225, 1235 (1971). FINDINGS OF FACT - MEDICAL EXPENSES On his return petitioner claimed a medical expense deduction of $ 116 representing one-half of insurance premiums paid by petitioner. The parties have stipulated that one-half of a $ 218 premium for hospital insurance is properly deductible by petitioner. The item still in dispute is a $ 15 premium paid by petitioner 301 to the Travelers protective Association of America which provided for accident coverage. OPINION Section 213(a) provides for a deduction for amounts paid during the taxable year for medical care of the taxpayer, his spouse and dependents. Medical care is defined in section 213(e) which provides in pertinent part: Sec. 213. MEDICAL, DENTAL, ETC., EXPENSES. (e) Definitions.--For purposes of this section-- (1) The term "medical care" means amounts paid-- (A) for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body, (B) for transportation primarily for and essential to medical care referred to in subparagraph (A), or (C) for insurance (including amounts paid as premiums under part B of title XVIII of the Social Security Act, relating to supplementary medical insurance for the aged) covering medical carereferred to in subparagraphs (A) and (B). (2) In the case of an insurance contract under which amounts are payable for other than medical care referred to in subparagraphs (A) and (B) of paragraph (1)-- (A) no amount shall be treated as paid for insurance to which paragraph (1) (C) applies unless 302 the charge for such insurance is either separately stated in the contract, or furnished to the policyholder by the insurance company in a separate statement, (B) the amount taken into account as the amount paid for such insurance shall not exceed such charge, and (C) No amount shall be treated as paid for such insurance if the amount specified in the contract (or furnished to the policyholder by the insurance company in a separate statement) as the charge for such insurance is unreasonably large in relation to the total charges under the contract. Prior to 1967 amounts paid for accident insurance were deductible pursuant to the explicit language of the statute then in effect. However, section 213(e) was amended by the Social Security Amendments of 1965, section 106, Pub. L. 89-97, 79 Stat. 336, which deleted the reference to accident insurance. In this regard section 1.213-1(e)(4)(i), Income Tax Regs., states: Sec. 1.213-1(e)(4)(i)(a). * * In the case of an insurance contract under which amounts are payable for other than medical care (as, for example, a policy providing an imdemnity for loss of income or for loss of life, limb, or sight)-- (1) No amount shall be treated as paid 303 for insurance covering expenses of medical care * * unless the charge for such insurance is either separately stated in the contract or furnished to the policyholder by the insurer in a separate statement. This regulation is adequately supported by legislative history. See H. Rept. 213, 89th Cong., 1st Sess. 179 (1965). Since petitioner's expense relates only to accident coverage with no separate statement from the insurer regarding medical care, the respondent's determination that a deduction with respect to this item is not allowable is sustained. FINDINGS OF FACT - TAXES Petitioner deducted $ 960 on his 1973 return for taxes. Due to a mathematical error of $ 100 petitioner's claim has been reduced to $ 860. As noted earlier, petitioner purchased an automobile in March of 1973 on which sales tax of $ 94 was paid. Respondent, in his notice of deficiency allowed petitioner a deduction for tax of $ 704.10. 14 The parties have now stipulated that petitioner has provided substantiation for $ 798 in tax expenditures (rounded to the nearest dollar) and thus $ 62 still remains in dispute. OPINION 304 Petitioner's entitlement to deduct taxes paid under section 164 is conditioned on his satisfaction of the usual burden of proof, Rule 142(a) Tax Court Rules of Practice and Procedure.The vague assertions made by petitioner that he somehow underestimated items which have been allowed by respondent is thoroughly unconvincing. Petitioner admits that he has no documentation for the alleged $ 62 tax item still in dispute.Accordingly, we sustain respondent's position on this issue. FINDINGS OF FACT - CHARITABLE CONTRIBUTIONS On his return for 1973, petitioner deducted $ 227 as charitable contributions.Respondent, in the statutory notice, disallowed the entire amount but the parties have now stipulated that petitioner contributed $ 50 to the Boy Scouts of America. Thus the dispute centers on $ 177 deducted by petitioner as a charitable contribution. At trial petitioner requested and it was agreed that the record remain open in order that petitioner could properly document the contributions he deducted. Petitioner has not come forward with such documentation. OPINION Respondent's disallowance of petitioner's deduction for charitable contributions in excess of $ 50 is focused on the lack 305 of documentation to support the deduction. Petitioner's only substantiation for these claimed expenditures was his testimony. Petitioner asserts that he was president of the North Carolina Association for Children With Specific Learning Disabilities and that he made several trips on behalf of that organization. His testimony was overly general and indefinite, evincing no clue as to the exact nature of the expenditure, its amount, time or place. Accordingly, we view petitioner's testimony as insufficient to support the claimed deduction and respondent's view is sustained. FINDINGS OF FACT - DEPENDENCY EXEMPTION During 1973, petitioner's mother, Alice M. Hyde, resided in Asheville, North Carolina, in a house owned by Herbert L. Hyde, petitioner's brother. Mrs. Hyde paid no rent to Herbert Hyde for living in the house. She received social security benefits approximating $ 800 in 1973. Petitioner has not shown that he made any expenditures for support of his mother. Petitioner claimed a dependency exemption for his mother on his 1973 return asserting that he provided $ 800 for his mother's support.On February 6, 1979, Herbert L. Hyde signed a multiple support declaration stating 306 that he understood that his brother, the petitioner, was claiming a dependency exemption for Alice M. Hyde, and that Herbert would not so claim an exemption. Herbert did not claim Mrs. Alice M. Hyde as a dependent in 1973. In his notice of deficiency, respondent disallowed the dependency exemption on the ground that petitioner failed to establish that he provided more than one-half of his mother's support.OPINION The question posed herein is whether pursuant to section 151(e) petitioner is entitled to a dependency exemption for his mother.The general rule provides that a dependency exemption is authorized where certain prescribed individuals received over half of their support from the taxpayer. Section 152(a). Where no person contributed over half the support of an individual described in section 152(a), then persons contributing more than 10 percent of such support may enter into a multiple support agreement whereby the dependency exemption is assigned to one of the contributors. In this regard section 1.152-3(c), Income Tax Regs., provides in pertinent part: The member of a group of contributors who claims the dependency deduction for an individual under the multiple support 307 agreement provisions of section 152(c)must attach to his income tax return for the year of the deduction a written declaration from each of the other persons who contributed more than 10 percent of the support of such individual and who, but for the failure to contribute more than half of the support of the individual, would have been entitled to claim the individual as a dependent. * * * The taxpayer claiming the individual as a dependent should be prepared to furnish other information, when required, which will substantiate his right to claim such individual as a dependent. Such information may include a statement showing the names of all contributors (whether or not members of the group described in section 152(c)) and the amount contributed by each to the support of the claimed dependent. (Emphasis added.) In the instant case, the multiple support agreement was entered into almost 6 years after the due date of petitioner's 1973 return. Accordingly, we hold that the multiple support agreement is invalid. 15308 Thus, for petitioner to claim the exemption for his mother he must show he provided over half of her support.Petitioner's mother received approximately $ 800 in Social Security payments and received housing from petitioner's brother. The only evidence relating to petitioner's contributions for the support of his mother is petitioner's unsupported statement on his tax return that he contributed $ 800 for his mother's support. We have found that petitioner has not substantiated this expenditure, yet we note that even if documentation of this expenditure had been produced it would not have been nearly enough to constitute over one-half of Alice M. Hyde's support. 16 Respondent's determination is upheld. FINDINGS OF FACT 309 - EXPENSE OF PROFESSIONAL TAX ADVICE In an amended petition, petitioner claims a deduction for professional tax advice. 17 Petitioner produced no evidence at trial relating to the claimed expenditure. OPINION Since the burden of proof rests with petitioner on this issue and petitioner has failed to produce any evidence in support of this fact we must sustain respondent's determination. Rule 149(b), Tax Court Rules of Practice and Procedure.FINDINGS OF FACT - FILING STATUS Petitioner and his former spouse, Wanda Lee Hyde, were married on January 30, 1970. No children were born of this marriage. On November 14, 1972, petitioner and his former spouse executed a deed of separation certified by a Magistrate of Buncombe County, North Carolina. A judgment of divorce was rendered by the General Court of Justice, District Court Division of North Carolina on January 23, 1974. 310 During 1973, petitioner's mother, Mrs. Alice M. Hyde, resided in Asheville, North Carolina, in a house owned by petitioner's brother, Herbert L. Hyde. Petitioner did not furnish over half the cost of maintaining a household for his mother. Moreover, petitioner has not established that he made any expenditures for his mother's support. Petitioner had no dependents who lived with him. On his return for 1973, petitioner computed his tax liability utilizing the head of household rates.Respondent disallowed the use of these rates and applied the rates designated for married individuals filing separately. OPINION Section 1(b) prescribes a tax pursuant to the rates therein on the taxable income of a head of household. Section 2(b)(1) defines head of household as follows: SEC. 2. DEFINITIONS AND SPECIAL RULES. (b) Definition of Head of Household.-- (1) In General.--For purposes of this subtitle, an individual shall be considered a head of a household if, and only if, such individual is not married at the close of his taxable year, is not a surviving spouse (as defined in subsection (a)), and either-- (A) maintains as his home a household which constitutes for such taxable year the principal 311 place of abode, as a member of such household, of-- (i) a son, stepson, daughter, or stepdaughter of the taxpayer, or a descendant of a son or daughter of the taxpayer, but if such son, stepson, daughter, stepdaughter, or descendant is married at the close of the taxpayer's taxable year, only if the taxpayer is entitled to a deduction for the taxable year for such person under section 151, or (ii) any other person who is a dependent of the taxpayer, if the taxpayer is entitled to a deduction for the taxable year for such person under section 151, or (B) maintains a household which constitutes for such taxable year the principal place of abode of the father or mother of the taxpayer, if the taxpayer is entitled to a deduction for the taxable year for such father or mother under section 151. Section 2(b)(2)(B) provides that a person who is legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married. Separation arising from an agreement between husband and wife, without sanction of a court decree is not within the purview of the statute. See Donigan v. Commissioner, 632">68 T.C. 632 (1977). 18313 Petitioner's divorce was not final 312 until a judgment so declaring was entered on January 23, 1974. The deed of separation still in effect between petitioner and his former spouse at the end of 1973 was no more than a certified separation agreement. Its certification does not convert it into a decree of separate maintenance or divorce. Under North Carolina law such certification of separation agreements satisfies the mandate of N.C. Gen. Stat. sec. 52-6(a), (b) and (c) (repealed by 1977 N.C. Sess. Laws, c.375, s.1, effective January 1, 1978). 19314 Indeed the purpose of this section was to give validity to transactions invalid at common law, between husband and wife, provided the prescribed formality is observed. Perry v. Stancil, 237 N.C. 442">237 N.C. 442, 75 S.E.2d 512">75 S.E.2d 512 (1953). The statute allows the wife to contract away her right to support and maintenance. Hinkle v. Hinkle, 266 N.C. 189">266 N.C. 189, 146 S.E.2d 73">146 S.E.2d 73 (1966); Fuchs v. Fuchs, 260 N.C. 635">260 N.C. 635, 133 S.E.2d 487">133 S.E.2d 487 (1963); Kiger v. Kiger, 258 N.C. 126">258 N.C. 126, 128 S.E.2d 235">128 S.E.2d 235 (1962). Thus, certification by a magistrate of the agreement only upholds the validity of the contract rather than convert it into a court ordered decree. Nor may petitioner qualify as an unmarried individual by virtue of section 2(c). Section 2(c) directs us to section 143(b) which provides as follows: SEC. 143. DETERMINATION OF MARITAL STATUS. (b) Certain Married Individuals Living Apart.--For purposes of this part, if-- (1) an individual who is married (within the meaning of subsection (a)) and who files a separate return maintains as his home a household which constitutes for more than one-half of the taxable year the principal place of abode of a dependent (A) who (within the meaning of section 152) is a son, stepson, daughter, or stepdaughter of the individual, and (B) with respect to whom such individual is entitled to a deduction for the taxable year under section 151, (2) such individual furnishes over half of the cost of maintaining such household during the taxable year, and (3) 315 during the entire taxable year such individual's spouse is not a member of such household, such individual sall not be considered as married. Since petitioner had no dependents living with him be cannot be considered unmarried by virtue of section 143(b) for purposes of using the tax rates in section 1 (b). Furthermore, petitioner did not maintain the household in which his mother Alice M. Hyde 20 lived and thus he does not qualify as a head of household under section 2(b)(1)(B). Since petitioner was still married at the close of 1973 and no joint return was filed by petitioner and his former spouse for that year, the petitioner must file utilizing the tax rates applicable to married individuals filing separate returns as found in section 1(d). FINDINGS OF FACT - POLITICAL CONTRIBUTIONS CREDIT for the year 1973, petitioner has not shown that he made any political contributions. In his amended petition, 316 petitioner claimed a tax credit for political contributions in 1973. Petitioner seeks a $ 25 credit for alleged contributions. OPINION Section 4121317 allows an individual a tax credit for one-half of political contributions made within the taxable year. The maximum credit available to an individual for 1973 contributions is $ 12.50. Respondent's attack on the credit claimed by petitioner focuses on the poor recordkeeping system of petitioner. Petitioner's attempt at verifying his claimed contribution consists of a check register wherein an entry marked "Democrats" purports to substantiate an alleged contribution. Considering that this entry is chronologically out of order in the check register and that there is no other documentary corroboration of the date and purpose of the contribution we hold that this evidence is insufficient to sustain petitioner's claim for a tax credit for political contributions. Petitioner also contends that he is entitled to a tax credit carryover into 1973 for political contributions allegedly made during 1972. Even if petitioner could establish that he made these contributions, 318 there is no provision in the Internal Revenue Code for a tax credit carryover with respect to political contributions. Accordingly, respondent's position on this issue is sustained. Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the taxable year in issue.↩2. SEC. 165. LOSSES. (c) Limitation on Losses of Individuals.--In the case of an individual, the deduction under subsection (a) shall be limited to-- (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. A loss described in this paragraph shall be allowed only to the extent that the amount of loss to such individual arising from each casualty, or from each theft, exceeds $ 100. For purposes of the $ 100 limitation of the preceding sentence, a husband and wife making a joint return under section 6013 for the taxable year in which the loss is allowed as a deduction shall be treated as one individual. No loss described in this paragraph shall be allowed if, at the time of filing the return, such loss has been claimed for estate tax purposes in the estate tax return.↩3. N.C. Gen. Stat. sec. 50-16.9 provides: § 50-16.9. Modification of order.--(a) An order of a court of this State for alimony or alimony pendente lite, whether contested or entered by consent, may be modified or vacated at any time, upon motion in the cause and a showing of changed circumstances by either party or anyone interested. This section shall not apply to orders entered by consent before October 1, 1967. (b) If a dependent spouse who is receiving alimony under a judgment or order of a court of this State shall remarry, said alimony shall terminate. (c) When an order for alimony has been entered by a court of another jurisdiction, a court of this State may, upon gaining jurisdiction over the person of both parties in a civil action instituted for that purpose, and upon a showing or changed circumstances, enter a new order for alimony which modifies or supersedes such order for alimony to the extent that it could have been so modified in the jurisdiction where granted.↩4. See also the following cases from other jurisdictions: Taliaferro v. Taliaferro, 125 Cal. App. 2d 419">125 Cal. App.2d 419, 270 P.2d 1036">270 P.2d 1036 (1954); Brown v. Farkas, 195 Ga. 653">195 Ga. 653, 25 S.E.2d 411">25 S.E.2d 411 (1943); Davis v. Welber, 278 App. Div. 36, 103 NYS2d 239 (1951). In Davis v. Welber it was held that while a statute terminating or authorizing a court to terminate an award of alimony on the wife's remarriage does not affect payments due under a contract, the agreement should be construed in light of the policy of the statute terminating alimony on remarriage. In this connection see N.C. Gen. Stat. section 50-16.9↩ cited in fn. 3.5. See also Biddle v. Commissioner, T.C. Memo. 1979-347; Luhman v. Commissioner, T.C. Memo. 1970-81↩.6. Petitioner's home office deduction was computed as follows: Rent$ 1,800Telephone500$ 2,300.40(use of two rooms out of five)$ 920It is noted that on his return petitioner used $ 1,800 as the amount paid for rent in 1973 while he has now stipulated that $ 1,560 was the rent expense for the year. It is noted also that petitioner now claims that he is entitled to deductions for electric and fuel costs even though these items were omitted on his tax return.7. The pertinent portion of section 162(a) provides: 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. * *↩8. SEC. 167. DEPRECIATION. (a) General Rule.--There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)-- (1) of property used in the trade or business, or (2) of property held for the production of income.↩9. Section 167(g) provides: (g) Basis for Depreciation.--The basis on which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain on the sale or other disposition of such property.10. Section 1.162-5(b) provides in pertinent part: (b) Nondeductible educational expenditures--(1) In general. Educational expenditures described in subparagraphs (2) and (3) of this paragraph are personal expenditures, or constitute an inseparable aggregate of personal and capital expenditures and, therefore, are not deductible as ordinary and necessary business expenses even though the education may maintain or improve skills required by the individual in his employment or other trade or business or may meet the express requirements of the individual's employer or of applicable law or regulations. (2) Minimum educational requirements. (i) The first category of nondeductible educational expenses within the scope of subparagraph (1) of this paragraph are expenditures made by an individual for education which is required of him in order to meet the minimum educational requirements for qualification in his employment or other trade or business. The minimum education necessary to qualify for a position or other trade or business must be determined from a consideration of such factors as the requirements of the employer, the applicable law and regulations, and the standards of the profession, trade, or business involved. The fact that an individual is already performing service in an employment status does not establish that he has met the minimum educational requirements for qualification in that employment. Once an individual has met the minimum educational requirements for qualification in his employment or other trade or business (as in effect when he enters the employment or trade or business), he shall be treated as continuing to meet those requirements even though they are changed.11. The amount of investment credit claimed by petitioner appears only on brief and is summarized as follows: ↩1967 Pontiac Firebird$ 18.661973 Oldsmobile Cutlass296.34Furniture31.8512. The relevant portion of section 46 provides: SEC. 46. AMOUNT OF CREDIT. (c) Qualified Investment.-- (1) In general.-- For purposes of this subpart, the term "qualified investment" means, with respect to any taxable year, the aggregate of-- (A) the applicable percentage of the basis of each new section 38 property (as defined in section 48(b)) placed in service by the taxpayer during such taxable year, plus (B) the applicable percentage of the cost of each used section 38 property (as defined in section 48(c)(1)) placed in service by the taxpayer during such taxable year. (2) Applicable percentage.--For purposes of paragraph (1), the applicable percentage for any property shall be determined under the following table: The applicableIf the useful life ispercentage is--3 years or more but less than 5years 33 1/35 years or more but less than 7years 66 2/37 years or more100For purposes of this subpart, the useful life of any property shall be the useful life used in computing the allowance for depreciation under section 167 for the taxable year in which the property is placed in service.The pertinent portion of section 48 provides: SEC. 48.DEFINITIONS; SPECIAL RULES. (a) Section 38 Property.-- (1) In general.-- Except as provided in this subsection, the term "section 38 property" means-- (A) tangible personal property, or Such term includes only property with respect to which depreciation (or amortization in lieu of depreciation) is allowable and having a useful life (determined as of the time such property is placed in service) of 3 years or more.13. See footnote 12.↩14. The $ 704.10 deduction was arrived at as follows: ↩State and local income tax$ 533.10State and local gasoline tax69.00General sales tax102.00$ 704.1015. Even if the multiple support agreement was valid, petitioner would still not meet the requirements of section 152(a)(1) as it is necessary for petitioner to establish that no other person contributed more than half of his mother's support. De La Garza v. Commissioner, 46 T.C. 446">46 T.C. 446, 448-449↩ (1966). Petitioner has failed to prove that Herbert L. Hyde did not provide more than half of the support of Alice M. Hyde.16. This conclusion necessarily follows from the fact that lodging for Alice M. Hyde was provided by Herbert Hyde and Alice M. Hyde received $ 800 in social security benefits. Section 1.152-1(a)(2)(i) and (ii), Income Tax Regs.↩17. The petition omits any amount for the claimed expenditure. It is only in pertitioner's brief that $ 67.40 is claimed as an expenditure for professional tax advice. For this reason, we have omitted the amount of the claimed expenditure from our opinion. See Rule 143(b), Tax Court Rules of Practice and Procedure.↩18. See also Kellner v. Commissioner, T.C. Memo. 1971-103, affd. 468 F.2d 627">468 F.2d 627 (2nd Cir. 1972), which declares that actual separation is not enough to qualify for head of household status. 19. § 52-6. Contracts of wife with husband affecting corpus or income of estate; authority, duties and qualifications of certifying officer; certain conveyances by married women of their separate property.--(a) No contract between husband and wife made during their coverture shall be valid to affect or change any part of the real estate of the wife, or the accruing income thereof for a longer time than three years next ensuing the making of such contract, nor shall any separation agreement between husband and wife be valid for any purpose, unless such contract or separation agreement is in writing, and is acknowledged before a certifying officer who shall make a private examination of the wife according to the requirements formerly prevailing for conveyance of land. (b) The certifying officer examining the wife shall incorporate in his certificate a statement of his conclusions and findings of fact as to whether or not said contract is unreasonable or injurious to the wife. The certificate of the officer shall be conclusive of the facts therein stated but may be impeached for fraud as other judgments may be. (c) Such certifying officer must be a justice, judge, magistrate, clerk, assistant clerk or deputy clerk of the General Court of Justice or the equivalent or corresponding officers of the state, territory or foreign country where the acknowledgment and examination are made and such officer must not be a party to the contract.↩20. We have held that petitioner was not entitled to a dependency exemption for his mother. Even if petitioner had so qualified, by virtue of the multiple support agreement which he introduced, he would still be precluded from using head of household rates by section 2(b)(3)(B)(ii).↩21. The relevant portion of section 41 provides: SEC. 41. CONTRIBUTIONS TO CANDIDATES FOR PUBLIC OFFICE. (a) General Rule.--In the case of an individual, there shall be allowed, subject to the limitations of subsection (b), as a credit against the tax imposed by this chapter for the taxable year, an amount equal to one-half of all political contributions, payment of which is made by the taxpayer within the taxable year. (b) Limitations.-- (1) Maximum credit.--The credit allowed by subsection (a) for a taxable year shall be limited to $ 12.50 ($ 25 in the case of a joint return under section 6013). (2) Application with other credits.--The credit allowed by subsection (a) shall not exceed the amount of the tax imposed by this chapter for the taxable year reduced by the sum of the credits allowable under section 33 (relating to foreign tax credit), section 35 (relating to partially tax-exempt interest), section 37 (relating to retirement income), and section 38 (relating to investment in certain depreciable property). (3) Verification.--The credit allowed by subsection (a) shall be allowed, with respect to any political contribution, only if such political contribution is verified in such manner as the Secretary or his delegate shall prescribe by regulations.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623358/	HUGHES A. BAGLEY AND MARILYN B. BAGLEY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBagley v. CommissionerDocket No. 531-93.United States Tax Court105 T.C. 396; 1995 U.S. Tax Ct. LEXIS 63; 105 T.C. No. 27; December 11, 1995, Filed 63 Decisions will be entered under Rule 155. In 1987, P received $ 150,000 in compensatory damages and $ 500,000 in punitive damages pursuant to judgment on a claim for tortious interference with future employment, with statutory interest thereon, and $ 1.5 million in settlement of claims for tortious interference with future employment, libel, and invasion of privacy. P excluded all of these amounts from income under sec. 104(a)(2), I.R.C. R determined that the punitive damages and interest received from the judgment and $ 1.305 million of the settlement amount attributable to punitive damages were not excludable under sec. 104(a)(2), I.R.C., as damages received on account of personal injuries or sickness. P paid attorney's fees in connection with the litigation. Held: $ 500,000 of the settlement proceeds are properly characterized as punitive damages. Held, further, Commissioner v. Schleier, 515 U.S. , 115 S.Ct. 2159, 132 L. Ed. 2d 294">132 L. Ed. 2d 294 (1995), has effectively overruled our decision in Horton v. Commissioner, 100 T.C. 93">100 T.C. 93 (1993), affd. 33 F.3d 625">33 F.3d 625 (6th Cir. 1994), insofar as it held that punitive damages, 64 even if noncompensatory, are excludable from income under sec. 104(a)(2), I.R.C., if the underlying claim is based on tort or tort-type rights, and to this extent we will no longer follow Horton v. Commissioner, Supra. Held, further, to the extent P's attorney's fees are allocable to the taxable portion of P's awards, they are deductible as a miscellaneous itemized deduction to which the provisions of sec. 67(a), I.R.C., are applicable. Held, further, the interest on the judgment award received by P is not excludable from income, but attorney's fees applicable to this portion of the award is deductible as miscellaneous itemized deductions. Mark Arth, for petitioners. Jack Forsberg, for respondent. HAMBLEN, CHABOT, COHEN, SWIFT, JACOBS, GERBER, WRIGHT, PARR, WELLS, RUWE, WHALEN, COLVIN, HALPERN, BEGHE, CHIECHI, LARO, AND FOLEY, JJ., agree with this opinion. VASQUEZ, J., did not participate in the consideration of this opinion. SCOTT396 SCOTT, Judge: Respondent determined a deficiency in petitioners' income tax for the calendar year 1987 in the amount of $ 488,976.31. The issues for decision are: (1) What portion, if any, of the amount of $ 65 1.5 million paid to Hughes Bagley (petitioner) in settlement of a suit against Iowa Beef Processors, Inc. (IBP), is allocable to punitive damages; (2) whether the $ 500,000 in punitive damages paid to petitioner pursuant to a judgment against IBP, and the portion, if any, of the $ 1.5 million paid to petitioner in settlement of his suit 397 against IBP which is allocable to punitive damages, are excludable from petitioner's income under section 104(a) (2)1 as damages received on account of personal injuries; (3) whether the portion of the legal fees of $ 768,484.87 paid by petitioner during 1987 in connection with his suit against IBP, which was a contingency fee based on a percentage of the recovery, is properly to be offset against the recovery and, therefore, not includable in income, or is a miscellaneous itemized deduction subject to the adjustment for 2 percent of adjusted gross income under section 67(a); and (4) whether the portion of the legal fees paid by petitioner in 1987, which was computed on an hourly basis, is deductible by petitioner on Schedule C or is an itemized deduction to the extent deductible; (5) whether the amount of $ 48,575.34 of prejudgment and the amount66 of $ 282,772.41 of postjudgment interest paid to petitioner, pursuant to a judgment against IBP, are includable in petitioners' gross income. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, who resided in Sioux City, Iowa, at the time of the filing of their petition in this case, filed their Federal income tax return (Form 1040) for the calendar year 1987 with the Internal Revenue Service Center at Atlanta, Georgia. Petitioner was vice president of retail sales development for IBP from October 1971 until July 1975. In July 1975 IBP terminated petitioner's employment, and in October 1975 IBP and petitioner entered into a settlement agreement resolving certain issues arising from the termination of petitioner's employment. When petitioner left IBP he took67 with him numerous documents (the Bagley documents), including IBP's weekly profit and loss statements, IBP's monthly production and sales reports, confidential legal memoranda, and memoranda outlining IBP's goals, marketing strategies, and pricing formulas. In late 1976 and early 1977, petitioner met with various individuals who were interested in the activities of 398 IBP, including several attorneys who were contemplating pursuing antitrust litigation against IBP. Petitioner discussed IBP's activities with the attorneys and provided them with access to the Bagley documents. On June 7, 1977, IBP filed a suit against petitioner and others in the U.S. District Court for the Northern District of Iowa seeking $ 4 million in damages and injunctive relief, including recovery of the Bagley documents (the IBP suit). The suit was Civil No. 77-4040 and was entitled Iowa Beef Processors, Inc. v. Amalgamated Meat Cutters & Butcher Workmen of N. Am., et al. The claims asserted in the suit against petitioner by IBP were breach of contract, breach of fiduciary duty, causing and assisting in another's breach of fiduciary duty, and conspiracy. In late 1977 the Subcommittee on General Small Business68 Problems of the U.S. House of Representatives' Committee on Small Business (the subcommittee) initiated an investigation into the meat packing industry. The subcommittee's investigation focused in large part on the activities of IBP. In the course of its investigation, the subcommittee subpoenaed the Bagley documents and various witnesses, including petitioner, for oral testimony. Petitioner testified before the subcommittee on July 23 and 24, 1979. Petitioner's testimony tended to show that IBP was involved in monopolistic and questionable business practices. IBP was invited to send a representative to the subcommittee's hearing, but declined to do so. On August 1, 1979, IBP, by its president Robert Peterson, responded to the subcommittee by a 31-page letter (the Peterson letter). The Peterson letter was in answer to testimony given to the subcommittee about IBP and its business practices. Approximately 14 pages of the Peterson letter addressed the testimony of petitioner. The Peterson letter not only addressed the business practices with respect to which petitioner testified, but also included statements which attacked petitioner's character and veracity. Among other things, the69 Peterson letter alleged that petitioner was "a disgruntled ex-IBP employee" who had "stolen IBP documents", and that petitioner's testimony was "absolutely false" and "constituted perjury", and was "a malicious attempt to blacken IBP's name and belatedly manufacture a defense to IBP's breach-of-fiduciary duty suit" (i.e., the IBP suit). The Peterson letter in essence called petitioner a liar and a thief. IBP sent a copy 399 of the Peterson letter to each member of the subcommittee and requested that it be made a part of the public record. At the time petitioner testified before the subcommittee, he was employed as vice president of Dubuque Packing Co. (Dubuque Packing). Petitioner's employment at Dubuque Packing was abruptly terminated on July 30, 1979. The contents of the Peterson letter had been widely reported by the media. On October 4, 1979, petitioner filed a suit against IBP in the U.S. District Court for the Northern District of Iowa (Bagley v. Iowa Beef Processors, Inc., Civil No. 79-4087) (the Bagley suit). In the complaint, petitioner asserted five claims against IBP. The five claims asserted were: (1) IBP's suit against petitioner constituted an abuse of process; (2) 70 IBP tortiously interfered with an existing contract of employment by causing Dubuque Packing to terminate petitioner's employment; (3) IBP tortiously interfered with petitioner's future employment within the meat-packing industry; (4) IBP libeled petitioner by publishing and circulating the Peterson letter; and (5) IBP invaded petitioner's privacy. In the complaint, petitioner asked for $ 1.5 million in compensatory damages and $ 10 million in punitive damages. The jurisdiction of the District Court in the IBP suit and the Bagley suit was based on diversity of citizenship. Some of the claims made by petitioner in his suit against IBP alleged physical injuries which he sustained as a result of IBP's conduct. Petitioner had suffered a heart attack after IBP took his deposition for 1 straight week. This was the third deposition of petitioner that IBP had taken. The IBP suit and the Bagley suit were consolidated for trial. Prior to trial, IBP voluntarily dismissed its claim for compensatory and punitive damages. Petitioner's abuse of process claim was dismissed prior to trial on the ground that the statute of limitations on that claim had expired. The remaining claims were tried before71 a jury between December 13 and December 29, 1982. The District Court's instructions to the jury respecting libel, in part, stated that-- The words complained of by the plaintiff in the Peterson letter, specifically, that "he stole 7 boxes of IBP documents" and that "Bagley's version of IBP's quantity discount program is absolutely false, and . . . constitutes perjury," are libelous per se in that the words themselves tend to disgrace and degrade him. Such words create a legal presumption of their falsity 400 thus shifting to the defendant the burden of proving the truth of the statements by a preponderance of the evidence. * * * With respect to punitive damages for libel, the District Court instructed the jury that-- If you find that plaintiff has established the essential elements of his libel claim and if you find, on the basis of clear and convincing evidence that the defendant acted with actual malice in publishing the writing in question, then you may award the plaintiff punitive damages in addition to the actual damages assessed. Punitive damages are designed to punish the offender and serve as an example to others. Whether or not to award such damages, and the amount72 thereof, are matters confided to you for decision.The District Court Judge instructed the jury respecting punitive damages generally that-- In addition to the actual damages set out above, plaintiff's complaint seeks to recover what is known in law as punitive damages. These damages are not compensatory in the ordinary sense but are allowed by way of punishment to restrain defendant or others from the commission of like acts in the future. You are instructed that the law permits but does not require a jury to allow punitive damages in certain cases if it is found by the jury that the act causing the injury complained of is malicious or wanton.On December 30, 1982, the jury returned verdicts in favor of petitioner on all four remaining claims and awarded petitioner actual and punitive damages in the following amounts: DamagesClaimActualPunitiveTortious interferencewith present employment$ 150,000$ 500,000Tortious interferencewith future employment100,000250,000Libel1,000,0005,000,000Invasion of privacy250,0001,500,000Total1,500,0007,250,000On January 10, 1983, IBP filed a motion for judgment notwithstanding the verdict73 or alternatively for a new trial. IBP's motion contained a number of arguments, including the argument that the damages awarded on the libel claim were duplicated by the awards on the other claims. On June 24, 1983, the District Court entered an order granting IBP's 401 motion with respect to the invasion of privacy claim on the grounds that the award on that claim was duplicative of the award on the libel claim and dismissed that claim. IBP appealed the judgment on the three remaining claims to the Court of Appeals for the Eighth Circuit. The Court of Appeals for the Eighth Circuit, sitting en banc: (1) Reversed the judgment on the libel claim and remanded it for a new trial with instructions; (2) affirmed the judgment on the tortious interference with present employment claim; and (3) affirmed the judgment on the tortious interference with future employment claim as to liability, but reversed and remanded it as to damages on the ground that an award on that claim could be duplicative of any award on the libel claim. The reversal of the judgment on the libel claim by the Court of Appeals was on the ground that the District Court erroneously instructed the jury that IBP had the burden74 of proving that the allegedly libelous statements were true. The Court of Appeals in its opinion stated that petitioner must prove that IBP's statements that he "stole" documents and committed "perjury" were, in fact, false and that he must establish that IBP was at fault in publishing these statements. The Court of Appeals held that to recover punitive damages, petitioner, in addition to proving falsity, must prove by clear and convincing evidence that IBP's actions in publishing the challenged statements constituted "actual malice". With respect to the tortious interference with future employment claims, the Court of Appeals held that if petitioner failed to recover on his libel claim, the award of damages should be reinstated, but if petitioner recovered on his libel claim the District Court should then determine to what extent a recovery for tortious interference with future employment would duplicate his libel recovery. To the extent of any duplication, the Court of Appeals held that the award of damages on the tortious interference with future employment claim should not be reinstated. On remand, the District Court entered a judgment on the tortious interference with present75 employment claim in accordance with the opinion of the Court of Appeals for the Eighth Circuit, and on April 23, 1987, IBP paid petitioner $ 983,281.23 on this claim. This payment was composed of the following amounts: Compensatory damages$ 150,000.00Punitive damages500,000.00Costs1,933.48Prejudgment interest48,575.34Postjudgment interest282,772.41Total983,281.23402 On May 29, 1987, petitioner filed a motion in the District Court to reinstate the award of $ 250,000 in actual damages and $ 1.5 million in punitive damages which he had received from the jury on the invasion of privacy claim which the District Court had set aside as duplicative of the libel award. Petitioner argued that since the judgment on the libel claim had been reversed and remanded, the invasion of privacy award was no longer duplicative of the libel award and, therefore, should be reinstated. By order dated August 4, 1987, the District Court denied petitioner's motion as premature, but stated in the order that if petitioner decided to forgo retrial of the libel claim, the court would be disposed to reinstate the two damage awards, and that petitioner also would be entitled to reinstatement76 of those two damage awards if on retrial he failed to establish IBP's liability for libel. A new trial was scheduled to begin with respect to petitioner's libel claim on September 28, 1987. In August 1987, the parties were required to meet for a settlement conference with a magistrate. Present at the conference were Mr. Richard Smith (Mr. Smith), an attorney for IBP who had been retained after the remand of the case by a new vice president and general counsel of IBP, Mr. Lonny Grigsby (Mr. Grigsby); the magistrate; petitioner's counsel Mr. William J. Rawlings (Mr. Rawlings); and an associate of Mr. Rawlings, Mr. Michael P. Jacobs. For a brief time, Judge McManus was present at the conference. At the settlement conference, the parties agreed to an out-of-court settlement whereby IBP was to pay petitioner $ 1.5 million, and each party agreed to dismiss the suit against the other. The settlement was agreed to on behalf of IBP by Mr. Smith, Mr. Grigsby, and Mr. Robert Peterson, IBP's president. In negotiating the settlement, IBP's primary motivation was to resolve the litigation for the lowest possible payment. 403 IBP agreed to the settlement primarily to limit its monetary exposure, resolve77 its dispute with petitioner with finality, and avoid further publicity about the case. Given the hazards of litigation, IBP's attorney thought the settlement was favorable for IBP. The settlement was reached after some give and take by the parties over the amount to be paid to petitioner. The $ 1.5 million figure was not based on any formula or calculation. During the course of the settlement conference, Mr. Rawlings stated that petitioner would receive punitive damages if the case were retried and that the potential for punitive damages had to be taken into consideration. Mr. Smith, as a representative of IBP, responded that IBP would not agree to pay punitive damages, and Mr. Rawlings replied that that is what he would state if he were in Mr. Smith's position. It took the parties approximately 2 weeks to agree on the wording of the settlement agreement and to execute the agreement. During this period, there were no further discussions between the parties with respect to the $ 1.5 million to be paid to petitioner. IBP's principal concern in the drafting of the settlement agreement was that the document clearly release IBP from any and all liability to petitioner, and clearly provide78 that petitioner was to return the Bagley documents to IBP, and that the settlement remain confidential. On September 10, 1987, the parties executed a release and settlement agreement which provided: This Settlement Agreement and Release is entered into this 10th day of September, 1987, between IBP, INC. (IBP) and HUGHES A. and MARILYN BAGLEY (Bagley). 1. IBP and Bagley each hereby release and forever discharge the other from all sums of money, accounts, actions, suits, proceedings, claims and demands whatsoever which either of them at any time had or has up to the date hereof against the other for or by reason of or in respect of any act, omission, statement, writing, or cause whatsoever. 2. Bagley hereby acknowledges payment and receipt in the sum of One Million Five Hundred Thousand Dollars ($ 1,500,000.00) as damages for personal injuries including alleged damages for invasion of privacy, injury to personal reputation including defamation, emotional distress and pain and suffering. 3. Bagley hereby agrees to return forthwith to IBP all documents previously in Bagley's possession and generated by or at IBP in the course of its business except those which are identified as79 personal to Bagley. 404 4. The parties will file forthwith a stipulation of dismissal of IBP's pending cause of action against Bagley, case number C 77-4040 in the United States District Court for the Northern District of Iowa, Western Division. 5. The parties will file forthwith a stipulation of dismissal of Bagley's causes of action pending against IBP, case number C 79-4087, in the United States District Court for the Northern District of Iowa, Western Division. 6. Both parties agree to exercise their best efforts to avoid public disclosure of the settlement terms hereof including this document itself, except as may be by law required. 7. This release is executed as a compromise settlement of disputed claims, liability for which are expressly denied by the party and/or parties released, and this release does not constitute an admission of liability on the part of either party. 8. This release and settlement agreement contains the entire agreement between the parties and the terms hereof are contractual and not a mere recital.Pursuant to the settlement agreement, IBP paid petitioner $ 1.5 million by check dated September 8, 1987. The invoice for the check indicated the check80 was issued for "settlement". The check was deposited into Mr. Rawlings' firm's trust account, and the funds were then distributed out of the trust account. Prior to the filing of the Bagley suit, Mr. Rawlings had a flat hourly fee arrangement with petitioner for an hourly fee of $ 75 for certain work, and $ 85 for other work, with respect to the defense of the IBP suit. After the Bagley suit was commenced, Mr. Rawlings and petitioner changed the fee agreement arrangement to a hybrid basis whereby Mr. Rawlings would receive a fee of $ 50 per hour, plus 25 percent of any judgment or settlement received in the litigation. Petitioner was to pay all expenses incurred in the litigation. During the year 1987, petitioner paid a total of $ 768,484.87 in legal fees and costs in connection with the IBP litigation. This amount was composed of $ 378,426.39 paid in connection with the judgment petitioner received in the tortious interference with present employment claim and $ 390,058.48 paid in connection with the settlement petitioner received from IBP. Of the $ 378,426.39 in legal fees paid by petitioner in connection with the tortious interference with present employment claim, $ 245,336.9481 represented the 25-percent contingency fee, and $ 133,089.93 represented the $ 50-per hour fixed fee. The fee agreement had been structured with a contingency fee, as well as an hourly fee, because of the difficulty in determining 405 when the attorneys were defending against IBP's claims and when they were prosecuting petitioner's claims, when they were working on the litigation. On their 1987 Federal income tax return, petitioners reported $ 333,000 of interest received from IBP on Schedule B and deducted $ 105,869 of legal and accounting fees as miscellaneous itemized deductions on Schedule A. Petitioners showed the receipt of the $ 150,000 of compensatory damages from the tortious interference with present employment claim, and the receipt of $ 500,000 of punitive damages from that claim, but excluded both the compensatory damages and punitive damages from their taxable income. Also, petitioners showed the receipt of $ 1.5 million paid in connection with the settlement, but excluded the entire $ 1.5 million from their taxable income. The amounts were shown on the tax returns on a Form 8275, Disclosure Statement Under Section 6661. Respondent, in her notice of deficiency, increased82 petitioner's income as shown on petitioners' Federal income tax return for the year 1987 by the amount of $ 500,000, explained as a court-ordered award, and by the amount of $ 1,305,000, explained as an out-of-court settlement payment. Although the notice of deficiency does not state an explanation for the increases in income, other than stating "it is determined that petitioner received additional income in these amounts which was not reported", respondent, at the trial, stated that these amounts represented the amounts of the awards which were punitive damages, which were not excludable from income under section 104(a)(2) as damages received on account of personal injuries or sickness. Respondent, in the notice of deficiency, reduced petitioner's income by the amount of $ 534,932, which she computed as the amount of legal fees deductible. The amount was computed by showing legal fees allowable for deduction as $ 661,013.30, less legal fees claimed per return of $ 82,038, leaving $ 578,975.30 of deductible legal fees not claimed on the tax return, which, after the adjustment for 2 percent of adjusted gross income, left a deduction of $ 534,932.30. Respondent, in the notice of deficiency, 83 stated that these legal fees were applicable to the taxable amount of the court-ordered award and the out-of-court settlement payment and were deductible as miscellaneous deductions subject to reduction by an amount of 2 percent of adjusted gross income. 406 OPINION The first issue we have for decision is what portion, if any, of the $ 1.5 million paid to petitioner by IBP in connection with the settlement of all claims (other than the tortious interference with present employment claim, which had been disposed of by an entry of judgment by the District Court pursuant to the opinion of the Court of Appeals for the Eighth Circuit prior to the time of settlement), was paid in lieu of punitive damages. The parties are not in disagreement as to the law with respect to the allocation of an amount paid in a settlement, but have decided disagreements as to how the law should be applied to the facts of this case. Both parties agree that where an amount is paid in settlement of a case, the critical question is, in lieu of what was the settlement amount paid. McKay v. Commissioner, 102 T.C. 465">102 T.C. 465, 482 (1994); Robinson v. Commissioner, 102 T.C. 116">102 T.C. 116, 126 (1994);84 Church v. Commissioner, 80 T.C. 1104">80 T.C. 1104, 1109 (1983). The parties agree also that all of the facts surrounding the settlement must be considered in determining in lieu of what was the settlement amount paid. McKay v. Commissioner, supra.Where there is an express allocation contained in the agreement between the parties, it will generally be followed in determining the allocation if the agreement is entered into by the parties in an adversarial context at arm's length and in good faith. Robinson v. Commissioner, supra. However, an express allocation set forth in the settlement is not necessarily determinative if other facts indicate that the payment was intended by the parties to be for a different purpose. It is petitioners' position that the express language in the settlement agreement provides that the payment is a payment for the actual injuries. In support of this position petitioners quote the provision of the agreement that petitioner acknowledges payment and receipt of the sum of $ 1.5 million as damages "for personal injuries, including alleged damages for invasion of privacy, 85 injury to personal reputation including defamation, emotional stress, and pain and suffering". It is petitioners' contention that this express language in the settlement shows that the entire payment of $ 1.5 million was made for a tort-type personal injury and, 407 therefore, is excludable under section 104(a)(2). In support of this position, petitioners cite the statement in Glynn v. Commissioner, 76 T.C. 116">76 T.C. 116, 120 (1981), affd. without published opinion 676 F.2d 683">676 F.2d 683 (1st Cir. 1982), that the most important fact in determining the purpose of the payment is "express language [in the agreement] stating that the payment was made on account of personal injuries". See also Metzger v. Commissioner, 88 T.C. 834">88 T.C. 834, 847 (1987), affd. without published opinion 845 F.2d 1013">845 F.2d 1013 (3d Cir. 1988). Petitioners state that the situation in petitioner's case is almost identical with that in McKay v. Commissioner, supra, and is distinguishable from the situation in Robinson v. Commissioner, supra, relied on by respondent. In86 both Robinson v. Commissioner, supra at 127, and McKay v. Commissioner, supra at 483, we recognized that when a settlement agreement clearly allocates the settlement proceeds between tort-like personal injury damages and other damages, the allocation is generally binding for tax purposes to the extent that the agreement is entered into by the parties in an adversarial context at arm's length and in good faith. Where the taxpayer's claims are settled and the express allocations among the various claims are contained in the settlement agreement, we carefully consider such allocations, if these express allocations were, negotiated at arm's length between the parties. In Robinson v. Commissioner, supra, the parties had made an allocation that was reflected in the final judgment as being 95 percent in payment for mental anguish and 5 percent for lost profits. We held that the allocation in the final judgment did not control the tax effects because it was uncontested, nonadversarial, and entirely tax-motivated, and did not accurately reflect the underlying claims. In the McKay case87 we stated that the settlement was made by hostile parties who were in an adversarial position with respect to the allocations to be made in the settlement. In that case we pointed out that the taxpayer wanted the settlement award to be as high an amount as possible to compensate him for his losses and wanted the other party to be punished for its behavior. However, the other party wanted to minimize the amount payable to the taxpayer as well as to avoid making any payment on account of the taxpayer's RICO claim. We pointed out that the party dealing with the taxpayer in that case had made 408 it clear that he would not settle if any damages were allocated to RICO claims because of the negative impact that payment of such damages would have on its reputation in the oil industry. The settlement agreement stated affirmatively that no amount was being paid to the taxpayer to satisfy damages under RICO. In that case, the settlement agreement provided: "McKay has necessarily acceded to Ashland's demand that nothing be allocated to the RICO Claim, punitive damages claims, or alleged intentional misconduct claims and Ashland and McKay have both relied upon their appellate counsel's consensus88 estimate of McKay's probability of appellate success with respect to the two other claims. * * "McKay v. Commissioner, 102 T.C. at 473. In the McKay case the record showed that the taxpayer was never given freedom to structure the settlement on his own. In our view, the instant case is distinguishable from the McKay case, since there is no specific statement with respect to punitive damages in the settlement agreement, and the parties structured the settlement agreement by jointly participating in the drafting of the agreement. Although this case is not exactly comparable to Robinson v. Commissioner, supra, there are some aspects of similarity to the Robinson case. Here, the record shows that a judgment had been entered by a jury with respect to the libel claim, and the jury had allowed $ 1 million of compensatory damages and $ 5 million of punitive damages. The record shows that the Court of Appeals had held the claim with respect to tortious interference with future employment duplicative of the libel claim, but did not reverse the jury award of $ 100,000 of compensatory damages and $ 250,00089 of punitive damages, if on retrial petitioner was unsuccessful in the libel suit. The record further shows that the District Court had held that consideration would be given to reinstatement of the invasion of privacy award, of $ 250,000 in compensatory and $ 1.5 million in punitive damages if on retrial petitioner was unsuccessful in the libel suit. Therefore, $ 1 million was likely to be the total petitioner would receive as compensatory damages, if on retrial he succeeded on the libel claim. The record shows that counsel for IBP was unwilling to have a statement made that a portion of the $ 1.5 million was paid as punitive damages, and the parties agreed to a statement that the sum 409 of $ 1.5 million was paid as damages for personal injuries, including alleged damages for invasion of privacy, injury to personal reputation, defamation, emotional stress, and pain and suffering. However, there is no specific statement, as there was in McKay v. Commissioner, 102 T.C. 465">102 T.C. 465 (1994), that the damages referred to were not in consideration of any amount that might have been awarded as punitive damages had the case gone to trial. The overall picture here clearly90 shows that IBP would necessarily have considered the possibility in a retrial of having to pay punitive damages in the libel suit, and, if IBP won the libel suit, IBP would have to pay $ 250,000 in punitive damages under the tortious interference with future employment judgment, and possibly $ 1.5 million as punitive damages on the invasion of privacy claim. The record is also clear here that IBP's primary concern was that it pay as little as possible to dispose of all claims of petitioner, while providing for the return of the Bagley documents, and that the settlement remain confidential. The evidence here shows that both parties worked on the wording of the settlement document and were aware that even if petitioner lost on the retrial of the libel claim the tortious interference with future employment judgment of $ 100,000 compensatory damages, and $ 250,000 punitive damages, and possibly the invasion of privacy award would be reinstated. The parties in coming to their agreement were aware that the jury had previously awarded compensatory damages in the libel suit of $ 1 million and punitive damages of $ 5 million. Although the record supports the fact that counsel for IBP did not91 want to show an allocation to punitive damages, the record as a whole, including the discussions and give-and-take between the parties as to the amount to be paid to petitioner, shows that both parties considered the clear possibility of petitioner recovering punitive damages. In fact, the testimony of the attorneys shows that this was in the minds of the attorneys when the negotiations were going on. Furthermore, it was clearly in the interest of both parties not to show an amount allocated to punitive damages. Petitioner's counsel testified that in the beginning of the negotiations he was not aware of whether it might make a difference if a portion were allocated to compensatory damages and a portion to punitive damages, but that between the time of agreement to the total payment of $ 1.5 million and 410 the completion of drafting the settlement agreement petitioner had consulted a tax attorney and was aware that there could possibly be a difference, since an amount of compensatory damages would clearly be excludable from income. Here, we have a situation in which the jury award, which was not reversed by the court because of its amount, but rather because of an improper jury instruction92 as to burden of proof, gave five times as much in punitive damages to petitioner as in compensatory damages, and an award of two and one-half times as much in punitive as compensatory damages that would be reinstated on the claim for tortious interference with future employment if the libel case of petitioner were unsuccessful. Also, there existed the possibility that an additional $ 1.5 million of punitive damages might be reinstated on the invasion of privacy claim. Based on these facts, we conclude that some of the $ 1.5 million is properly allocable to punitive damages. However, we do not agree with the amount respondent allocated. The parties were negotiating for an amount in lieu of the overall amount petitioner might recover if the case went to trial. They were considering the risk of trial, as well as items unrelated to the money that petitioner might recover, such as the return of the Bagley documents and the confidentiality of the settlement. All of these factors were important to IBP. Also, it is clear that there would have been, in any event, a $ 350,000 payment to petitioner for the tortious interference with future employment award, of which $ 250,000 were punitive damages93 if petitioner was unsuccessful in the libel suit. Probably there would have been interest on that award. However, clearly IBP did not want to acknowledge a payment of punitive damages. Under these circumstances, it is reasonable to assume that IBP would have paid in settlement to petitioner the entire $ 1 million that the jury had found he was due as compensatory damages. However, in our view, the remaining $ 500,000 was in settlement of possible punitive damages petitioner might have recovered. We, therefore, hold that of the $ 1.5 million settlement amount, $ 1 million was for compensatory damages and $ 500,000 was for punitive damages. Petitioner argues that the amounts received by petitioner as punitive damages, which we have found total $ 1 million, 411 are properly excludable from petitioner's income for 1987 under section 104(a)(2). In a fairly recent Court-reviewed case, Horton v. Commissioner, 100 T.C. 93">100 T.C. 93 (1993), affd. 33 F.3d 625">33 F.3d 625 (6th Cir. 1994), we held that the punitive damages received by a taxpayer in a personal injury suit in a Kentucky State court were excludable from the taxpayer's gross income under section 104(a)(2)94 as "damages received * * on account of personal injury". Our first basis for excluding punitive damages from a taxpayer's income under section 104(a)(2) was a rejection of the concept that section 104(a)(2) excludes only amounts that restore lost capital, as opposed to amounts that would otherwise constitute gains or accession to wealth. We stated that, in our view, the beginning and end of the inquiry "should be whether the damages were paid on account of 'personal injuries'". We then stated that this inquiry should be answered by determining the nature of the underlying claim. We concluded that once the nature of the underlying claim is established as one for personal injury, any damages received on account of that claim, including punitive damages, are excludable. In the Horton case, we stated that the recent decision of the Supreme Court in United States v. Burke, 504 U.S. 229">504 U.S. 229, 119 L. Ed. 2d 34">119 L. Ed. 2d 34, 112 S. Ct. 1867">112 S. Ct. 1867 (1992), supported the analysis we had adopted. We stated that the taxpayers in the Burke case were claiming that a backpay award in a sex discrimination suit under title VII was excludable from income, but the Supreme Court, in holding to the contrary, stated that95 in determining whether the section 104(a)(2) exclusion applies, the nature of the claim underlying an award of damages is a critical factor. In Horton v. Commissioner, supra, we held that punitive damages should be excluded from a taxpayer's income under section 104(a)(2). We held that we would follow our own opinion in Miller v. Commissioner, 93 T.C. 330">93 T.C. 330 (1989), rather than the reversal by the Court of Appeals, 914 F.2d 586">914 F.2d 586 (4th Cir. 1990). However, we pointed out that the Court of Appeals for the Fourth Circuit in the Miller case had concluded that under Maryland law punitive damages were not excludable, since they were purely punitive and not compensatory to the injured party, whereas under Kentucky law punitive damages served both to compensate the injured party and punish the wrongdoer. Therefore, even though we held we would follow our position in the Miller case, we also distinguished the Miller412 case from Horton v. Commissioner, supra, on the basis of the difference in Kentucky and Maryland law. The four circuits, in addition to the Fourth Circuit in Miller and the Sixth Circuit in 96 Horton, which have addressed the deductibility of punitive damages have come to the conclusion reached by the Court of Appeals for the Fourth Circuit in Miller that damages which are compensatory in nature are excludable, but damages which are noncompensatory in nature are not excludable under section 104(a)(2). The Court of Appeals for the Ninth Circuit held that punitive damages were not excludable from gross income where the punitive award was not a restoration of lost capital and was "'not intended to compensate the injured party, but rather to punish the tort-feasor whose wrongful action was intentional or malicious, and to deter him and others from similar extreme conduct.'" ( Hawkins v. United States, 30 F.3d 1077">30 F.3d 1077, 1083 (9th Cir. 1994), citing City of Newport v. Fact Concerts, Inc., 453 U.S. 247">453 U.S. 247, 266, 69 L. Ed. 2d 616">69 L. Ed. 2d 616, 101 S. Ct. 2748">101 S. Ct. 2748 (1981)). The Court of Appeals for the Ninth Circuit further found that punitive damages were not awarded to a taxpayer "on account of" personal injury, but rather were awarded "on account of" the tortfeasor's deplorable conduct. Hawkins v. United States, supra at 1080. In Reese v. United States, 228">24 F.3d 228 (Fed. Cir. 1994),97 the court found that punitive damages received by a taxpayer in an action under the District of Columbia Human Rights Act were not excludable since they were in the nature of noncompensatory damages. The Federal Circuit, relying on a District of Columbia case as well as the Supreme Court's language in City of Newport v. Fact Concerts, Inc., supra, and similar cases, and on the legislative history of section 104(a)(2), stated that "it would be inconsistent with the legislative history to treat punitive damages as excludable from income; since punitive damages in no way resemble a return of capital". Reese v. United States, supra at 233. The Court of Appeals for the Federal Circuit rejected the taxpayer's argument that United States v. Burke, 504 U.S. 229">504 U.S. 229, 119 L. Ed. 2d 34">119 L. Ed. 2d 34, 112 S. Ct. 1867">112 S. Ct. 1867 (1992), was applicable to the issue it was considering on the ground that the Burke case did not involve punitive damages and was, therefore, not controlling or even relevant to the issue. Reese v. United States, supra at 233. The Court of Appeals for the Fifth Circuit has recently decided98 that noncompensatory punitive damages are not 413 excludable under section 104(a)(2). In Wesson v. United States, 48 F.3d 894">48 F.3d 894 (5th Cir. 1995), the court concluded, as did the Federal Circuit, that the Supreme Court did not address whether punitive damages are excludable from gross income in United States v. Burke, supra. The Fifth Circuit agreed with the opinions of the Courts of Appeals for the Fourth, Ninth, and Federal Circuits that Congress did not intend that noncompensatory damages be excludable from a taxpayer's income, since such damages did not restore lost capital. Wesson v. United States, supra at 899. Since the Fifth Circuit concluded that under Mississippi law punitive damages were noncompensatory in nature, it held punitive damages not to be excludable from income under section 104(a)(2). Wesson v. United States, supra.2 On September 19, 1995, the Court of Appeals for the Tenth Circuit issued an opinion in O'Gilvie v. United States, 66 F.3d 1550">66 F.3d 1550 (10th Cir. 1995), concluding: "We thus join the majority of 99 the circuits that have addressed this issue in holding that section 104(a)(2) does not exclude punitive damages from income." Of the six Courts of Appeals which have decided the issue of exclusion from income of punitive damages, five have held that punitive damages are not excludable.3101 The Court of Appeals for the Sixth Circuit, in affirming our Horton case, primarily relied on the language of United States v. Burke, supra at 237, which indicated that in order to determine whether an award is excludable under section 104(a)(2), "we should focus 'on the nature of the claim underlying [the taxpayer's] damages award.'" Horton v. Commissioner, 33 F.3d 625 (6th Cir. 1994),100 affg. 100 T.C. 93">100 T.C. 93 (1993). The Court of Appeals for the Fourth and Fifth Circuits have looked to State law to determine the nature of 414 punitive damages, while the Federal Circuit has interpreted opinions of the Supreme Court as well as an opinion of the District of Columbia Court of Appeals to determine whether punitive damages were compensatory in nature. Commissioner v. Miller, supra, at 589; Moore v. Commissioner, 53 F.3d 712">53 F.3d 712, 715-716 (5th Cir. 1995); Reese v. United States, supra at 231-232. 4However, most important to a consideration of whether in this case we should follow our holding in Horton v. Commissioner, supra, is whether our holding in the Horton case has effectively been overruled by the decision of the Supreme Court in Commissioner v. Schleier, 515 U.S. , 115 S.Ct. 2159, 132 L. Ed. 2d 294">132 L. Ed. 2d 294 (1995).102 In the Schleier case, the taxpayer included as gross income the backpay portion, but not the liquidated damages portion, of a settlement award received under the Age Discrimination in Employment Act of 1967 (ADEA). The Commissioner sent the taxpayer a notice of deficiency determining that the taxpayer should have included the liquidated damages portion of his settlement as gross income. We found for the taxpayer, holding that the entire settlement was damages received "on account of personal injuries or sickness" within the meaning of section 104(a)(2) and was, therefore, excludable from gross income, and the Court of Appeals for the Fifth Circuit affirmed. Commissioner v. Schleier, 26 F.3d 1119 (5th Cir. 1994). The Supreme Court reversed the Court of Appeals. The Supreme Court stated that the taxpayer argued that his damages were excluded from gross income since they were "damages received * * on account of personal injuries or sickness." Commissioner v. Schleier, supra at 2162. The Supreme Court rejected this argument, stating that the "plain language of [section 104(a)(2)] undermines [the taxpayer's] contention." Commissioner v. Schleier103 , supra at 2163. The Supreme Court concluded that each element of the settlement 415 must satisfy the requirement under section 104(a)(2), that the damages were received "on account of personal injuries or sickness." Commissioner v. Schleier, supra at 2164. Since the backpay was not directly caused by the injury, section 104(a)(2) did not apply. The Court reasoned: In short, section 104(a)(2) does not permit the exclusion of * * * [the taxpayer's] back wages because the recovery of back wages was not "on account of" any personal injury and because no personal injury affected the amount of back wages recovered.Commissioner v. Schleier, supra at 2164. The taxpayer argued that liquidated damages fit within section 104(a)(2), citing Overnight Motor Transp. Co. v. Missel, 316 U.S. 572">316 U.S. 572, 583, 86 L. Ed. 1682">86 L. Ed. 1682, 62 S. Ct. 1216">62 S. Ct. 1216 (1942), which held that liquidated damages under the Fair Labor Standards Act (FLSA) were "compensation, not a penalty or punishment". The Court, however, distinguished liquidated damages recovered under the FLSA from those recovered under the ADEA. In finding that section 104(a)(2) did not apply to liquidated damages under the ADEA, the Court104 stated, "'Congress intended for liquidated damages [under the ADEA] to be punitive in nature.'" Commissioner v. Schleier, 515 U.S. , 115 S.Ct. at 2165 (quoting Trans World Airlines, Inc. v. Thurston, 469 U.S. 111">469 U.S. 111, 126, 83 L. Ed. 2d 523">83 L. Ed. 2d 523, 105 S. Ct. 613">105 S. Ct. 613 (1985)). The taxpayer in the Schleier case made essentially the same argument as the taxpayer in Horton v. Commissioner, 100 T.C. 93 (1993), with regard to United States v. Burke, 504 U.S. 229">504 U.S. 229, 119 L. Ed. 2d 34">119 L. Ed. 2d 34, 112 S. Ct. 1867">112 S. Ct. 1867 (1992). See Horton v. Commissioner, supra at 96-99. The taxpayer argued that the Burke case stood for the proposition that a taxpayer need only prove that the underlying claim was based on a "tort or tort type rights" to be excludable under section 104(a)(2). In addressing the taxpayer's argument that the Burke case limited the analysis under section 104(a)(2) to determining whether recovery is based on "tort or tort type rights", the Supreme Court stated at 515 U.S. , 115 S.Ct. at 2167: Second, and more importantly, the holding of Burke is narrower than * * [the taxpayer] suggests. In 105 Burke, following the framework established in the IRS regulations, we noted that section 104(a)(2) requires a determination whether the underlying action is "based upon tort or tort type rights." United States v. Burke, 504 U.S., at 234, 112 S.Ct., at 1870. 416 In so doing, however, we did not hold that the inquiry into "tort or tort type rights" constituted the beginning and end of the analysis. In particular, though Burke relied on Title VII's failure to qualify as an action based upon tort type rights, we did not intend to eliminate the basic requirement found in both the statute and the regulation that only amounts received "on account of personal injuries or sickness" come within section 104(a)(2)'s exclusion. Thus, though satisfaction of Burke's "tort or tort type" inquiry is a necessary condition for excludability under section 104(a)(2), it is not a sufficient condition. [Fn. ref. omitted.]In our view, the Supreme Court in the Schleier case adopted a position contrary to our holding in the Horton case, that the underlying claim is the "beginning and end" of the analysis. Under the holding in the Schleier case, once it 106 is determined that the nature of the claim is based on a "tort or tort type right", it is necessary to further determine whether the amounts received were "on account of personal injuries or sickness." The Supreme Court has made it clear in the Schleier case that damages which are not compensatory but punitive in nature are not excludable from gross income under section 104(a)(2). The Supreme Court stated: We agree with * * [the taxpayer] that if Congress had intended the ADEA's liquidated damages to compensate plaintiffs for personal injuries, those damages might well come within section 104(a)(2)'s exclusion. There are, however, two weaknesses in * * * [the taxpayer's] argument. First, even if we assume that Congress was aware of the Court's observation in Overnight Motor that the liquidated damages authorized by the FLSA might provide compensation for some "obscure" injuries, it does not necessarily follow that Congress would have understood that observation as referring to injuries that were personal rather than economic. Second, and more importantly, we have previously rejected * * * [the taxpayer's] argument: We have already concluded that the liquidated damages107 provisions of the ADEA were a significant departure from those in the FLSA, see Lorillard v. Pons, 434 U.S. at 581, 98 S.Ct., at 870; Trans World Airlines, Inc. v. Thurston, 469 U.S. at 126, 105 S.Ct., at 624, and we explicitly held in Thurston: "Congress intended for liquidated damages to be punitive in nature." Id., at 125, 105 S.Ct., at 624. Our holding in Thurston disposes of * * [the taxpayer's] argument and requires the conclusion that liquidated damages under the ADEA, like back wages under the ADEA, are not received "on account of personal injury or sickness." [Fn. refs. omitted]Commissioner v. Schleier, 515 U.S. , 115 S.Ct. at 2165. It is clear from this paragraph that if punitive damages are not of a compensatory nature, they are not excludable 417 under section 104(a)(2). The Supreme Court in the Schleier case left open when punitive or exemplary damages under a particular Federal or State law are intended to be compensatory. We, therefore, look to the State law to determine whether the punitive damages petitioner received108 were compensatory in nature. The present case involves Iowa law. See Bagley v. Iowa Beef Processors, Inc., 797 F.2d 632 (8th Cir. 1985). Under Iowa law, it is clear that punitive damages are to punish the person who is liable for injury and set an example to deter future malicious actions. In Team Cent., Inc. v. Teamco, Inc., 271 N.W.2d 914">271 N.W.2d 914, 925 (Iowa 1978), the Iowa Supreme Court stated that the purpose of punitive damages is to punish the wrongdoer rather than to compensate the victim. This case is in line with previous cases by the Supreme Court of Iowa. In Meyer v. Nottger, 241 N.W.2d 911">241 N.W.2d 911, 922 (Iowa 1976), the court stated: Exemplary damages are not intended to be compensatory. An award of exemplary damages is never made as a matter of right, but depends upon whether under the facts in a particular case such award is appropriate in order to punish an offending party or discourage others from similar wrongful conduct. [Citations omitted.]The court in Meyer v. Nottger, supra, concluded that the noncompensatory nature of punitive damages is well109 established under Iowa law. The Supreme Court stated in Commissioner v. Schleier, supra at 2165-- We have already concluded that the liquidated damages provisions of the ADEA were a significant departure from those in the FLSA * * and we explicitly held in Thurston "Congress intended for liquidated damages to be punitive in nature." Id., at 125, 105 S.Ct. at 624. [Citations and fn. ref. omitted.]We conclude that in Commissioner v. Schleier, supra, the Supreme Court effectively overruled the part of our holding and that of the Court of Appeals for the Sixth Circuit in Horton v. Commissioner, supra, that since the claim as originally made was one for a personal injury or a tort-like claim, even if the punitive damages received were as punishment for malicious actions and an example to deter others from such malicious action, they are excludable from income under section 104(a)(2). We will, therefore, no longer follow our opinion 418 in Horton v. Commissioner, supra, to the extent that it holds that punitive damages which are not compensatory in nature are excludable from income under section 104(a)(2). We, therefore, hold that the $ 110 1 million received by petitioner in 1987, composed of $ 500,000 received on April 23, 1987, pursuant to the judgment entered by the District Court and the $ 500,000 received on September 8, 1987, as part of the settlement of the remaining issues in the IBP litigation, which we have held to be for punitive damages, is not excludable from his income under section 104(a)(2). Petitioner contends that the contingent legal fees paid to his attorney in connection with his litigation with IBP should be a reduction of the amount he received pursuant to judgment or in settlement of the IBP litigation. Respondent contends that these fees, to the extent deductible, should be considered miscellaneous itemized deductions subject to reduction by 2 percent of petitioner's adjusted gross income under section 67(a). The basis of petitioner's contention is that the contingent fee arrangement created a joint venture or partnership between him and the law firm. Petitioner argues that the portions of the judgment and settlement paid over to the law firm pursuant to that contingency fee were not income to petitioner. Section 7701(a)(2) defines a partnership as "a syndicate, group, pool, joint venture, 111 or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on". Whether a partnership exists is a question of fact. To be a partnership, the parties, in good faith and acting with a business purpose, must intend to join together in the present conduct of an enterprise. Commissioner v. Culbertson, 337 U.S. 733">337 U.S. 733, 742, 93 L. Ed. 1659">93 L. Ed. 1659, 69 S. Ct. 1210">69 S. Ct. 1210 (1949); see Estate of Smith v. Commissioner, 313 F.2d 724">313 F.2d 724, 732-733 (8th Cir. 1963), affg. in part, revg. in part and remanding 33 T.C. 465">33 T.C. 465 (1959). In determining whether a partnership exists for purposes of Federal tax, we have looked at such factors as the agreement of the parties and their conduct in executing its terms; the contributions which each party has made to the venture; each party's control over income and capital, and the right of each to make withdrawals; and, most relevant to the issue here before us, whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net 419 profits and having an obligation to share the net losses. This is distinguished from a relationship where112 one party receives contingent compensation in the form of a percentage of income for his services rendered to the other party. Based on the record, we find that there is nothing to indicate that the parties intended the contingency fee arrangement to be a joint venture or partnership. Mr. Rawlings testified that he regarded the agreement between himself and petitioner as nothing more than an arrangement for the payment for his services. Petitioner did not testify with respect to the fee agreement. There is, therefore, no testimony whatsoever that either party intended to form a partnership. Petitioner did not report any profit or loss from any partnership with Mr. Rawlings, but instead claimed a miscellaneous itemized deduction for attorney's fees paid. We, therefore, find petitioner's argument to be without merit. Petitioner also argues that the $ 50-per-hour portion of the legal fees he paid is deductible as a Schedule C expense under section 162, since petitioner was "defending his professional name and attempting to protect his occupation as a consultant to the meat packing industry." There is no Schedule C attached to petitioner's 1987 return. There is attached a Form 2106, 113 Employee Business Expenses. Petitioner has made no showing of any connection of the IBP litigation with a consulting business, if any, in which he was engaged in 1987 or any other year. Therefore, to the extent the IBP litigation costs are deductible, they are deductible either as employee business expenses or expenses incurred for the production of income. A deduction for either such expense is a miscellaneous itemized deduction, allowable only to the extent that the total of such deductions exceeds 2 percent of adjusted gross income. See McKay v. Commissioner, 102 T.C. 465">102 T.C. 465, 493 (1994). Petitioner contends that the statutorily-imposed interest received on the amount of the judgment he received on account of the personal injury he suffered, should be excludable from income. This issue has been before us on other occasions, and we have held that interest paid on damages awarded in connection with personal injury claims is taxable and not excludable from income, but that the amount of the attorney's fees paid in connection with the interest award is deductible from income. Kovacs v. Commissioner, 100 T.C. 124">100 T.C. 124, 128-130420 (1993),114 affd. without published opinion 25 F.3d 1048">25 F.3d 1048 (6th Cir. 1994); Aames v. Commissioner, 94 T.C. 189">94 T.C. 189, 192 (1990); Riddle v. Commissioner, 27 B.T.A. 1339">27 B.T.A. 1339, 1341 (1933). We, therefore, hold that the interest received by petitioner on the amount of the judgment in the IBP case is taxable income that is not excludable under section 104(a)(2). Decision will be entered under Rule 155. Reviewed by the Court. HAMBLEN, CHABOT, COHEN, SWIFT, JACOBS, GERBER, WRIGHT, PARR, WELLS, RUWE, WHALEN, COLVIN, HALPERN, BEGHE, CHIECHI, LARO, AND FOLEY, JJ., agree with this opinion. VASQUEZ, J. did not participate in the consideration of this opinion. Footnotes1. All section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩2. In Estate of Moore v. Commissioner, 53 F.3d 712">53 F.3d 712 (5th Cir. 1995), revg. T.C. Memo. 1994-4, the Court of Appeals for the Fifth Circuit also held that punitive damages were noncompensatory under Texas law and, therefore, were not excludable from gross income under sec. 104(a)(2)↩.3. While the Court of Appeals for the Seventh Circuit has yet to address this issue, it has favorably quoted Commissioner v. Miller, 914 F.2d 586">914 F.2d 586 (4th Cir. 1990), revg. 93 T.C. 330">93 T.C. 330 (1989), stating in Kurowski v. Commissioner, 917 F.2d 1033">917 F.2d 1033, 1035-1036 (7th Cir. 1990), affg. T.C. Memo 1989-149">T.C. Memo. 1989-149: Section 104(a)(2) of the Internal Revenue Code provides that gross income does not include "the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness." The rationale of the exemption is to free a taxpayer from liability for an amount received as compensation for a loss of that nature. "The recovery does not generate a gain or profit but only makes the taxpayer whole by compensating for a loss." Commissioner v. Miller, 914 F.2d 586">914 F.2d 586, 590↩ (4th Cir. 1990), citing 1 B. Bittker, Federal Taxation of Income, Estates and Gifts para. 13.1.4 (1981). * * *4. While Horton v. Commissioner, 33 F.3d 625 (6th Cir. 1994), affg. 100 T.C. 93">100 T.C. 93 (1993), held that the nature of the claim underlying the taxpayer's damages award decided whether punitive damages were excludable, the Court of Appeals stated, after its conclusion that punitive damages under Kentucky State law were partly compensatory in nature, "this case is distinguishable both from Miller, in which the Fourth Circuit noted that under Maryland defamation law, punitive damages served no compensatory purpose, and from Hawkins, in which the Arizona taxpayers 'concede[d] that the punitive damage award bears no relationship to their injuries and represents pure gain.' (quoting Hawkins v. United States, 30 F.2d 1077">30 F.2d 1077, 1080↩ (9th Cir. 1994).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623359/	JAY N. KARPA and ELIZABETH J. KARPA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKarpa v. CommissionerDocket No. 10361-88United States Tax CourtT.C. Memo 1989-535; 1989 Tax Ct. Memo LEXIS 535; 58 T.C.M. (CCH) 278; T.C.M. (RIA) 89535; September 27, 1989Jay Fred Cohen, for the petitioners. Clare J. Brooks, for the respondent. COLVINMEMORANDUM OPINION COLVIN, Judge: This matter is before the Court on the parties' cross motions for judgment on the pleadings under536 Rule 120. 1 The sole issue to be resolved is whether the retroactive increase in the addition to tax from 10 percent to 25 percent under section 6661 (substantial understatement of liability), enacted in 1986 is prohibited by the Constitution of the United States as an ex post facto law. We hold that retroactive imposition of the increase in the addition to tax rate from 10 percent to 25 percent is not a prohibited ex post facto law. Respondent determined that additions to tax for taxable year 1984 were due from petitioners as follows: Section 6653(a)(1)$ 546.65Section 6653(a)(2)50% of the interest due on theunderpayment caused bynegligence of $ 10,933.07.Section 6661$ 2,733.27Petitioners timely filed a petition placing in dispute only the addition to tax under section 6661 in the amount of $ 2,733.27 by providing in their petition: 3. The deficiency as determined by the Commissioner are the penalties for the calendar year 1984 in the537 amount of $ 2,733.27 under Section 6661 and 546 under Section 6653(a1)(a2) (sic) of the I.R.S. Code, of which only the penalty issued under Section 6661 in the amount of $ 2,733.27 is in dispute. The error alleged in the petition is set forth as follows: a. The imposition of this penalty on a tax year prior to 1986 is in violation of the Constitution of the United States, Section 9, Limitations upon Power of Congress, "No Bill of Attainder or Ex Post Facto Law Shall Be Passed." In their petition, petitioners prayed "that the penalty imposed by the Commissioner under Section 6661 be declared unconstitutional and void." Respondent filed a motion for judgement on the pleadings alleging the petition raises no factual dispute and that the pleadings in this case are closed and that respondent is entitled to a decision in its favor. Petitioner filed a motion for judgment on the pleadings along with petitioner's objection to respondent's motion. Petitioners agree that the only issue raised in the pleadings is whether section 6661 as applied to them is constitutional. Petitioners claim that section 6661 is an ex post facto law which is prohibited by article 1, section538 9, clause 3 of the Constitution of the United States of America. We disagree. When originally enacted in 1982, section 6661 provided for an addition to tax of 10 percent of the amount of any underpayment attributable to a substantial understatement of income tax liability for returns due after December 31, 1982. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, section 323(a), 96 Stat. 324, 615. Amendments to section 6661 were contained in two bills which became law in October of 1986. The addition to tax was increased to 20 percent by the Tax Reform Act of 1986, Pub. L. 99-514, section 1504, 100 Stat. 2085, 2743, and to 25 percent by the Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509, section 8002, 100 Stat. 1874. The President signed the Omnibus Budget Reconciliation Act of 1986 on October 21, 1986, and the Tax Reform Act of 1986 on October 22, 1986. Thus, the 25-percent rate became effective one day before the 20-percent rate. Question arose about which tax rate applies. This Court resolved the proper rate of the increase in the addition to tax under section 6661 by holding that the 25 percent rate applies. Pallottini v. Commissioner, 90 T.C. 498 (1988),539 which involved the section 6661 addition for the 1982 taxable year. In that decision we did not reach the issue of whether section 6661 was unconstitutional as a prohibited ex post facto law. We do so here. The Constitution bars ex post facto laws. Article I, section 9, clause 3. This bars retroactive penal and criminal statutes. Calder v. Bull, 386">3 U.S. 386 (1798). Ex post facto laws impose criminal punishment for conduct which was lawful when committed. Beazell v. Ohio, 269 U.S. 167">269 U.S. 167, 169 (1925); United States v. Hopkins, 529 F.2d 775">529 F.2d 775 (8th Cir. 1976), cert. denied 431 U.S. 965">431 U.S. 965 (1977). That part of our Constitution which prohibits ex post facto laws is not applicable to statutes imposing civil sanctions. Harisiades v. Shaughnessy, 342 U.S. 580">342 U.S. 580 (1952). The ex post facto clause extends only to criminal statutes. Galvan v. Press, 347 U.S. 522">347 U.S. 522, 531 (1954); Johannessen v. United States, 225 U.S. 227">225 U.S. 227, 242 (1912); United States v. Hopkins , supra at 777; Mathes v. Commissioner, 63 T.C. 642">63 T.C. 642, 644 (1975) (section 51(a)(1)(A) not unconstitutional540 ex post facto law). However, the constitutional prohibition may not be evaded by giving civil form to a criminal law. Burgess v. Salmon, 97 U.S. 381">97 U.S. 381 (1878). Petitioners argue that the issue is not what the addition is called, but rather whether the addition is of a penal or criminal nature, and so punitive to transform what is a civil remedy into a criminal remedy. We decline to construe the section 6661 addition to tax as penal or criminal in nature. The Supreme Court has held that the ex post facto prohibition is not applicable to a civil addition to tax. Bankers Trust Co. v. Blodgett, 260 U.S. 647">260 U.S. 647, 652 (1923). In Bankers Trust Co. the civil addition to tax was a retroactive state tax penalty. An analogy that may be useful here in evaluating the distinction between the penal aspects of criminal punishment and a civil tax addition is the Supreme Court decision in United States v. Halper, U.S. , 109 S. Ct. 1892">109 S.Ct. 1892 (May 15, 1989), vacating and remanding 664 F. Supp. 852">664 F. Supp. 852 (S.D.N.Y. 1987). In Halper, the Supreme Court examined criminal and civil sanctions and held that double jeopardy prohibits the Government541 from criminally prosecuting a defendant, imposing a criminal penalty upon him, then bringing a separate civil action based on the same conduct and receiving a civil judgment that is not rationally related to the goal of making the Government whole. United States v. Halper, supra at 1903. The civil sanction in Halper was held to be "overwhelmingly disproportionate" (more than 220 times the Government's measurable loss) to the damages caused by the defendant such that it was considered penal in nature for purposes of double jeopardy. United States v. Halper, supra at 1902. In the case before us, the civil addition is not overwhelmingly disproportionate to the damages caused by petitioner, such that the civil addition is penal in nature for purposes of double jeopardy. Thus, we conclude that the retroactive increase in additions to tax from 10 percent to 25 percent is not prohibited by the constitutional bar of ex post facto laws. In our recent decision in Starling v. Commissioner, T.C. Memo. 1989-392, we held that a taxpayer is not entitled to the preclusive effect of a prior criminal proceeding on a later civil proceeding*542 under a theory resembling double jeopardy, res judicata, or collateral estoppel because the taxpayer failed to show that he was being twice punished for the same offense. The addition to tax under section 6661 for substantial underpayment of taxes was among the civil tax additions that the taxpayer sought to bar in Starling. Accordingly, an appropriate order will be issued granting respondent's motion for judgment on the pleadings and denying petitioners' motion. Decision will be entered for the respondent. Footnotes1. All Rules references are to the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986 as in effect at the present time.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623363/	McDonnell Aircraft Corporation, a Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentMcDonnell Aircraft Corp. v. CommissionerDocket No. 22763United States Tax Court16 T.C. 189; 1951 U.S. Tax Ct. LEXIS 298; January 25, 1951, Promulgated 298 Decision will be entered under Rule 50. 1. Petitioner entered into a financing agreement with nine lending institutions to acquire funds necessary for financing its performance under war contracts with the War and Navy Departments, and under subcontracts with other prime contractors. This arrangement was made in accordance with Regulation "V" of Federal Reserve System, and was of the type commonly referred to during World War II, as a "V-Loan." Petitioner's borrowings pursuant to this arrangement were evidenced by its notes, and the Government acted as guarantor for 90 per cent of the indebtedness evidenced thereby.Held: The primary obligation to pay the principal and interest rested with petitioner, and not with the Government. Accordingly, the amounts received by petitioner under the "V-Loan" arrangement constituted borrowed invested capital within the purview of section 719, I. R. C.2. Petitioner paid $ 5,000 to Washington University toward the establishment of an aeronautical engineering course within the latter's Engineering School.Held: The payment so made is not deductible under section 23 (a) (1) (A) as a business expense of petitioner. Thomas S. McPheeters, Jr., Esq., for the petitioner.George E. Gibson, Esq., for the respondent.Jacquin D. Bierman, Esq., filed brief as amicus curiae. Van Fossan, Judge. VAN FOSSAN 189 This case involves deficiencies determined against petitioner, McDonnell Aircraft Corporation, for its fiscal years ended June 30, 1943, 1944, and 1945. The taxes involved are income taxes for fiscal years 1943 and 1944, excess profits taxes for fiscal years 1943 and 1945, and declared value excess-profits tax for the fiscal year 1943. The detail of such deficiencies follows:Declared valueExcessYear endedIncomeexcess-profitsprofitstaxtaxtax6/30/43$ 803.12$ 2,216.87$ 26,427.766/30/449,864.706/30/45293,728.32Three issues are raised by the petition. One has been300 withdrawn and the two remaining are:1. Whether the amounts received by petitioner under a financing arrangement, commonly known as a "V-Loan", constituted borrowed capital of the petitioner within section 719 of the Internal Revenue Code.190 2. Whether petitioner is entitled to a deduction under section 23 (a) (1) (A) of the Internal Revenue Code for $ 5,000 paid to Washington University during its taxable year 1944, which it claimed on its return for that year as a contribution under section 23 (q) and which has been disallowed in part because of the 5 per centum limitation contained in the latter section.FINDINGS OF FACT.The facts stipulated are so found.Petitioner, McDonnell Aircraft Corporation, was incorporated under the laws of the State of Maryland, July 6, 1939. It was licensed to do business in the State of Missouri immediately after its incorporation. Petitioner was incorporated for the purpose of designing and manufacturing aircraft and aircraft parts. It has been engaged in that business since its incorporation. Its original place of business was located at Lambert-St. Louis Municipal Airport in the County of St. Louis, Missouri. During the calendar years301 1941 through 1946, inclusive, it carried on its business of designing and manufacturing aircraft and aircraft parts in a number of locations in the City and County of St. Louis, Missouri, and in Shelby County, Tennessee. The business of petitioner from July 1, 1942, to June 30, 1946, consisted exclusively of designing and manufacturing aircraft and aircraft parts in accordance with prime contracts with the War and Navy Departments of the United States of America, and with subcontracts under prime contracts between other manufacturers and the War and Navy Departments. Certain prime contracts and subcontracts called for the manufacture by petitioner of completed aircraft and of component parts of aircraft to be completed by others. Certain of such contracts called for the design and development by petitioner of aircraft and aircraft parts (including guided missiles and self-propelled practice target aircraft) on an experimental and developmental basis.During 1942 and the early part of 1943 the petitioner financed its manufacturing and experimental operations under its prime contracts and subcontracts with the War and Navy Departments, all of which were cost-plus-fixed-fee contracts, 302 by obtaining advance payments from the War and Navy Departments or the prime contractor. These funds were advanced under the customary advance payment agreements that were in effect at that time by the Services. This form of financing required petitioner to have a separate bank account for each advance payment agreement. It also involved detailed procedures and a great amount of accounting work. Petitioner was invited to bid on certain additional work by the Government which was to be let on a fixed-price basis, but felt that to intermingle its cost-plus-fixed-fee contracts with fixed-price contracts would bring about a 191 situation which probably could not be properly administered from an accounting standpoint.Disagreements as to accounting practices in connection with certain types of war contracts arose between the General Accounting Office and the Army Air Forces auditors. The contracting officer of the Army Air Forces, assigned to the petitioner's operation, thought this disagreement would perhaps delay reimbursement of costs to petitioner. With that thought in mind, and knowing that funds had to be made available to petitioner in order for it to perform its war303 contracts with the United States, he called to the attention of Lawrence A. Smith, petitioner's vice-president, who had charge of its finances and accounting, the following provision in the War Department's procurement regulations:81.319 General -- (a) War Department policy. It is the policy of the War Department that, in general, guarantees of loans, not in excess of 90 percent of the principal amount of the loan, are to be employed rather than direct loans or participations in loans; and that likewise, guarantees of loans are, in general, to be employed in preference to advance payments. It is not intended entirely to supplant advance payments, especially where the supply service concerned concluded that the negotiation or performance of a particular contract will be facilitated by the use of advance payments.(b) Policy in connection with prime contractors. Guaranteed loans to a prime contractor are particularly preferable to advance payments to such a contractor in the following situations: (1) Where a number of supply services are involved,(2) Where the prime contractor is at the same time a subcontractor under other prime contracts,(3) Where the prime contractor has304 contracts with several branches of the government,(4) Where the prime contractor has a large number of contracts and purchase orders.In the above situations, guaranteed loans avoid the difficulties of segregation, accounting and supervision which are inherent in advance payments.(c) Policy in connection with subcontractors. Guaranteed loans to subcontractors are preferable to sub-advances even though the guarantee may exceed 90 per cent of the principal amount of the loan.Thereafter, in December 1942, Smith, on behalf of the petitioner, started negotiating with the First National Bank, Mercantile-Commerce Bank & Trust Co., and the Federal Reserve Bank (all of St. Louis, Missouri) for a financing arrangement under Regulation "V" of the Federal Reserve System, which was in accordance with the War Department policy set out above.These negotiations culminated in a financing agreement commonly known as a "V-Loan." The Bank Credit Agreement dated January 2, 1943, was executed by petitioner and the nine participating banks on or about March 24, 1943. In this agreement and the supplements thereto, the petitioner is referred to as the "Company" and the Mercantile-Commerce 192 305 Bank & Trust Company and the First National Bank in St. Louis as "Agents." The latter bank is also referred to as "Trustee." The stated purpose of the agreement was to create a line of credit in the amount of $ 6,000,000 for the purpose of financing the performance of the contracts and subcontracts (set forth in the agreement and the six supplements) which the Company had with the War and Navy Departments and other prime contractors. Under the terms of this agreement, portions of the amounts payable to the petitioner under some of these contracts were assigned as security to the First National Bank in St. Louis as agent for all of the banks and also for petitioner itself. Funds received under such assignment were to be deposited in a special account. They could be used by the petitioner to perform the contracts in question or to reduce its indebtedness to the banks.The agreement recited:1. The BANKS, each for itself and not for the others, hereby grant to the COMPANY a bank credit in the amount set opposite their respective names above, and the COMPANY hereby accepts said bank credit, which said bank credit shall be severally made and kept available for the period beginning from306 the date of this Bank Credit Agreement until December 31, 1945, or the date of the final audit by the Government of the last to be finally audited of the contracts hereinabove mentioned (whichever is earlier); provided, however, that the COMPANY, by giving thirty (30) days' written notice to the AGENTS, may terminate in whole or in part the bank credit hereby granted to it. The COMPANY covenants and agrees to pay to the BANKS, in case this bank credit be terminated in whole by the COMPANY so as to enable the COMPANY to obtain another Bank Credit Agreement, in which agreement the several BANKS are not offered the right to participate to the same extent in dollar amount as they participate in this Bank Credit Agreement, a termination fee of one-quarter of one per cent (1/4 of 1%) of the principal amount of this bank credit.It further provided that the Company should give at least five days' notice prior to the time funds were to be made available for its use; that each borrowing should be in an aggregate amount of $ 60,000 or multiple thereof; that each such borrowing should be apportioned among the participating banks, and that each should be evidenced by notes of the Company in 307 a prescribed form set forth therein. In addition it contained restrictive covenants with respect to:(a) the acquisition of its own stock by petitioner,(b) the creation of mortgages or other bias or encumbrances on petitioner's property,(c) other borrowings,(d) the maintenance of net current assets by the petitioner,(e) maintenance of insurance and payment of taxes,(f) general covenants with respect to the conduct of petitioner's business and affairs.The obligations of the bank to lend money under this agreement were conditioned upon the banks receiving, as additional protection 193 to them, Guarantee Agreements executed by the War Department acting through the Federal Reserve Bank of St. Louis. Such Guarantee Agreements were authorized by the First and Second War Powers Acts, 50 U. S. C. A., App. Sec. 601 et seq. and Executive Order No. 9112, 7 F. R. 2367, and were executed concurrent with the Bank Credit Agreement by the Federal Reserve Bank to each of the nine banks. Each Guarantee Agreement provided in substance that the War Department (Guarantor), upon demand, would purchase from each bank (financing institution) 90 per cent of the308 unpaid principal amount of the loans which it made to petitioner pursuant to the Bank Credit Agreement. 1They also gave protection to the petitioner and the participating banks against cancellation of contracts by the Government without fault by the petitioner. They further provided the right to the Department to purchase 90 per cent of the loans voluntarily at any time, 2 and contained numerous provisions with respect to administration of the loans, the disposition of collateral and similar matters. In substance and effect, the Agreements constituted 90 per cent guarantees of the loans. 309 Pursuant to the foregoing agreements the banks from time to time advanced money to the petitioner. The average daily amounts of these advances outstanding during the fiscal years of petitioner shown below were as follows:Year endedAmount6/30/43$ 981,792.166/30/445,222,622.446/30/456,000,000.006/30/464,209,729.20No demand was ever made upon the War Department that it purchase any of the loans or any part thereof under these provisions of the Guarantee Agreements. The loans were in fact paid by petitioner and were never purchased by the Government. In his notice of deficiency dated February 1, 1949, respondent disallowed these loans as representing borrowed invested capital for the purpose of determining310 petitioner's excess profits tax liability.On or about February 21, 1944, petitioner paid $ 5,000 to Washington University at St. Louis, Missouri, pursuant to the following resolution of its board of directors adopted July 14, 1943:194 RESOLVED, that the officers be and are hereby authorized to appropriate $ 5,000.00 as a contribution to Washington University Engineering School upon condition that said appropriation comes within the allowable donations of corporations for Federal income tax purposes, and further provided that Washington University is able to obtain firm commitment to cover their budget of $ 123,000.00 for the Engineering School, and further provided that an aeronautical engineering course is included in the courses of study offered by the school.Commencement of instruction in aeronautical engineering at the University was discussed orally and in correspondence by the officers of the taxpayer and the University prior to February 21, 1944. Because of wartime conditions and the draft, a limited number of engineering students were attending the school. Washington University Engineering School, beginning with its academic year 1944-1945, offered a number of courses311 in fields directly relating to and necessary for the training of aeronautical engineers. It has since maintained such courses or similar plans of study. These courses were taken by employees of McDonnell Aircraft Corporation, and over half of the students so enrolled were employees of petitioner.Additional payments were made by petitioner to Washington University for the benefit of its School of Engineering subsequent to petitioner's fiscal year 1944.During all the period involved, maintenance of a large force of trained aeronautical engineers was important in petitioner's business. Consequently, it was desirable that courses in aeronautical engineering be available in the St. Louis area, both to undergraduate students and at the graduate level for the benefit of its employees. Petitioner's officers and directors intended, at all times involved, to establish working relations with the School of Engineering, Washington University, and to assist the University in providing training in aeronautical engineering. They further intended to work out a cooperative program for the installation of wind-tunnel facilities which could be used in testing products designed and manufactured312 by petitioner.Washington University is and was at all times herein mentioned a corporation organized and operated exclusively for educational and similar purposes within the meaning of section 23 (q) of the Internal Revenue Code.In its income tax return for its fiscal year ended June 30, 1944, petitioner deducted the $ 5,000 payment to Washington University as a contribution paid. Under petitioner's computation, the total of this and other contributions deducted was within the 5 per centum limitation established by section 23 (q) of the Internal Revenue Code. After application of a loss carry-back from petitioner's fiscal year 1946, the total contributions so deducted exceeded such limitation by $ 3,505.77. This amount was disallowed as a deduction by respondent in his notice of deficiency.195 Petitioner's tax returns for the period here involved were filed with the collector of internal revenue for the first district of Missouri.OPINION.During the years involved herein petitioner was engaged in the manufacture and experimental development of aircraft and aircraft parts either under prime contracts with the War and Navy Departments or under subcontracts with other prime313 contractors. It was relatively a new corporation having been in existence only since July 6, 1939. Its capital was limited and in order to carry out its commitments additional funds were needed. Prior to the early part of 1943 the required funds were made available in the form of advance payments from the Government. At the suggestion of the Army Air Forces contracting officer assigned to petitioner's operations, negotiations were started which culminated in a financing arrangement known as a "V-Loan." This arrangement was in line with the War Department policies set forth in the Findings of Fact.This financing arrangement consisted of a "Bank Credit Agreement" and nine "Guarantee Agreements." These agreements were executed concurrently. The "Bank Credit Agreement" was made between petitioner and a group of nine lending banks. It recited that petitioner and the banks wished to create a $ 6,000,000 line of credit to enable the petitioner "to borrow money from time to time," and that the money was to be used solely to finance petitioner's performance under certain limited contracts and other contracts to be designated in subsequent supplemental agreements.The "Guarantee Agreements" 314 were executed by each of the nine lending banks and the Federal Reserve Bank of St. Louis, acting as the fiscal agent of the War Department. They provided that upon 10 days' written demand the War Department would purchase 90 per cent of petitioner's outstanding indebtedness incurred pursuant to the "Bank Credit Agreement." They also provided for voluntary purchase of the unpaid principal by the War Department.Petitioner contends that the amounts received by it under this arrangement constitute borrowed invested capital within the meaning of section 719 of the Internal Revenue Code. 3315 196 Respondent's Regulations 112, section 35.719-1 provide, in part, that:In order for any indebtedness to be included in borrowed capital it must be bona fide. It must be one incurred for business reasons and not merely to increase the excess profits credit. If indebtedness of the taxpayer is assumed by another person it ceases to be borrowed capital of the taxpayer. For such purpose an assumption of indebtedness includes the receipt of property subject to indebtedness.It has been held that the borrowed funds must be used for essential purposes of the business and they will not constitute borrowed capital if they are used for activities entirely unrelated to the taxpayer's business. Mahoney Motor Co., 15 T.C. 118">15 T. C. 118. They must be invested in the working capital of the taxpayer. They must be utilized for the earning of profits and must be subject to the risks of the business. Hart-Bartlett-Sturtevant Grain Co., 12 T.C. 760">12 T. C. 760, affd. (CA-8, May 5, 1950), 182 Fed. (2d) 153.Every formal requirement of section 719 and the regulations thereunder would appear to be met by the so-called "V-Loans" 316 made by petitioner. These loans were made directly to the petitioner. They were evidenced by its notes and they were made solely for business purposes. The funds so acquired were needed and used for working capital and were subject to the risks of the business.It is now well established, however, that strict formal compliance is not enough for an indebtedness to qualify as borrowed capital. There must be compliance in substance as well as in form. Player Realty Co., 9. T. C. 215; Brann & Stuart Co., 9 T. C. 614; Hart-Bartlett-Sturtevant Grain Co., supra.It is the respondent's position that these loans were made on the credit of the United States; that they were, in substance, an indirect method employed by the Government for making advance payments; that it was the Government upon which the banks actually placed their reliance and to which they looked as the real obligor, and that, therefore, such amounts do not qualify as borrowed capital under section 719. We are unable to agree.As a factual matter it is inaccurate to state categorically that the banks never took into consideration the credit of the petitioner. 317 The "Bank Credit Agreement" executed between petitioner and the nine lending banks contains certain specific covenants by which petitioner bound itself not to purchase or retire its own stock, create loans or other encumbrances, borrow money or dispose of any substantial portion of its assets. Affirmatively, petitioner agreed to maintain current assets, carry insurance, pay its taxes, fulfill its contracts and agreements and furnish the lenders with periodic statements of its financial condition. It was forbidden to pay dividends in excess of 197 specified amounts. These strict covenants required by the lending banks are evidence that the petitioner's credit and assets were more than incidentally involved in the loans.Furthermore, we can not agree that the arrangement was, in substance, merely an indirect method employed by the Government to make advance payments. The amounts received by petitioner were lent to it by third parties, the banks. The loans were evidenced by the notes of the taxpayer. The obligation to pay the principal and interest thereon rested primarily with petitioner. The fact that payments due petitioner under its war contracts were assigned to the318 lenders and payment was made directly to them, does not alter the character of the loans or constitute them advanced payments. Brann & Stuart Co., supra.Nor would the Government's assuming the role of guarantor of the loans change their status as borrowed capital. With the Government guarantee available to lending institutions, it was only natural that such institutions should desire it as an additional protection to them. The Government did not assume primary and direct liability for these loans made to petitioner. Until default by petitioner, the Government had no principal liability. Its liability was not only secondary to petitioner's personal liability but also to petitioner's assets pledged to secure the loan. It matters not whether, upon default, the lending institutions would look to the Government first as guarantor or to the petitioner. If the Government had been forced to fulfill its guarantee it would have been entitled to look to petitioner for reimbursement. Du Val's Estate v. Commissioner, 152 Fed. (2d) 103, certiorari denied, 328 U.S. 838">328 U.S. 838. See In re: Jamison's Estate, (Mo., 1947) 202 S. W. (2d) 879.319 Accordingly, we hold that the funds borrowed by petitioner and 90 per cent guaranteed by the Government, both in form and substance, constituted borrowed invested capital within the purview of section 719, supra.The remaining issue involves the $ 5,000 payment made by petitioner to Washington University. Couched in the terms of pertinent statutes, the issue may be stated to be whether it is barred as a deduction under section 23 (a) (1) (A), Internal Revenue Code, by section 23 (a) (1) (B). 4320 198 On or about February 21, 1944, petitioner paid $ 5,000 to Washington University pursuant to the resolution of its board of directors set out in our Findings of Fact. It is stipulated that Washington University is "a corporation organized and operated exclusively for educational and similar purposes within the meaning of section 23 (q)" 5 and it is conceded in petitioner's brief that its directors expected the payment to be treated as a contribution or gift within the purview of that section. In its return for the year ended June 30, 1944, petitioner included the $ 5,000 within its total deduction for "contributions or gifts paid." As set up by petitioner, the entire amount of the deduction claimed did not exceed the 5 per centum limitation set out in section 23 (q)supra. However, as a result of a net operating loss deduction carried back from a subsequent year and other adjustments, the respondent in his notice of deficiency reduced petitioner's net income for the fiscal year 1944 so that the total amount of the claimed deduction for contributions was no longer within the 5 per centum limitation. Accordingly, the respondent disallowed the deduction to the extent321 of $ 3,505.77.322 Petitioner claims that the $ 5,000 payment is nevertheless deductible under section 23 (a) (1) (A), supra. In support of this claim it relies on section 29.23 (a)-13 of Regulations 111 which provides, in part, that:The limitations provided in section 23 (a) (1) and this section apply only to payments which are in fact contributions or gifts to organizations described in section 23 (q). For example, payments by a street railway corporation to a local hospital (which is a charitable organization within the meaning of section 23 (q)) in consideration of a binding obligation on the part of the hospital 199 to provide hospital services and facilities for the corporation's employees are not contributions or gifts within the meaning of section 23 (q) and may be deductible under section 23 (a) if the requirements of that section are otherwise satisfied. * Respondent contends that in order for the payment to come squarely within the terms of these regulations, petitioner must now show that the $ 5,000 which was paid to Washington University, was not in fact a contribution or a gift, as claimed in its return, but was paid in consideration of a binding obligation to set up 323 an aeronautical engineering course within the latter's engineering school. He argues that the evidence fails to show that the University was, in fact, bound to do anything in exchange for the money paid to it. We agree with respondent.Until the argument that the $ 5,000 payment was deductible as a business expense was advanced here by petitioner, the payment had been considered by all to be a gift or contribution.Albeit there are some facts giving color to petitioner's present claim, we believe the weight of the evidence preponderates in favor of the respondent. The communications between the parties preceding the payment refer to it as a contribution. The resolution, pursuant to which the $ 5,000 was paid, required that the University obtain commitments for an engineering school budget and contemplated the establishment of a course of instruction in aeronautical engineering and refers to the payment as a contribution or donation. Petitioner's directors expected the payment to be treated as a contribution for the purposes of Federal taxation and so conditioned the payment. Petitioner deducted the payment as a contribution in its tax return. The correspondence between the officials324 of petitioner and the University indicates that there was a common goal in the minds of both -- the establishment of the above mentioned courses. This fact, however, proves nothing conclusively. The University could proceed with the project equally as well whether the payment was, as to petitioner, a gift or a business expense. Many, if not most, contributions to colleges are limited to support of some particular phase of activity and many are in consideration of the gifts of others. But these facts do not automatically render such contributions deductible as business expenses of the donor.Looking at all the evidence, we have concluded, and accordingly hold, that petitioner is not entitled to deduct its $ 5,000 payment to Washington University as a business expense within the purview of section 23 (a) (1) (A), supra.Decision will be entered under Rule 50. Footnotes1. Within ten (10) days after the receipt by the Reserve Bank of written demand made by the Financing Institution, Guarantor will purchase from the Financing Institution for cash and subject to the terms and conditions herein stated, 90 per cent of the then unpaid principal amount of a loan which the Financing Institution proposes to make to McDonnell Aircraft Corporation, Robertson, Missouri, (herein called 'Borrower'), * ↩2. The Guarantor, at any time subsequent to ninety (90) days after the date of the original advance on the loan and after giving ten (10) days' notice in writing to the Financing Institution, may purchase, and the Financing Institution shall sell to it, the entire unpaid principal amount of said loan.↩3. SEC. 719. BORROWED INVESTED CAPITAL.(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following: (1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, * ** * * (b) Borrowed Invested Capital. -- The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day.↩4. 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, * .(B) Corporate Charitable Contributions. -- No deduction shall be allowable under subparagraph (A) to a corporation for any contribution or gift which would be allowable as a deduction under subsection (q) were it not for the 5 per centum limitation therein contained and for the requirement therein that payment must be made within the taxable year.↩5. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions: * * (q) Charitable and Other Contributions by Corporations. In the case of a corporation, contributions or gifts payment of which is made within the taxable year to or for the use of: * * (2) A corporation, trust, or community chest, fund, or foundation, created or organized in the United States or in any possession thereof or under the law of the United States, or of any State or Territory, or of the District of Columbia, or of any possession of the United States, organized and operated exclusively for religious, charitable, scientific, veteran rehabilitation service, literary, or educational purposes or for the prevention of cruelty to children (but in the case of contributions or gifts to a trust, chest, fund, or foundation, payment of which is made within a taxable year beginning after December 31, 1948 only if such contributions or gifts are to be used within the United States or any of its possessions exclusively for such purposes), no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation. * ** * * to an amount which does not exceed 5 per centum of the taxpayer's net income as computed without the benefits of this subsection. Such contributions or gifts shall be allowable as deductions only if verified under rules and regulations prescribed by the Commissioner, with the approval of the Secretary. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623364/	Pumi-Blok Company, et al. 1 v. Commissioner. Pumi-Blok Co. v. CommissionerDocket Nos. 637-68, 638-68, 639-68.United States Tax CourtT.C. Memo 1972-48; 1972 Tax Ct. Memo LEXIS 203; 31 T.C.M. (CCH) 197; T.C.M. (RIA) 72048; February 24, 1972, Filed John W. Nelson, Suite 507 United California Bank Bldg., 200 Pine Ave., Long Beach, Calif., for the petitioners. Melvern Stein, for the respondent. RAUMMemorandum Findings of Fact and Opinion The Commissioner determined deficiencies in income tax as follows: Dkt. No.PetitionersYear EndingDeficiency637-68Pumi-Blok CompanyMar. 31, 1964$ 3,913.36Mar. 31, 196518,908.31638-68Peter G. and Mary M. MuthDec. 31, 19644,198.00Dec. 31, 19655,226.00639-68Arvid T. and Clara JohnsonDec. 31, 19644,370.00Dec. 31, 19655,285.00 The204 issues for decision are: (1) whether Pumi-Blok Company was entitled to deductions in its taxable years ending March 31, 1964, and March 31, 1965, in the amounts of $7,527.20 and $39,062.02, as bad debts, or alternatively as losses, and (2) whether certain payments made by Pumi-Blok Company in 1964 and 1965 in the amounts of $17,000 and $25,480, respectively, to a partnership composed of Arvid T. Johnson and Peter G. Muth constituted dividends. Findings of Fact The parties have stipulated certain facts, which, together with the attached exhibits, are incorporated herein by this reference. Petitioner in Docket No. 637-68 is Pumi-Blok Company. During the years in issue it was a California corporation. It filed its Federal corporate income tax returns for the taxable years ending March 31, 1964, and March 31, 1965, with the district director of internal revenue at Los Angeles, California. At the time its petition was filed herein Pumi-Blok Company's principal place of business was at Stanton, California. Petitioners in Docket No. 638-68 are Peter G. and Mary M. Muth. They are husband and wife. The Muths filed joint Federal income tax returns for the calendar years 1964 and 1965205 with the district 198 director of internal revenue at Los Angeles, California, and resided in Santa Ana, California, at the time of the filing of their petition herein. Petitioners in Docket No. 639-68 are the Estate of Arvid T. Johnson and Clara Johnson, Arvid's wife. Arvid T. and Clara Johnson filed joint Federal income tax returns for the calendar years 1964 and 1965 also with the district director of internal revenue at Los Angeles, California, and resided in Anaheim, California, at the time of the filing of their petition herein. Arvid T. Johnson died on November 11, 1970, after the filing of the petition, and the Bank of America National Trust and Savings Association, Santa Ana, has been duly appointed executor of his will, and has been substituted as a party petitioner in Docket No. 639-68 herein. Since 1946, Pumi-Blok Company ("Pumi-Blok" or the "corporation") has been in the business of manufacturing lightweight building blocks at its plant in Stantion, California, situated in Orange County. During the 1950's the corporation was one of several manufacturers of building blocks in the Southern California area which dominated the market. The building blocks manufactured206 by Pumi-Blok were marketed through a sister corporation, Orco Block Company, which was not involved in the transactions here in issue. Pumi-Blok first operated as a partnership. In 1948 it was incorporated, and at all times here relevant the stock of the corporation was owned equally and wholly by Arvid T. Johnson ("Johnson"), Peter G. Muth ("Muth") and their respective wives. Also at all pertinent times both Mr. and Mrs. Muth and Mr. and Mrs. Johnson were the directors of the corporation. Besides their interests in Pumi-Blok, Arvid T. Johnson and Peter G. Muth were also partners engaged in the business of owning and renting real property in Southern California. Each owned a 50 percent interest in the partnership which was known as Johnson and Muth (hereinafter the "Johnson and Muth partnership" or the "partnership"). The partnership did not have an office of its own, and Pumi-Blok's bookkeeper kept the books of the partnership along with Muth who did some of the work at his home. In addition, at least part of the land upon which the corporation conducted its business of building block manufacture was leased from the partnership. During the years in issue the Johnson and Muth partnership207 was not in the business of financing business ventures. For approximately the first one and a half years of its operation Pumi-Blok used pumice as the base material in the composition of its building blocks. Pumice is a soft, volcanic material with "slow acting" properties. Building blocks made from this substance were prone to crack approximately six months after being used in wall construction, and for this reason the building block industry found pumice to be an unsuitable base material. Accordingly, from the late 1940's until around 1966, Pumi-Blok and other members of the industry constructed building blocks from natural cinder. Sometime around 1955 building blocks composed of expanded shale aggregate were brought into market by two other building block manufacturers. Expanded shale was made from raw shale, a natural substance. The raw shale was extracted from the ground, "pre-sized" in its dry state, and then expanded to the desired size for production of building blocks by heating in a rotary kiln at approximately 2,100 degrees. Rocklite Company ("Rocklite") and Ridgelite Company (Ridgelite") had developed sources of supply of shale and were actively involved in the production208 of expanded shale. Building blocks produced from expanded shale were of lower weight but greater strength and insulation value than those composed of natural cinder. Because of these features such expanded shale building blocks enjoyed a superior market position. Pumi-Blok attempted to purchase expanded shale from both Rocklite and Ridgelite, but neither company would sell the product to the corporation. Rocklite was itself involved in the production of building blocks in competition with Pumi-Blok. Ridgelite was wholly owned by another building block manufacturer, Chamco Building Block Company, and sold the product solely to its parent company. Because of the competitive superiority of expanded shale building blocks, Pumi-Blok's position in the market place began to deteriorate. Accordingly, in addition to its attempts to purchase expanded shale from Rocklite and Ridgelite, the corporation also made other efforts to obtain expanded shale aggregate. At one point Pumi-Blok agreed to make a prepayment of $25,000 for expanded shale aggregate 199 to Paul Splein ("Splein") from whom the corporation purchased natural cinder. Such payment was intended to promote Splein's formation209 of a new company to produce expanded shale, but the new company never came into being. In 1956 Pumi-Blok was contacted by a Mr. Chaffee ("Chaffee"), the president of O'Kelly-Eccles Company, another of the prominant building block manufacturers in the Southern California area. Chaffee had located a deposit of natural shale and interested both Pumi-Blok and another building block company, Elliott Precision Block Company, in the formation of a new corporation to manufacture expanded shale aggregate. The minutes of the board of directors meeting of Pumi-Blok on September 14, 1956, reported the following proposals in respect of the expanded shale production proposed by Chaffee: It was moved by Peter Muth and seconded by Clara Johnson that a new corporation be formed which would be known under the name - Southern California Lightweight Aggregate Co. - and that the Pumi Blok Co. would purchase one fourth interest at a cost of $25,000.00 as a stock purchase, and [the] Johnson & Muth [partnership] would put up an additional $62,500.00 maximum when needed, which would be guaranteed by Pumi Blok Co. This sum, $62,500.00 would be loaned to the Southern California Lightweight Aggregate210 Co. Since the Pumi Blok Co. cannot raise this $62,500.00, the Johnson and Muth combine would do so, and the Pumi-Blok Co. at it's [sic] earliest opportunity will take over the loans of the Johnson & Muth [partnership]. Sometime in 1956 or 1957, Southern California Lightweight Aggregate Company was incorporated by Pumi-Blok, O'Kelly-Eccles Company and Elliott Precision Block Company. The new corporation's name was subsequently changed to Shale-Lite Corporation, and the name "Shale-Lite" will be used hereinafter. The purpose of forming Shale-Lite was to acquire a source of supply of expanded shale aggregate for Shale-Lite's incorporators which would afford them a competitive base material for building block manufacture. The three incorporating Shale-Lite stockholders did not anticipate any immediate profit from the venture; their principal purpose was merely to obtain a source of inexpensive expanded shale aggregate for themselves. Initially, 85-90 percent of the aggregate produced by Shale-Lite was sold to its three stockholders, as explained hereinafter. Nonetheless, it was contemplated that sales of expanded shale would be made to other purchasers if the venture ever proved211 successful. On September 10, 1957, Pumi-Blok acquired 2,500 shares of $10 par value Shale-Lite stock, representing paid-in capital of $25,000. The record does not adequately disclose what percentage of Shale-Lite's capital stock was purchased by Pumi-Blok at the time. In the initial years of Shale-Lite's existence, it was necessary for its shareholders to make several advances to it for the purchase of land and equipment and in respect of certain construction costs. During this period Shale-Lite was unable to obtain financing from any other source. It was anticipated that the advances from its shareholders would be repaid by Shale-Lite out of its earnings from sales of expanded shale aggregate to the three shareholder-block manufacturers. Pumi-Blok itself, however, experienced difficulties in maintaining adequate working capital. Accordingly, a plan was devised whereby the Johnson and Muth partnership advanced funds to Shale-Lite on behalf of Pumi-Blok and received in return Pumi-Blok notes evidencing the corporation's indebtedness to the partnership for the advances made on the corporation's behalf. Pumi-Blok itself received Shale-Lite notes in respect of the advances. In effect, 212 the partnership lent the funds to the corporation which in turn made advances to Shale-Lite also in the form of loans, as explained hereinafter. Johnson and Muth maintained at least two accounts at the Bank of America from which it made disbursements. One of these accounts was a general account in the name of the partnership. The other was a special account set up specifically to make advances to Shale-Lite in the name of Pumi-Blok and was referred to in the partnership's books and records as the Bank of America Construction Account. The bank requested that this special account be set up independently of the general partnership account to prevent amounts lent by the bank to the Johnson and Muth partnership for the Shale-Lite advances from being commingled with general partnership funds. The partnership's disbursement journal disclosed that in 1957 advances to Shale-Lite were made in the amount of $33,500 200 from the Bank of America Construction Account. In respect of these advances, Pumi-Blok issued its own notes to the Johnson and Muth partnership on May 8, 1957, and April 15, 1957, in the respective amounts of $20,000 and $13,500. In addition to the above advances of $33,500, 213 the Johnson and Muth partnership advanced $12,500 to Shale-Lite on December 10, 1957, from its general partnership account at the Bank of America. Also on December 10, 1957, Pumi-Blok issued its note to the partnership in the amount of $12,500 in respect of this advance, and the Pumi-Blok loan account on Shale-Lite's books and records was credited in the same amount on December 30, 1957. On January 22, 1958, Johnson and Muth advanced $43,000 to Shale-Lite from its general partnership account and an additional $1,000 from its Bank of America Construction Account. In respect of these two advances, Pumi-Blok issued two notes to the partnership in the amounts of $43,000 and $1,000, respectively, on January 27, 1958. The obligation in the amount of $43,000 was subsequently discharged. In addition to the above notes issued by Pumi-Blok to the partnership in respect of advances made to Shale-Lite, the corporation also issued a note to the Johnson and Muth partnership in the amount of $40,000 on December 15, 1959, for advances made to Shale-Lite. The contributions which its stockholders designated as loans to Shale-Lite were made in direct proportion to their shareholdings. Shale-Lite's214 account on its general ledger entitled "Loans From Incorporators" disclosed that as of October 31, 1959, total advances made by Pumi-Blok amounted to $111,767.52. In respect of these advances Pumi-Blok's account on its general journal and ledger entitled "Notes Receivable - Shale-Lite Corp." similarly showed a debit balance as of June 30, 1960, of $111,767.52. Although the record establishes that Shale-Lite notes in respect of the advances made by Pumi-Blok were extant during the years in issue, no formal notes evidencing the indebtedness on Shale-Lite's part were introduced into evidence, and the record does not disclose the terms of such notes. Shale-Lite's general ledger also disclosed that interest was accrued on what was designated as indebtedness owing to its shareholders in respect of the advances described above, and that payments were periodically made in respect of such interest until January 31, 1960. After January 31, 1960, no payments were made on the accrued interest because of certain financial reverses experienced by Shale-Lite, as explaine hereinafter. On July 31, 1960, Pumi-Blok acquired an additional 1,952 shares of $10 par value Shale-Lite stock, in respect215 of which the Shale-Lite account "Loans From Incorporators" was debited in the amount of $19,520; also, the Pumi-Blok account designated "Notes Receivable - Shale-Lite Corp." was credited in the amount of $19,520. As of July 31, 1960, the outstanding shares of Shale-Lite stock were owned as follows: Pumi-Blok Company4,452 shares32.02%Elliott Precision Block Company4,452 shares32.02%O'Kelly-Eccles Company 5,000 shares35.96%13,904 shares100%As a consequence of the above transaction involving the purchase of the additional 1,952 shares of Shale-Lite stock by Pumi-Blok, Pumi-Blok's "Notes Receivable - Shale-Lite Corp." account revealed a debit balance of $92,247.52 as of March 31, 1961, and the Shale-Lite account in respect of "Loans From Incorporators" disclosed a credit balance also of $92,247.52. Also, as of March 31, 1961, Pumi-Blok's account for "Investments - Shale-Lite Corp." reflected a debit balance of $44,520. The total of the amount carried as an investment on Pumi-Blok's books and records ($44,520) and the amount carried as loans to Shale-Lite ($92,247.52) was $136,767.52, and this amount represented the total unrepaid advances made216 by or on behalf of the corporation to Shale-Lite during the years in issue. Pumi-Blok's account entitled "Notes Payable - Johnson & Muth" disclosed a credit balance of $99,857.93 as of May 31, 1961, which included the five amounts aggregating $87,000 referred to hereinabove as the indebtedness incurred by Pumi-Blok in respect of advances made to Shale-Lite by the Johnson and Muth partnership on behalf of Pumi-Blok. These amounts (as found hereinabove) were as follows: May 8, 1957$20,000September 15, 195713,500December 10, 195712,500January 27, 19581,000December 15, 1959 40,000$87,000 201 Shale-Lite started to produce expanded shale aggregate around April 1, 1958. As explained above, 85 to 90 percent of the expanded shale aggregate was sold to its three shareholders, Pumi-Blok, Elliott Precision Block Company and O'Kelly-Eccles Company. The remaining 10-15 percent was sold to two or three small manufacturers of building blocks. Sometime in early 1960 and about the time that the Shale-Lite operation began to show some success, Shale-Lite experienced certain difficulties in respect of its production of expanded shale aggregate. The raw shale217 from which Shale-Lite manufactured its products revealed deposits of lime. Such so-called "hot lime" caused "pop-outs" or fissures in the building blocks. The presence of "hot lime" in the raw shale meant that Shale-Lite could not produce expanded shale aggregate that was suitable for manufacturing building blocks. Over a period of time not disclosed by the record, Shale-Lite made several attempts to remedy the "hot lime" problem but was unable to find an adequate solution. Sometime in early 1961 Pumi-Blok was informed by the Bank of America, which also made loans to the corporation, that in view of Pumi-Blok's financial situation the bank could not lend Pumi-Blok additional funds. The bank took a "dim view" of the Shale-Lite venture and suggested that Pumi-Blok's credit position would be improved if the corporation transfered certain assets it held in Shale-Lite to the Johnson and Muth partnership. In this respect the minutes of the board of directors meeting of Pumi-Blok for April 18, 1961, reported as follows: Under new business it was moved and seconded to transfer enough Shale-Lite notes to Johnson and Muth to cover the following notes owed by Pumi-Blok Co. to Johnson and218 Muth: Note dated May 8, 1957$20,000.00Note dated Sept. 15, 195713,500.00Note dated Dec. 10, 195712,500.00Note dated Jan. 27, 19581,000.00Note dated Dec. 15, 1959 40,000.00Total$87,000.00 This will retire the loan by Johnson and Muth to Pumi Blok Co. for the Shale-Lite Investment. The Pumi-Blok Co. also guarantees and agrees to make these notes good to Johnson and Muth if for some unknown reason Shale-Lite Corp. does not fulfill their obligations. It was moved and seconded by Pete Muth and Clara Johnson to notify the Shale-Lite Corp. to transfer stock certificate No. 4 and Stock certificate No. 5 covering 4452 shares of stock to Arvid T. Johnson and Peter G. Muth as tenents in common. This stock will secure the Shale-Lite notes transferred to Johnson and Muth to cover loan. Although the April 18, 1961 minutes reported that the transfer of the 4,452 shares of Shale-Lite stock to the Johnson and Muth partnership was meant only to "secure" the Shale-Lite notes to be transfered at the same time to the partnership, and that "enough Shale-Lite notes" were to be transferred to discharge the $87,000 in Pumi-Blok notes held by the partnership, the219 exchange was entered on Pumi-Blok's general journal and ledger on May 31, 1961, as follows: Acct.No.ChargesDescriptionCredit2060$87,000Stock Certificate #4 for$44,5202500 shares ShaleliteStock, stock certificate#5 for 1952 shares Shale-lite Stock was trans-ferred to Johnson andMuth to cover notesowed by Pumi Blok Co.to Johnson & MuthTo transfer enough42,480Shalelite notes to John-son & Muth to retire thebalance of notes owedby Pumi Blok to John-son & Muth As a result of the transfer Pumi-Blok's account for "Notes Receivable - Shale-Lite Corp." was credited in the amount of $42,480 and thereby reduced from a balance of $92,247.52 to $49,767.52 as of May 31, 1961. Also, an entry to the corporation's "Investments - Shale-Lite Corp." account was made crediting that account in the amount of $44,520 in respect of the stock transfer, thereby leaving a remaining balance of zero as of May 31, 1961. In respect of the five notes issued by Pumi-Blok to the partnership, Pumi-Blok's account "Notes Payable - Johnson & Muth" was debited in the total amount of $87,000. 220 The Johnson and Muth partnership's general ledger reflected the transfer of the Shale-Lite stock and notes in cancellation of the Pumi-Blok notes as follows: Acct.1961DescriptionNo.ChargesCredit5/31Investment - Shale-LiteCorp.125$44,520Notes Receivable -Pumi Blok Co.120$44,520To credit 4452 sharesof Stock Certificate No.7 received from PumiBlok Co. to apply onnote in the sum of$44,520.00 202 Acct.1961DescriptionNo.ChargesCredit5/31Notes Receivable -Shale-Lite Corp.120$42,480Notes Receivable -Pumi Blok Co.120$42,480Shale-Lite notes re-ceived from Pumi BlokCo. to retire note owedby Pumi Blok Co. As of May 31, 1961, the partnership's general ledger account for "Notes Receivable" disclosed a debit balance of $42,480 in Shale-Lite notes, and its account for "Investment - Shale-Lite Corp." stated a debit balance of $44,520. Because of the difficulties Shale-Lite was experiencing in respect of the presence of the "hot lime" in its shale deposit, the Shale-Lite stock and notes transferred to the Johnson221 and Muth partnership by Pumi-Blok were worth less than their face value. At the time of the transfer in 1961, the stock had a minimal value, and the notes were worth only approximately 15 cents on the dollar. The notes, however, were guaranteed by Pumi-Blok as mentioned in the minutes of the corporation's board of directors meeting of April 18, 1961. Ultimately, as a result of its difficulties with the "hot lime" deposits, Shale-Lite ceased active operations in September, 1962. Accordingly, pursuant to the guarantee of the Shale-Lite notes the partnership transferred the Shale-Lite notes back to Pumi-Blok. In this respect the minutes of Pumi-Blok's board of directors meeting of February 19, 1963, reported as follows: In our minutes of April, 1961, the notes were sold in affect to Johnson and Muth in order that the financial statement of Pumi-Blok would have a better financial appearance so that the company could borrow money from the bank. At that time the Pumi-Blok Co. guaranteed these notes and agreed to make them good if the Shale-Lite Corp. could not fulfill their obligation. At this time, it is definitely known that the Shale-Lite Corp. have ceased active business in September222 1962, and has no chance of continuing or re-entering the lightweight aggregate field. Consequently it is now necessary according to the guarantee, to return the notes to the Pumi-Blok Co. since it has been well established that the Shale-Lite Corp's finances are in bad shape. Since there is a possibility of a sale of the physical assets, not necessarily a probability, but a possibility, that it would be well to take action on these notes at this time for the corporate year end. The minutes did not refer to the Shale-Lite stock transferred by Pumi-Blok to the Johnson and Muth partnership simultaneously with the notes as explained hereinabove. To reflect the transfer of the Shale-Lite notes from the partnership back to Pumi-Blok, Pumi-Blok's account for "Notes Receivable -shale-Lite Corp." was debited in the amount of $42,480 by a journal entry dated February 28, 1963. Moreover, in respect of the guarantee a new subaccount under "Notes Payable - Others", entitled "Johnson & Muth (Shale-Lite)", was set up on Pumi-Blok's general journal and ledger on February 28, 1963, reflecting a credit balance of $42,480. Pumi-Blok's general journal and ledger also disclosed the following entry223 on February 28, 1963: Gen-Gen-Acct.eralDescriptionAcct.eralNo.Ledger Dayof EntryNo.Ledger1201$42,480 28To reverse J E 2142060$42,480These shares werenot turned over toJohnson & Muth toretire note "JE 214" referred to the page in the general journal and ledger where the transfer of the Shale-Lite stock to the partnership was recorded. The record does not adequately explain the nature of this entry inasmuch as the shares transferred on "J E 214" were treated as having a value of $44,520, and the Shale-Lite stock transferred by Pumi-Blok to the Johnson and Muth partnership was never returned to the corporation, as explained hereinafter. After Shale-Lite ceased its operations in 1962 several efforts were made to "sell the corporation". Advertisements were placed through the Expanded Shale Institute and at one point Riverside Cement Company Shale-Lite. But the option was not Shale-Lite offered for sale the Johnson exercised and the $12,500 was forfeited at the end of the year. During this period when Shale-Lite offered for sale the Johnson and Muth partnership made certain advances to Shale-Lite224 on its own for which no corresponding entries were made on Pumi-Blok's general journal and ledger as was the case with the prior advances totaling $87,000 here in issue. The last such advance was in the amount of $30,500, and was apparently made in order to allow Shale-Lite to pay off its creditors and thereby stave off insolvency proceedings. 203 This advance of $30,500 was secured by a first trust deed on certain land owned by Shale-Lite. On December 2, 1964, Pacific Vegetable Oil Corporation entered into an option agreeement with Arvid T. Johnson and Peter G. Muth, individually, and Elliott Precision Block Company and O'Kelly-Eccles Company for the sale of all the stock and notes of Shale-Lite. The option agreement provided in part as follows: RECITALS: A. Elliott Precision Block Company owns 4452 shares, O'Kelly-Eccles Company owns 5000 shares, Arvid T. Johnson and Peter G. Muth, a tenants in common, own 4452 shares of the $10 par value common stock of Shale-Lite Corporation, a California corporation, hereinafter referred to as "Shale-Lite", (hereinafter collectively referred to as the "shares") constituting all of the outstanding shares of said corporation, all of225 which shares are held in escrow pursuant to the conditions of the Permit authorizing their issuance. B. Sellers own notes of Shale-Lite (hereinafter referred to as the "notes") in the amount set opposite their respective names in Exhibit "A" hereto. * * * AGREEMENT: * * * 4. Purchase Price: The total purchase price which Buyer agrees to pay in the event of exercise of the option and which Sellers agree to accept is $185,265.80, $10 for each of said shares ($139,040) and $46,225.80 for the notes. * * * 7. Warranties and Representations of Sellers: Sellers warrant, represent and agree to and with Buyer as follows: (a) Sellers have authority to enter and grant the option herein given and each of them, respectively, have full, complete and absolute title to the shares and the notes. (b) The title of Sellers to said shares and notes is, and will be, at the time of delivery to Buyer, free and clear of any liens, charges, or encumbrances, except the aforesaid escrow conditions, and said 13,904 shares constiute all of the outstanding capital stock of Shale-Lite, and that by sale of said shares and notes hereunder, Buyer will receive good and absolute title thereto, free from any226 liens, charges or encumbrances thereon; * * (i) All accrued interest on any amount owed by Shale-Lite to Sellers shall be forgiven, discharged and released, by Sellers, as soon after exercise of the option, as possible, but in any event, prior to the closing date, and it is agreed that neither Shale-Lite nor Buyer shall have any further responsibility therefor after said date. * * * PROMISSORY NOTES OWNED BY STOCKHOLDERS 13 (Exclusive of Current Liabilities Dis- closed on Exhibit "B")O'Kelley-Eccles Company[sic]$103,539.39Arvid T. Johnson and Peter G. Muth92,247.52Elliott Precision Block Company 92,209.69 $287,996.60 The option agreement also included an interim balance sheet for Shale-Lite as of October 31, 1964, which disclosed total assets in the amount of $309,601.04, and notes payable to shareholders of $287,996.60. At the time the option agreement was entered into with Pacific Vegetable Oil Corporation, Johnson and Muth called two errors in the agreement to the attention of an attorney involved in the transaction. One such error was in respect of the recital in Exhibit "A" to the option agreement that Johnson and Muth, rather than227 Pumi-Blok, held $92,247.52 in Shale-Lite notes. The other error related to their understanding that the Shale-Lite stock which the partnership had originally received in 1961 was to be transferred back to Pumi-Blok prior to the sale of Shale-Lite stock and notes. They were advised in effect not to jeopardize the consummation of the sale by pressing the matter, to allow the sale to go through, and then to allocate the amounts received by them between the partnership and Pumi-Blok according to their understanding. In fact, the partnership had transferred all the Shale-Lite notes it had previously received back to Pumi-Blok prior to the execution of the option agreement, but it had not returned the Shale-Lite stock. The sale of the Shale-Lite stock and notes was concluded on March 29, 1965, and the partnership received $59,321.50, or 32.02 percent of the purchase price, in accordance with the provisions of the option agreement of December 2, 1964. Pursuant to the allocation of the purchase price in paragraph four of the option agreement $44,520 was in respect of the 4,452 shares of Shale-Lite stock still held by the partnership. The remaining $14,801.50 was in respect of the portion228 of Shale-Lite's 204 outstanding notes which were described in the option agreement as held by the Johnson and Muth partnership. The partnership retained the $44,520 paid for the stock held by it. The $14,801.50 in respect of the notes was turned over to Pumi-Blok. Prior to the purchase of Shale-Lite stock and notes by Pacific Vegetable Oil Corporation and on December 31, 1964, and January 26, 1965, Pumi-Blok made payments of $17,000 and $25,480, respectively, to the Johnson and Muth partnership in connection with the corporation's guarantee of the Shale-Lite notes originally transferred to the partnership in 1961. These amounts ($17,000 and $25,480) taken together with the $44,520 received by the partnership from the sale of the Shale-Lite stock to Pacific Vegetable Oil Corporation totaled $87,000, the same amount as the Pumi-Blok indebtedness to the partnership which was cancelled in exchange for the Shale-Lite stock and notes. A net total of $136,767.52 was originally contributed to the Shale-Lite venture by Pumi-Blok or on its behalf by the Johnson and Muth partnership (as found hereinabove). Of this amount $44,520 was in respect of the Shale-Lite stock transferred to the229 Johnson and Muth partnership on May 31, 1961, for which indebtedness in that amount owing by Pumi-Blok to the partnership was discharged. In respect to the remaining $92,247.52, which was carried on the corporation's books and records as "Notes Receivable - Shale-Lite Corp.", $14,801.50 was discharged by the payment, described above, which the partnership made to the corporation as a consequence of the sale of the Shale-Lite stock and notes to Pacific Vegetable Oil Corporation. The remaining amount ($77,446.02) was reflected in bad debt write-offs on Pumi-Blok's general journal and ledger for which it claimed deductions on its corporate tax returns in the years and amounts as follows: Bad-DebtYear EndingDeductionMarch 31, 1963$30,856.80March 31, 19647,527.20March 31, 1965 39,062.02Total$77,446.02In his deficiency notice to Pumi-Blok the Commissioner determined that the corporation was not entitled to the bad debt deductions claimed in the amounts of $7,527.20 and $39,062.02 in its taxable years ending March 31, 1964, and March 31, 1965, respectively. In his deficiency notices to the individual petitioners herein the Commissioner determined230 that the payments of $17,000 and $25,480 made by Pumi-Blok to the Johnson and Muth partnership in 1964 and 1965, respectively, represented "dividend income". The Commissioner therefore included in each partner's income for 1964 his distributive share (1/2) of the $17,000. The Commissioner likewise included in each partner's income for 1965 their distributive share of the $25,480. The Commissioner also determined that the Johnson and Muth partnership incurred a net capital loss in 1965 from the sale of the Shale-Lite notes and stock to the Pacific Vegetable Oil Corporation, as follows: Sale of notes and stock - basis$87,000.00Amount received 59,321.50Capital loss$27,678.50One-half to each partner13,839.25It is further determined that your distributive share of said capital loss was $13,839.25. Your net capital loss deduction and adjustment to income, as above, is computed as follows:Capital loss allowable (limitation)$ 1,000.00Capital loss per return NoneDecrease in income$ 1,000.00Opinion RAUM, Judge: The issues for decision are: (1) whether Pumi-Blok was entitled to deductions either as bad debts or as losses in respect of portions231 of the $87,000 advanced to Shale-Lite, 2 and (2) whether the payments made by Pumi-Blok to the Johnson and Muth partnership in 1964 and 1965 in the amounts of $17,000 and $25,480, respectively, constituted dividends to the partners. We deal first with the deduction issue in respect of the corporate petitioner. 1. The deduction issue. (a) We consider preliminarily the Commissioner's contention that Pumi-Blok did not own the Shale-Lite notes, in respect of which the deductions in issue were claimed, at the time of the sale to Pacific Vegetable Oil Corporation. In this connection the Commissioner has directed our attention to the 205 December 2, 1964, option agreement232 with Pacific Vegetable Oil Corporation to which both Johnson and Muth were parties. The agreement contained recitals and warranties that the Johnson and Muth partnership held "full, complete and absolute title" to both the Shale-Lite stock and notes. The Commissioner, relying upon Commissioner v. Danielson, 378 F. 2d 771, 775 (C.A. 3), certiorari denied, 389 U.S. 858">389 U.S. 858, argues that Pumi-Blok should not be allowed to contradict this language in the option agreement. The Danielson case represents the rule followed in the Third Circuit. However, a less extreme rule has been approved elsewhere to the effect that if a taxpayer presents "strong proof", he may take a position contrary to the language in the pertinent agreement. Ullman v. Commissioner, 264 F.2d 305">264 F. 2d 305, 308 (C.A. 2), affirming 29 T.C. 129">29 T.C. 129. This Court has adhered to the "strong proof" rule, J. Leonard Schmitz, 51 T.C. 306">51 T.C. 306, 315-318, on appeal (C.A. 9, Mar. 18, 1969), which had also been approved by the Ninth Circuit in Schulz v. Commissioner, 294 F.2d 52">294 F. 2d 52, 55,233 affirming 34 T.C. 235">34 T.C. 235. And while we have indicated in Meyer Mittleman, 56 T.C. 171">56 T.C. 171, 175, that we will follow Danielson in cases arising in the Third Circuit under the compulsion of Jack E. Golsen, 54 T.C. 742">54 T.C. 742, affirmed 445 F. 2d 985 (C.A. 10), certiorari denied, - U.S. -, we are nevertheless free to apply the "strong proof" rule elsewhere. The present case arises in the Ninth Circuit which has explicitly approved the "strong proof" rule of the Ullman case, and we hold that it is applicable here rather than the Danielson rule. Moreover, the Danielson case involved the allocation of a purchase price upon the sale of a business between a covenant not to compete and other assets, and there is substantial doubt as to the extent to which that case may be regarded as controlling in other types of situations. See $ Edith M. Gerlach, 55 T.C. 156">55 T.C. 156, 168-169. While it is true that the option agreement contained not only recitals that the notes were held by the Johnson and Muth partnership but also warranties to that effect, the record calls for a contrary finding. The evidence before us convincingly establishes that these provisions234 of the option agreement were in error, that Muth called the error to the attention of an attorney who participated in the transaction, but was advised to let the agreement go through as it was rather than to jeopardize the consummation of the sale, and then to allocate the proceeds of the sale between the partnership and Pumi-Blok. Furthermore, the books and records of both the partnership and corporation reflect that the only Shale-Lite notes transferred by Pumi-Blok to the Johnson and Muth partnership were in the face amount of $42,480, and that these notes were transferred on May 31, 1961. Moreover, these same books and records show that such $42,480 in Shale-Lite notes were transferred by the partnership back to the corporation on February 28, 1963, prior to the December 2, 1964 option agreement. Even more significant is that as a consequence of the sale of the Shale-Lite stock and notes to Pacific Vegetable Oil Corporation, the partnership paid $14,801.50 to Pumi-Blok in respect of the notes. In these circumstances, we think the petitioners have presented "strong proof" that the December 2, 1964, option agreement wrongly represented that the Shale-Lite notes were held by the235 partnership and not Pumi-Blok, and have so found in our Findings of Fact. (b) As we view the record Pumi-Blok participated in the formation of Shale-Lite in order to obtain a necessary source of supply of expanded shale aggregate which it required to retain its competitive position in the market. Unable itself to advance all the funds needed by Shale-Lite for starting-up costs, a plan was devised whereby the Johnson and Muth partnership made net advances in the aggregate amount of $87,000 to Shale-Lite on behalf of Pumi-Blok. The alleged indebtedness for these advances was carried on Shale-Lite's general ledger as owing to Pumi-Blok, and notes were issued in respect thereof. Pumi-Blok, in turn, issued its own notes to the partnership in the aggregate amount of $87,000 and thereby became indebted to the partnership in that amount. Although Johnson and Muth were individually interested in both the corporation and the partnership, Pumi-Blok and the Johnson and Muth partnership functioned as separate business entities in distinct fields prior to the inception of the Shale-Lite venture. We see no reason on the record before us to disregard these separate entities. Cf. Sam Siegel, 45 T.C. 566">45 T.C. 566, 575-577.236 The books and records of the corporation, the partnership and Shale-Lite 206 clearly reflect that the advances in question were regarded as coming from Pumi-Blok which had a direct interest in the success of the venture. The minutes of Pumi-Blok's September 14, 1956, board of directors meeting make it clear that such advances as were made by the partnership in the first instance were to be assumed at the "earliest opportunity" by Pumi-Blok. And, in fact, as indicated above, Pumi-Blok issued its own notes to the partnership and assumed the risks associated with the Shale-Lite venture by itself taking the Shale-Lite notes. In this respect it is also significant that the only other advances made to Shale-Lite during this period were similarly from its other two shareholders, which were also building block manufacturers. In the circumstances, we think the characterization of the advances as "loans" or "capital contributions" is not in itself controling for the purposes of this case. We agree with the Commissioner that although the advances in question were cast in the form of "loans", they nonetheless represented equitable interests in or "capital contributions" to Shale-Lite on237 behalf of its shareholders, rather than loans which could form the basis for a bad debt deduction.3 Accordingly, the amounts in question are not deductible as "bad debts" under section 166 of the 1954 Code. But the matter does not end there, for the losses which Pumi-Blok sustained may nevertheless be deductible in full under section 165, provided that they are not subject to the limitations upon capital losses made applicable by section 165(f). However, it is well settled in this latter respect that the tax treatment of losses (capital versus ordinary) arising out of the ownership of an interest such as the one which Pumi-Blok had in Shale-Lite depends on the purpose for which the interest was acquired and held by the taxpayer. Booth Newspapers, Inc. v. United States, 303 F.2d 916">303 F. 2d 916, 921 (Ct. Cl.); Schlumberger Technology Corp. v. United States, - F. 2d -, - (C.A. 5); Electrical Fittings Corporation, 33 T.C. 1026">33 T.C. 1026; 1031; Tulane Hardwood Lumber Co., 24 T.C. 1146">24 T.C. 1146, 1149-1150; Western Wine & Liquor Co., 18 T.C. 1090">18 T.C. 1090, 1098-1099. See Waterman, Largen & Co. v. United States, 419 F. 2d 845, 852-854238 (Ct. Cl.). The rule was stated in Booth Newspapers, Inc. v. United States, 303 F.2d 916">303 F. 2d 916, 921 (Ct. Cl) as follows: The cases * * stand for the proposition that, if securities are purchased by a taxpayer as an integral and necessary act in the conduct of his business, and continue to be so held until the time of their sale, any loss incurred as a result thereof may be fully deducted from gross income as a business expense or ordinary loss. If, on the other hand, an 207investment purpose be found to have motivated the purchase or holding of the securities, any loss realized upon their ultimate disposition must be treated in accord with the capital asset provisions of the Code. 239 In the case before us the record establishes that unless Pumi-Blok was able to secure a source of expanded shale aggregate its competitive position in the market place could not have been sustained. Virtually no "investment" motive existed on Pumi-Blok's part either in the formation of Shale-Lite or in respect of the advances made to it. 4 Rather Pumi-Blok advanced the $87,000 to Shale-Lite in order to obtain a source of expanded shale aggregate, which represented a "vital" raw material in the conduct of its business of manufacturing building blocks. Cf. Booth Newspapers, Inc. v. United States, supra, 303 F. 2d at 921, 922 (Ct. Cl.); Electrical Fittings Corporation, supra, 33 T.C. at 1031. 240 Moreover, we think Pumi-Blok's purpose in respect of the Shale-Lite venture did not change prior to the time of the sale of the Shale-Lite stock and notes to Pacific Vegetable Oil Corporation. Cf. Missisquoi Corporation, 37 T.C. 791">37 T.C. 791, 798; Gulftex Drug Co., 29 T.C. 118">29 T.C. 118, 121, affirmed per curiam 261 F. 2d 238 (C.A. 5). The record shows that after Shale-Lite ceased active operations in 1962 because of the difficulties it encountered with "hot lime" deposits, several efforts were made to sell Shale-Lite, including granting a one-year option to a prospective purchaser. In other words, as soon as Pumi-Blok and the other shareholders of Shale-Lite could no longer achieve their orignal purpose of manufacturing suitable expanded shale aggregate diligent efforts were made to dispose of Shale-Lite. And ultimately the Shale-Lite stock and notes were sold to Pacific Vegetable Oil Corporation in 1965. There was no intervening period when the stock and notes were held for investment purposes. Cf. Booth Newspapers, Inc. v. United States, supra, 303 F. 2d at 922 (Ct. Cl.). We therefore think that the losses incurred by the corporation upon241 the sale of the notes in question may be fully deducted from gross income as ordinary losses. Section 165, I.R.C. 1954; Booth Newspapers, Inc. v. United States, supra, 303 F. 2d at 921-922. 2. Dividend issue. We consider next whether the payments of $17,000 and $25,480 made by Pumi-Blok to the Johnson and Muth partnership in 1964 and 1965, respectively, constituted dividends to Johnson and Muth. Much of what we have said above in connection with the bad debt issue applies here also. It is clear that from the time of the initial negotiations in respect of Shale-Lite, Pumi-Blok intended to assume all the risks involved in the venture. The corporate minutes of September 14, 1956, indicate that Pumi-Blok would at the "earliest opportunity * * take over the loans of the Johnson & Muth". Indeed the Shale-Lite notes were issued to Pumi-Blok in respect of the $87,000 in advances, and Pumi-Blok, in turn, issued its own notes in the amount of $87,000 to the partnership upon which the corporation became indebted. This indebtedness on Pumi-Blok's part to the partnership was cancelled in 1961 in exchange for the Shale-Lite stock and notes and the corporation's*242 guarantee "to make these notes good" should Shale-Lite fail to do so. When Shale-Lite ceased active operations, and it became clear that Shale-Lite could not pay off the notes, Pumi-Blok took the Shale-Lite notes back from the partnership and made the payments here in issue pursuant to its guarantee. The payments, therefore, were not dividends but rather partial repayment of the corporation's initial indebtedness of $87,000 to the partnership, which inhered in the corporation's guarantee of the Shale-Lite notes. Decision will be entered under Rule 50 in Docket No. 637-68. Decisions will be entered for the petitioners in Docket Nos. 638-68 and 639-68. 208 Footnotes1. Cases of the following petitioners are consolidated herewith: Peter G. Muth and Mary M. Muth, docket No. 638-68; and Estate of Arvid T. Johnson, Deceased, Bank of America National Trust and Savings Association, Santa Ana, Executor, and Clara Johnson, docket No. 639-68.↩2. It claimed such deductions in the aggregate amount of $77,446.02 over a three year period in the amounts of $30,856.80, $7,527.20, and $39,062.02 for its fiscal years ending March 31, 1963, 1964, and 1965, respectively. Only the second and third of such years are involved herein; no issue has been raised or presented as to the correct year or years in which such deductions might properly be taken if otherwise allowable, and accordingly our decision herein is not to be read as passing upon any such issue.↩3. Whether advances to a corporation represent risk capital or loans is, of course, a question of fact. Jewell Ridge Coal Corporation v. Commissioner, 318 F. 2d 695, 698 (CA-4), affirming a Memorandum Opinion of this Court; O.H. Kruse Grain & Milling v. Commissioner, 279 F.2d 123">279 F. 2d 123, 125 (CA-9), affirming a Memorandum Opinion of this Court; Gilbert v. Commissioner, 262 F.2d 512">262 F. 2d 512, 513 (CA-2), certiorari denied 359u.s./ 1002, affirming a Memorandum Opinion of this Court. The mere fact that the advances are carried on the corporation's books and records as loans is not dispositive. Sam Schnitzer, 13 T.C. 43">13 T.C. 43, 60-61, affirmed per curiam 183 F. 2d 70 (CA-9), certiorari denied 340 U.S. 911">340 U.S. 911; Isidor Dobkin, 15 T.C. 31">15 T.C. 31, 33, affirmed per curiam 192 F. 2d 392 (CA-2). There are several factors present in this case which indicate that the advances in question constituted capital contributions. The prospect of repayment depended entirely on the success or failure of the venture inasmuch as the advances were to be repaid by Shale-Lite out of its earnings from sales of the expanded shale aggregate to its three stockholders. See Phil L. Hudson, 31 T.C. 574">31 T.C. 574, 583; Isidor Dobkin, supra, 15 T.C. at 34, affirmed per curiam 192 F. 2d 392 (CA-2); Curry v. United States, 396 F. 2d 630, 634 (CA-5), certiorari denied 393 U.S. 967">393 U.S. 967; Jewell Ridge Coal Corporation v. Commissioner, supra, 318 F. 2d at 699 (CA-4), affirming a Memorandum Opinion of this Court. The funds were required by Shale-lite to purchase assets in the form of land and equipment and also in respect of certain construction costs, all of which were necessary to the inception of the enterprise. See Isidor Dobkin, supra, 5 T.C. at 33, affirmed per curiam 192 F. 2d 392 (CA-2); Charter Wire, Inc. v. United States, 309 F.2d 878">309 F. 2d 878, 880 (CA-7), certiorari denied 372 U.S. 965">372 U.S. 965. Indeed, the record does not disclose the terms of the notes, including whether the notes had a particular maturity date, and to the extent that there is a lack of proof in this respect the petitioners must bear the consequences. Moreover, aside from the advances made by its shareholders Shale-Lite was unable to obtain financing from any other source, and such advances as were made were in direct proportion to established equity holdings. Road Materials, Inc. v. Commissioner, 407 F. 2d 1121, 1125 (CA-4), affirming and remanding a Memorandum Opinion of this Court; Curry v. United States, supra, 396 F. 2d at 634 (CA-5), certiorari denied 393 U.S. 967">393 U.S. 967; Isidor Dobkin, supra, 15 T.C. at 44, affirmed per curiam 192 F. 2d 392↩ (CA-2).4. To be sure, there is some suggestion in the evidence that the parties anticipated that Shale-Lite at some future date might make sales to the general public if the venture proved successful. But that prospect was of such distinctly secondary significance that the only real motive for Pumi-Blok's purchase of stock in and "loans" to Shale-Lite was to obtain a source of needed material with which to manufacture its building blocks. There was no "investment" motive of substance in connection with the venture.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623366/	PETER J. RANDAZZO and HELEN M. RANDAZZO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRandazzo v. CommissionerDocket No. 4155-76.United States Tax CourtT.C. Memo 1977-303; 1977 Tax Ct. Memo LEXIS 140; 36 T.C.M. (CCH) 1199; T.C.M. (RIA) 770303; September 7, 1977, Filed Peter J. Randazzo, pro se. Lowell F. Raeder, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined a deficiency in petitioners' Federal income tax for the taxable year 1973 in the amount of $518.30. The two questions presented for decision are whether petitioners may deduct under section 162(a) of the Code 1 $1,890 claimed for automobile expenses in traveling between the home and place of employment of Petitioner Peter J. Randazzo and whether petitioners are entitled to deduct more than the $774.93141 allowed by the Commissioner as sales tax on materials used by them in constructing their residence. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated by reference. Petitioners are husband and wife and resided in Millville, New Jersey when they filed their petition. Petitioner will hereinafter refer to Peter J. Randazzo. Petitioner is an electrician. Since February 15, 1970, he was employed in the construction of a nuclear power generating plant at Artificial Island, New Jersey, some 4 or 5 miles from Salem, New Jersey. The job site was approximately 32 miles from petitioners' residence. Petitioners resided approximately 5 or 6 blocks from a bus stop on the line that went to Salem, New Jersey. There was no public transportation from Salem to the job site, some 4 or 5 miles distant. During 1973 petitioner drove his 1970 Chevrolet Monte Carlo between his residence and job site. His job required that he carry his own tools which were contained in two tool boxes which he carried in the trunk of his automobile. Petitioner did142 not investigate the possibility of commuting to work in public transportation. Petitioner would have driven his automobile to work even if he had not been required to transport his tools. On their income tax return for the taxable year 1973 petitioners claimed $1,890 as petitioner's automobile expenses in traveling between his residence and job site. The Commissioner disallowed the deduction on the grounds that the expenses were not ordinary and necessary, that his employment was indefinite in nature and that none of the deduction was allowable in connection with the transportation of tools. On their income tax return petitioners deducted $1,000 as sales tax on building materials used in the construction of their home. The Commissioner disallowed $225.07 of the amount claimed because petitioners failed to verify any amount in excess of $774.93. OPINION Petitioner contends that he should be allowed to deduct the cost of commuting to work because it was necessary to transport his tools. The briefs filed by the parties are of little value to the Court because both parties filed "form briefs," virtually identical to those that the parties filed in Grayson v. Commissioner,143 docket No. 3736-76 and respondent's brief is not only virtually identical to the brief he filed in Grayson but also virtually identical to the brief he filed in . The issue is factual and it goes without saying that "form briefs" which are not addressed to the facts of the case contained in the stipulation of facts and exhibits are of little value to the Court. Under most circumstances the cost of traveling between a taxpayer's residence and his place of employment is a nondeductible personal expense. Sec. 262.The Supreme Court has held, however, that if the taxpayer incurs additional expense by reason of the necessity of carrying his tools to work, that he may deduct such additional expense. . If the taxpayer would have driven his car to work had he not been required to transport his tools, he has incurred no such additional expense and nothing is deductible. . Respondent concedes in his "form brief" that if petitioner would have used transportation other than his automobile except for the144 fact that he was required to transport his tools that he is entitled to the deduction. We doubt if petitioner would have taken the bus had he not been required to transport his tools. The bus would take him only to Salem which was 4 or 5 miles from the job site where he worked. Petitioner knew nothing about the bus schedules or busfare. He offered no testimony as to how he would get from Salem to the job site. He offered no testimony as to the possibility of participating in a carpool. His automobile had adequate space for another electrician and another set of tools but petitioner offered no testimony as to the possibility of sharing a ride with a fellow worker. Based on the record before us, we conclude that petitioner would have driven his automobile to work even if he had not carried his tools and, therefore, he cannot deduct his automobile expenses. Petitioners offered no evidence to support the deduction for sales tax paid on building materials in excess of that allowed by the Commissioner in his statutory notice of deficiency. The Commissioner is, therefore, sustained in disallowing the deduction to the extent of $225.07. Decision will be entered for the respondent*145 . Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623352/	MORRIS N. MAGIN and JANICE MAGIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMagin v. CommissionerDocket No. 23927-82.United States Tax CourtT.C. Memo 1985-304; 1985 Tax Ct. Memo LEXIS 321; 50 T.C.M. 208; T.C.M. (RIA) 85304; June 25, 1985. 1985 Tax Ct. Memo LEXIS 321">321 Held, M's purported investment in a videotape tax shelter was a factual sham. The claimed deductions and investment credit based upon the purported videotape investment are denied. Jeffrey A. King, for the petitioners. James W. Clark, for the respondent. NIMS MEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: Respondent determined a deficiency of $20,464 in petitioners' 1977 Federal income tax. The issues for decision are: (1) whether Morris N. Magin and Janice Magin (petitioners) were engaged in a bona fide business activity of television program distribution; (2) if so, whether petitioners' 1985 Tax Ct. Memo LEXIS 321">322 activity constituted an activity engaged in for profit under section 183; 1 (3) if petitioners engaged in the licensing and distribution of the videotape for profit: (a) whether the videotape may be depreciated under the sliding scale method of depreciation; (b) whether petitioners are entitled to deduct $2,000 for legal and professional fees attributable to their distribution of the videotape; and (c) whether petitioners are entitled to a $6,500 investment credit. FINDINGS OF FACT All of the facts in this case have been stipulated subject to numerous qualifications and numerous evidentiary objections by respondent. The stipulation of facts and exhibits attached thereto are incorporated herein to the extent reflected in the following findings of fact. Petitioners Morris N. Magin and Janice Magin, husband and wife, resided at Dix Hills, New York, at the time their petition was filed in this case. Janice Magin is involved in this case only by virtue of having1985 Tax Ct. Memo LEXIS 321">323 filed a joint return with her husband. Morris Magin is hereinafter sometimes referred to as "petitioner." Petitioner, a self-employed physician, reported a net profit of $71,640 from his medical practice on Schedule C of his 1977 joint Federal income tax return. Petitioner's wife was employed as a clerk in his office and earned $4,000. In addition, petitioners received $7,833 of taxable interest and dividends during 1977. On a second Schedule C attached to their 1977 Federal income tax return, petitioners reported a $41,000 net loss from a business named National Film Production. Petitioners listed the principal business activity and product of National Film Production as TV Production and TV Shows, respectively, and claimed to have owned the business for 12 months in 1977. The $41,000 net loss was comprised of a $39,000 deduction for depreciation of property identified as "TV Production" and a $2,000 deduction for legal and professional fees. The $39,000 depreciation deduction was shown on Schedule C-2 as follows: a. Description of property TV Production b. Date acquired / /77 [the dates are left blank on Schedule C-2] c. Cost or othe basis1985 Tax Ct. Memo LEXIS 321">324 65,000 d. Depreciation allowed or allowable in prior years e. Method of computing depreciation f.Life or rate 10 yrs. g. Depreciation for this year 39,000 On Form 3468 attached to their income tax return, petitioners computed a tentative investment credit of $6,500, presumably based on their purported purchase of the videotape. Petitioners, however, were only able to utilize $3,049 of the investment credit since that amount offset the entire Federal income tax they owed for 1977. Petitioners received no income in the years 1977, 1978, 1979, 1980, 1981, 1982 and 1983 from the distribution of the television videotape series "Peter Lupus' Body Shop." The "Peter Lupus' Body Shop" television series consists of 130 half-hour programs or 260 15-minute programs which are purchased as 20-minute videotape cassettes. OPINION Petitioner, a physician, netted in excess of $70,000 from his medical practice during 1977, the taxable yeat at issue in the instant case. Sometime in 1977 he purportedly purchased a 15-minute segment of a 30-minute segment of a television series entitled "Peter Lupus' Body Shop." Petitioner then allegedly entered into a distribution1985 Tax Ct. Memo LEXIS 321">325 agreement licensing the videotape to Film Syndicators, Inc. On their 1977 Federal income tax return, petitioners deducted depreciation of $39,000 and legal and professional fees of $2,000 based upon Dr. Magin's alleged investment in the videotape, thus offsetting most of the income which he earned from practicing medicine. Petitioners' remaining tax liability was eliminated by a $3,049 investment credit which they claimed for the investment in the videotape. The first issue for decision is whether petitioner was engaged in a bona fide business activity of television program distribution. Resolution of this issue is dependent upon a determination of whether petitioner ever acquired a television program tape. Respondent argues that petitioners' claimed deductions and investment credit with respect to the videotape should be denied because they have not met their burden of proving that Dr. Magin actually acquired the videotape. Alternatively, respondent argues that even if petitioner acquired the videotape, the deductions and investment credit should nonetheless be disallowed because petitioner's television distribution activity was not engaged in with the objective1985 Tax Ct. Memo LEXIS 321">326 of making a profit under section 183. Finally, respondent contends that the videotape was improperly depreciated under the sliding scale method of depreciation and did not qualify for investment credit as new section 38 property. Petitioners contend that Dr. Magin acquired the videotape and that "the issue is whether or not the activities were engaged in for profit." We disagree. After careful consideration of the entire record, we conclude that petitioners have failed to meet their burden of proving that Dr. Magin actually acquired the videotape. Rule 142(a). Accordingly, we hold petitioner was not engaged in a bona fide business activity and therefore not entitled to any deductions. Under Rule 142(a), petitioners bear the burden of proof in this case, since none of the exceptions provided in the Rule are applicable. At trial, no witnesses appeared or testified on behalf of either party. The trial consisted solely of a showing of the videotape that petitioner purportedly acquired. Dr. Magin's failure to appear at trial and present his own testimony to support petitioners' contentions permits us to draw the inference that Dr. Magin's testimony would not support petitioners' 1985 Tax Ct. Memo LEXIS 321">327 position. . Petitioners' case fails at the very threshold because they have abundantly failed to show that Dr. Magin was in any way connected by ownership to the asset petitioners seek to utilize as a tax shelter. As stated, Dr. Magin did not testify at the trial of this case. Petitioners' counsel represented in a pretrial motion that the promoter, one Conrad Frank, C.L.U., declined to testify voluntarily, and petitioners did not summon him to testify by subpoena. The stipulated material (to most of which respondent took strong exception at trial and on brief) consists essentially of material relating to the production and general attempts to market the entire TV series entitled "Peter Lupus' Body Shop." Petitioners also offered incomplete documents related to Dr. Magin's purported investment in a segment of the videotape series and his purported licensing of distribution rights to the segment. None of the material relating to the production and Marketing of the entire TV series contains any references to Dr. Magin. 21985 Tax Ct. Memo LEXIS 321">328 The parties did not stipulate and petitioner did not offer any evidence, documentary or otherwise, as to any cash payments which might have been made by Dr. Magin although the Purchase Agreement, hereinafter discussed, calls for a cash payment of $13,000 to be made by certified or cashier's check. The incomplete documents which purport to establish Dr. Magin's investment are as follows: 1. Purchase Agreement. This undated document, consisting of eight pages, purports to set out the terms by which the buyer acquires a "Film Program" for $65,000 -- $13,000 in cash and an additional $52,000 payable on some unspecified future date, with eight percent interest. This document bears only a signature which may well be Dr. Magin's, although its authenticity has not been established. There are no other signatures on this two-party form of agreement. If there is an actual seller, it is not identified. Since the Purchase Agreement is nothing more than an incomplete form, we deem it to be a nullity. It therefore does not establish the fact of any investment by Dr. Magin. 2. Distribution Agreement. This document, dated August 15, 1977, purports to be an agreement1985 Tax Ct. Memo LEXIS 321">329 between petitioner as Licensor and one "Charles T. Miller of Film Syndicators, Inc., as Licensee," whereby petitioner licenses his "right, title and interest in a Film Program entitled Peter Lupus' Body Shop #56, Robert Carreno" to the Licensee. The document purports to be signed by "Morris Magin." It is no signed by Charles T. Miller or anyone else. Paragraph 7 of the form of Distribution Agreement provides for a 50-50 division of gross receipts between Licensor and Licensee, but also contains the following provision: (c) Half of the fifty per cent (50 %) of the gross receipts (Twenty-five per cent (25 %) of the total gross receipts) credited to the account of Licensor shall be remitted by Licensee directly to until the sum of together with interest at the annual rate of eight per cent (8 %), commencing , owing by Licensor shall be paid in full. Thereafter Licensor shall receive the full fifty per cent (50 %) of the gross receipts. [All of the blank spaces appear in the document submitted to the Court.] Presumably (c) was intended by the draftsman to be the device by which the deferred obligation to the seller1985 Tax Ct. Memo LEXIS 321">330 was to be paid, but here, as in the Purchase Agreement, the seller remains an unidentified phantom. Similarly, the terms of payment remain undisclosed. Like the Purchase Agreement, the Distribution Agreement is also hereby held to be a nullity. 3. Risk Factors. At the top of the last page of the five-page undated document entitled "Risk Factors" there is a paragraph which reads as follows: I HAVE READ THE RISK FACTORS STATED ABOVE AND HAVE CONSULTED WITH MY PROFESSIONAL LEGAL, ACCOUNTING AND TAX ADVISORS AND AGREE TO PURCHASE A NEW FILM PROGRAM NOTWITHSTANDING THESE RISKS. Petitioner purportedly also signed this document. Below the space for the investor's (petitioner's) signature is a sentence which reads as follows: I HAVE EXPLAINED TO MY CLIENT THE TAX AND ECONOMIC RISKS CONNECTED WITH THE PURCHASE OF A NEW T. V. FILM PROGRAM. No advisor's name or signature appear. As stated previously, petitioners offered no evidence that any cash was paid by Dr. Magin or that the two-party Purchase and Distribution Agreements were ever fully executed and delivered. For all that appears in the record, Dr. Magin simply signed some blank forms and delivered them to1985 Tax Ct. Memo LEXIS 321">*331 his tax preparer for computation of deductions and credit. From this we can only conclude that petitioners' claim of tax deductions and the investment credit are based on a factual sham, and we so hold. Having done so, we are not required and decline to dignify petitioners' position further by engaging in the academic exercise of deciding the merits of a case based on a factually sham transaction. See . To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect for the year in issue. All rule references are to the Tax Court Rules of Practice and Procedure.↩2. At the hearing respondent objected "to each an every exhibit on the grounds of authenticity, hearsay, relevancy and materiality." We believe it to be a permissible assumption that respondent did not intend to include within this blanket objection such formal documents as petitioners' 1977 return and the deficiency notice, both of which were stipulated. Since we decide this case for respondent, we need not rule on his various evidentiary objections, which we now deem moot.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623368/	LUANNE McCANLESS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; TOMLIN LEONARD McCANLESS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, PetitionerMcCanless v. CommissionerDocket Nos. 29538-84; 33728-84.1United States Tax CourtT.C. Memo 1987-573; 1987 Tax Ct. Memo LEXIS 573; 54 T.C.M. (CCH) 1111; T.C.M. (RIA) 87573; November 18, 1987. Virginia Kinkead for the petitioner Luanne McCanless. J. Floyd Pew for the petitioner Tomlin Leonard McCanless. Nancy Hale, for the respondent. PARRMEMORANDUM FINDINGS OF FACT AND OPINION PARR, Judge: Respondent determined deficiencies 2 in and additions to petitioners' Federal income tax in the following amounts for the following years: Luanne McCanless (hereinafter sometimes referred to as petitioner-wife) Additions to TaxYearDeficiencySec. 6653(a) 31978$ 774.74$ 158.71197911,349.40708.38575 Tomlin Leonard McCanless (hereinafter referred to as petitioner-husband) Additions to TaxYearDeficiencySec. 6653(a)1978$ 1,858.75$ 212.91197916,998.85990.0019803,790.36189.521981649.33-Additionally, in an amendment to his answer, respondent determined liability for additions to tax under section 6651(a)(1) for failure to file timely returns against Luanne and Tomlin McCanless in 1978 for $ 68.54 and $ 1,030.54 respectively, and against Tomlin McCanless in 1980 for $ 379.04. After concessions, 4 the issues remaining for decision are (1) whether Tomlin McCanless underreported his wagering income in 1979 and 1980; 5(2) whether Tomlin McCanless can deduct any of the following amounts in the respective taxable years; (A) 1980 business expense for money confiscated ($ 4,816.00), and automobile confiscated ($ 3,247.00); (B) 1980 business expense for "pool hall cost of sales" ($ 1,100.00); (C) 1980 loss from the disposition of his interest in a pool hall; (D) 1980 loss to a person identified as "Junior Moore"; (E) 1981 bad debts; (F) 1981 expenses for legal and professional576 services; (3) whether Luanne and Tomlin McCanless filed joint income tax returns for the 1978 and 1979 tax years; (4) whether part or all of the underpayments of tax for 1978, 1979 and 1980 tax years were due to negligence or intentional disregard of Internal Revenue rules and regulations; and (5) whether petitioners filed their 1978 tax return and whether Tomlin McCanless filed his 1980 tax return after the due date. FINDINGS OF FACT Some of the facts are stipulated and are so found. The stipulation of facts and exhibits are incorporated herein by this reference. Luanne McCanless577 resided in Leachville, Ark., and Tomlin McCanless resided in Blytheville, Ark. at the time they filed their petitions in the case. They are now divorced. Luanne and Tomlin McCanless were legally married during the 1978 and 1979 taxable years. During that time and through 1981 Tomlin McCanless was engaged in illegal bookmaking while Luanne McCanless stayed home and cared for their young son. Since Luanne McCanless was not employed outside the home she had no individual income. Tomlin McCanless first started in the bookmaking business in 1978 working for another person. During this time he did not take bets on any sporting events. Instead, he placed bets on his employer's behalf so the employer got a better point spread than he would otherwise obtain. In 1979, petitioner-husband broke out on his own and started his own bookmaking operation. He took bets on professional, semi-professional and collegiate sports. The majority of his activities centered around basketball, football and baseball. Petitioner-husband had some regular customers and others that placed bets sporadically. Many bets were placed in person, but a majority of bets came in over the telephone. As578 a result, petitioner-husband went out every day and paid off customers who won and collected from customers who lost. Many customers either were unable or refused to pay their debts. To the extent petitioner-husband maintained records of his bookmaking business, they usually reflected whether a customer had won or lost. However, this was not always the case. The records were incomplete in other ways also. That is, not all bets placed with him were recorded. Between 1979 and 1980 an undercover agent placed bets with petitioner-husband using the name of "Johnny Barren." That name did not appear anywhere in the records. Tomlin McCanless did not limit his participation in the gambling business to bookmaking. Depending on the location of the operation, he also conducted poker, craps, dominoes, pool, pinball and video games. Petitioner-husband kept no records of these gambling activities even though he occasionally participated in the games. For example, he claims that a "Junior Moore" owes him $ 5,710.00 from a poker game, but he has no records to substantiate his testimony. Between 1979 and 1981 petitioner-husband ran his gambling business out of three different locations. 579 He first started taking bets at T & G Mobile Homes in Blytheville, Ark. Then, for a period of about 90 days, he took bets at the Neon Gallery in Blytheville. Eventually Tomlin McCanless, his brother Gary Don, and Jerry Bo Hollingsworth purchased a lease to a pool hall also known as the Blytheville Recreation Center. The three men paid $ 15,000 for the lease and the Center's inventory on February 28, 1980. 6The recreation center was, in many ways, an ordinary business venture. While the activity engaged in (gambling) was illegal, petitioner-husband also apparently sold beer on the premises. Petitioner-husband failed to maintain adequate records of the legal aspect to the business. He had no invoices of purchases, no cancelled checks from payment made and no log or ledger which reflected money spent on keeping the bar stocked. On March 27, 1980, law enforcement officials raided all three locations where petitioner-husband had operated. During580 the raid the officers recovered $ 4,816.00 in cash, an automobile, and all of the books and records from the bookmaking operation. As a result of the raid, Tomlin McCanless was convicted of keeping a gambling house in violation of Arkansas law. 7After the recreation center was raided petitioner-husband was temporarily out the bookmaking business. In the summer of 1980 he got a job as the manager of the Sonic Drive-In located in Marion, Ark. Apparently, he was a trusted employee at Sonic Drive-In. Not only did he write his own salary checks, but he also determined the amount he should be paid. He worked at Sonic Drive-In for 45 to 60 days and was paid approximately $ 300.00 per month. He did not report this income on his 1980 tax return. Petitioner-husband also purchased a Federal wagering stamp for the first time between March 27 and September of 1980. After purchasing the tax stamp and leaving Sonic Drive-In petitioner-husband reopened his gambling business. This new operation, which was still in violation of Arkansas law, was conducted out of his home and continued through 1981. The items seized in the March 27, 1980 raid581 included all of petitioner-husband's books and records. The Arkansas law enforcement officials subsequently turned the binder, notebooks and some betting slips over to respondent. Revenue Agent Pitts reconstructed petitioner-husband's wagering income using this information. The books covered wagers placed with petitioner-husband between 1979 and March 27, 1980 but did not reflect any winnings from any other gambling activities such as poker or dominoes. Mr. Pitts made a careful review of all the information provided to him. Most of the items were undated. Mr. Pitts determined that the three ring binder represented a portion of wagers made in 1979 and that the 13 spiral notebooks represented a portion of wagers made in 1980. He was able to make this determination because a few items dated 1979 appeared in the black binder and few dated 1980 appeared in the spiral notebooks. All of Mr. Pitts' calculations were based upon information contained in petitioner-husband's books and records. Thus, even though respondent knew the records did not list all bets placed with petitioner-husband and that the records did not contain information on the non-bookmaking gambling activities, 582 and even though petitioner-husband reopened his gambling business in September of 1980, respondent did not increase wagering income unless the increase was supported by information actually contained in the books. Mr. Pitts cross-checked information from the betting slips against information contained in the records. There was no duplication. Mr. Pitts also offset wagering income by losses and did not include any "we bets" 8 or "lay-off bets" 9 in his recalculation of taxable income. He also did not include money earned at Sonic Drive-In in his recalculation of taxable income. Petitioner-husband's wagering income was increased $ 300.00 in 1978; $ 25,618.00 in 1979; and $ 14,239.13 in 1980. 10 The 1978 increase was agreed to at trial leaving only the 1979 and 1980 increases in dispute. Petitioner-husband disputes Mr. Pitts' findings in determining his wagering income, but offered no documentary evidence to support his position. He attempted at trial to583 introduce the books and records which had been seized in the raid in 1980 as well as books he had compiled "from memory" while his books were in the Government's possession. However, the books were excluded from evidence under Rule 104(c)(2) because petitioner-husband had violated a court order directing that the records be turned over to respondent by March 7, 1986 in compliance with Rule 72. 11 Consequently, petitioner-husband was unable to substantiate most of his claims at trial. 584 Tomlin McCanless did file Federal income tax returns for the years in question. He filed the 1978 tax return with the Internal Revenue Service Center on January 29, 1980. Three months after his bookmaking place was raided, he filed a Form 1040X amending the 1978 tax return. He filed a Form 1040 for the 1979 taxable year on July 17, 1980. He filed the 1980 return on July 14, 1981. The 1978 and 1979 returns listed the filing status as "married filed joint return." Luanne McCanless did not sign any of the tax returns at issue, even though her named appeared in the signature box. At her ex-husband's request, she did sign and file an administrative protest and appeal during audit. 12 She and petitioner-husband also signed consents to extend the limitations period for assessment of taxes for the 1978 and 1979 taxable years. On two of the consents to extend the statutory time limit 13 petitioner-wife added a statement that she had not signed either the 1978 or the 1979 Federal income tax return. In addition, petitioner-wife sent a handwritten statement to the Internal Revenue Appeals Office in which she swore that she had not signed the 1978 and 1979 tax returns, did not authorize585 anyone to sign her name and had no knowledge that anyone had signed her name on those returns. OPINION Before trial petitioner-husband submitted a motion to remove the presumption of correctness of the Revenue Agent's report and the statutory notice of deficiency. He sets forth several reasons why the presumption should be removed. In essence, petitioner-husband argues that (1) the determination was wrong and (2) respondent's agents did not operate properly at the administrative level. Both of petitioner-husband's contention would require us to go behind the notice of deficiency, which is contrary to the general rule of this Court. Proesel v. Commissioner,73 T.C. 600">73 T.C. 600, 606 (1979); Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 327 (1974); Human Engineering Institute v. Commissioner,61 T.C. 61">61 T.C. 61, 66 (1973).586 The rationale of this rule is that trials in this Court are de novo proceedings. Our determination is based on the merits of the case, not on a record developed at the administrative level. Greenberg's Express Inc. at 328. A narrow exception to this rule may exist in those cases where the respondent's deficiency is determined to be arbitrary. Jackson v. Commissioner,73 T.C. 394">73 T.C. 394 (1979). In this case, however, since petitioner-husband admits he was involved in gambling and he was convicted under Arkansas law, and since respondent relied exclusively on records maintained by petitioner-husband in recomputing income and disallowing deductions, no reasonable basis exists to find respondent's determination to be arbitrary. As such, no basis exists for removing the presumption of correctness from respondent's determination. The first substantive issue is whether petitioner-husband underreported his income for the 1979 and 1980 taxable years. Respondent's increase in wagering income is presumed to be correct and petitioner bears the burden of proving it erroneous. 587 Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). When a taxpayer fails to maintain complete and adequate books and records, respondent may use any method which clearly reflects income to reconstruct taxable income. Harbin v. Commissioner,40 T.C. 373">40 T.C. 373, 377 (1963). Respondent's method of reconstructing income was reasonable in this case. The Revenue Agent used petitioner-husband's books and records to reconstruct taxable income, cross-checked them against one another to avoid duplication and did not include any "we bets" or "layoff bets" in recomputing taxable income. Mr. Pitts deducted all reported wagering income from the total reconstructed wagering income. Moreover, not all of petitioner-husband's income was recorded in his books. Any inaccuracy that may exist in this case results from petitioner-husband's failure to maintain accurate books and records, not from respondent's actions. Petitioner-husband contends respondent made several mistakes in recomputing taxable income. For example, he claims that certain bets which were not listed either as wins or losses were totally included as wins. This, however, is a problem of petitioner-husband's588 own making. Also, petitioner-husband has never indicated the amount of the bets which were erroneously included in income. Instead he makes bald assertions that his statement of wagering income is correct with no documents whatsoever to support his declaration. Under these circumstances we conclude that petitioner-husband has failed to meet his burden of proof and respondent's recomputation of taxable income for 1979 and 1980 must stand. Petitioner-husband is also subject to self employment tax on wagering income. The next issue is whether petitioner-husband is entitled to any of his claimed deductions for 1980 and 1981. None of the deductions in issue were claimed on his Federal income tax return. Rather, these deductions were claimed for the first time in the petition. Petitioner-husband claims entitlement to bad debt deductions for 1981. 14Section 166 permits a taxpayer to deduct bona fide obligations which become worthless during the year. The bad debt claim in this case appears to be just another attack on respondent's determination of wagering income. The fact that petitioner-husband589 testified at trial that amounts read into the record by his counsel were still owing to him does not satisfy us that it is so. Again, there were absolutely no corroborating testimony or documentation. And, again petitioner-husband attempted to place the burden on respondent to prove that no bad debt existed. We reiterate that the burden of proof lies with petitioner, and he has failed to meet this burden as it applies to his bad debt deductions for 1981. Petitioner-husband also claimed a590 deduction of $ 1,100 for cost of goods sold in 1980. The only evidence of this expense was his uncorroborated testimony. While petitioner-husband asserts that he sold beer at the Blytheville Recreation Center, we do not know how much merchandise was purchased and what it cost. Petitioner-husband did not maintain records for any of these purchases. Neither did we have a starting or ending inventory as required by section 471. Thus, petitioner-husband's total lack of evidence prevents us from making a reasonable estimate of the cost of goods sold. Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d Cir. 1930). Petitioner-husband claimed a loss on the disposition of the lease to the pool hall. He claims he sold the lease to one Johnny Rankin. We have seen no evidence of this sale. Not only was there no bill of sale, but there was also no corroborating testimony from the alleged purchaser. Since there is no evidence a sale took place, we disallow any claimed loss for its disposition. Moreover, even if the sale of petitioner-husband's interest actually did occur in 1980, he has failed to substantiate that his adjusted basis in the lease exceeded any amount he may have received. 591 Petitioner-husband also claims a business deduction of $ 4,816 for money confiscated when his gambling establishment was raided. Section 162 generally permits deductions for ordinary and necessary business expenses. Section 162(f), however, specifically disallows a deduction "for any fine or similar penalty paid to a government for the violation of any law." The record is unclear as to what actually happened to the $ 4,816.00 confiscated in the raid on March 27, 1980. Petitioner-husband has not presented any evidence which suggests the money was not in fact a fine, or that if not, it was not used to reduce his actual or potential liability for a fine or penalty. 15 Since we have no contrary evidence and we know the state has the authority to impose a fine for a gambling infraction 16 we assume the $ 4,816.00 was a fine and is therefore not deductible. 592 Petitioner-husband's automobile was also seized during the raid. Unlike the cash, however, the automobile was returned in February 1982. Petitioner-husband claims a deduction in the amount of $ 3,247.00 for the time the automobile was in the state's possession. He did not claim this loss on his Federal tax return for 1980 or 1981. Additionally, we do not know how he arrived at this figure. We do not know if this is intended to be depreciation while in the state's possession, or loss on its disposition when allegedly sold to petitioner-husband's criminal defense attorney for $ 500.00, or something else. In any event, even if a deduction were allowable in this circumstance, without any evidence as to adjusted basis, we are unable to estimate the amount of a deduction. Petitioner-husband claims a loss in the amount of $ 5,710.00 to a "Junior Moore." The facts underlying this alleged loss are unclear. Apparently, however, the loss was ultimately attributable to a poker game. We note that in recomputing wagering income the Revenue Agent did not include any gains from poker. Because petitioner-husband has unreported winnings, under section 165(d) he must show his loss exceeded593 such unreported winnings before he may deduct the loss against recomputed wagering income. Schooler v. Commissioner,68 T.C. 867">68 T.C. 867 (1977). Petitioner-husband has failed to make this showing. Therefore, he is denied any deduction for a gambling loss to Junior Moore. Finally, petitioner-husband claims legal expense deductions for the 1980 taxable year. Section 162(a) authorizes a taxpayer to deduct all ordinary and necessary business expenses. Absent a statute or regulation denying a claimed deduction or frustration of clearly defined national or state policies proscribing particular types of conduct, we should not narrow the scope of the general rule. Commissioner v. Tellier,383 U.S. 687">383 U.S. 687, 694 (1966). In this case petitioner-husband was engaged in an unlawful business enterprise. He incurred legal costs in defending against criminal prosecution for that activity. The criminal prosecution was directly related to his trade or business. As such, a deduction for legal expenses should ordinarily be allowed. Commissioner v. Tellier,383 U.S. 687">383 U.S. 687, 691 (1966);594 United States v. Gilmore,372 U.S. 39">372 U.S. 39, 49 (1963); Johnson v. Commissioner,72 T.C. 340">72 T.C. 340, 348 (1979). In this case, however, petitioner-husband has failed to substantiate his claimed deduction. 17 He has not presented a bill for legal expenses nor has he offered testimony from the attorney who defended him. Thus, we have no evidence on which to base a reasonable estimate for a deduction. Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d Cir. 1930). In this instance as with most other expenses or claimed deductions, even though petitioner-husband may not have had contemporaneous documents to substantiate his claim, he could have had witnesses corroborate transactions which he claimed had occurred, and he was not precluded by the Court from offering their testimony. Since he failed in all cases to present corroborating testimony, we595 can only assume it would not have supported his claim. Wichita Terminal Elevator Co. v. Commissioner,6 T.C. 1158">6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Therefore, in light of the total lack of evidence, we are unable to allow any deductions based solely on petitioner-husband's questionable credibility. The next question in this case is whether Luanne and Tomlin McCanless filed joint Federal income tax returns in 1978 and 1979. This determination depends upon the intent of the parties. We consider the facts and circumstances surrounding the filing of the return to discover the parties' intent. Helfrich v. Commissioner,25 T.C. 404">25 T.C. 404, 407 (1955). Superficially, it appears that the McCanlesses did file joint income tax returns for 1978 and 1979. Both their names appeared on the return and in the signature boxes. However, Luanne McCanless never signed the return, never authorized another to sign in her place and was unaware that the return had even been filed. She was a thoroughly credible witness and we accept her testimony. 596 The fact that petitioner-wife signed a protest and appeal after receiving the deficiency notice does not ratify the signing of her name on the 1978 and 1979 returns. See Helfrich v. Commissioner,25 T.C. at 407(signing of power of attorney and consent relating to 1947 taxable year not deemed to be admission that return in question we intended as a joint return). We conclude that petitioner-wife did not intend to file a joint income tax return with petitioner-husband for 1978 and 1979. Moreover, since petitioner-wife did not have any income of her own, she was exempt from the filing requirements. 18 As a result, we find that petitioner-wife is not liable for any deficiency in the 1978 or 1979 taxable years nor is she liable for any deductions to tax associated with the tax returns filed for those years. 597 With regard to petitioner-husband, respondent determined additions to tax under Section 6653(a) for negligence or intentional disregard of rules or regulations. Petitioner-husband has the burden of proof on this issue. Bixby v. Commissioner,58 T.C. 757">58 T.C. 757 (1972). He has offered no evidence to contradict respondent's determination. Therefore, the additions to tax under section 6653(a) must stand. Finally, in an amendment to his answer respondent determined additions to tax under section 6651(a) for failure to file a timely return. As a new matter, respondent bears the burden of proof. Rule 142(a). To meet the burden respondent must prove that the returns were filed late and that the late filing was due to willful neglect. Bruner Woolen Co.,6 B.T.A. 881">6 B.T.A. 881, 882 (1927). Respondent has shown that Tomlin McCanless' Federal income tax returns for the years in question were filed late, but has failed to present any evidence on the issue of petitioner-husband's reasons598 for the late filing. Thus, respondent has failed to meet his burden of proof as to the additions to tax for delinquency. 19To reflect the foregoing, Decision will be entered for petitioner Luanne McCanless in docket No. 29538-84.Decision will be entered under Rule 155 in docket No. 33728-84 with respect to Tomlin Leonard McCanless.Footnotes1. The deficiencies and additions to tax determined against Luanne McCanless are at issue in docket No. 29538-84. The deficiencies and additions to tax determined against Tomlin Leonard McCanless are at issue in docket No. 33728-84. Since the only issue involving Tomlin Leonard McCanless, this Court granted the motion to consolidate the two dockets for trial, briefing and opinion. ↩2. Respondent took inconsistent positions with respect to filing status in determining deficiencies due from Luanne and Tomlin McCanless. The computations of deficiencies for Luanne and Tomlin McCanless in the 1978 and 1979 taxable years were based upon "married filing joint return" filing status. The computations of deficiencies due from Tomlin McCanless were based upon "married filing separate return" filing status in the 1978 and 1979 taxable years. ↩3. Unless otherwise indicated, all section references are to the Internal revenue Code as applicable to the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩4. Since the notice of deficiency was sent the parties have conceded the following amounts in issue: ↩1978197919801981Wagering Income$ 300.00Wagering Expenses[1,414.00][3,082.00]Schedule C Expenses:Wagering-Telephone1,164.42 493.12Wagering-Utilities1,800.00 Pool Hall-Rent400.00 Wagering Auto Expense1,833.00Gain on Sale of Residence4,000.00 5. Petitioner-husband has conceded that he would be subject to self-employment tax for the amount of increase in wagering income, if any. ↩6. The Bill of Sale, in fact, did not even mention the lease to the premises. Instead, on its face, the document indicates that Tomlin McCanless, his brother, and Mr. Hollingsworth paid $ 15,000 for the contents of the Center. ↩7. Ark. Stat. Ann. sec. 41-3251 (1977). ↩8. A "we bet" means that petitioner-husband was betting for his own account. ↩9. A "lay-off bet" was a bet made from petitioner-husband's own account with the purpose of covering payouts he might owe his customers. ↩10. Mr. Pitts calculated the increase for each of the years in question. After determining the amount of wagering income he subtracted the amounts actually reported on tax returns as wagering income and amounts reported as commissions on sales of mobile homes. ↩11. On January 19, 1986, respondent wrote to petitioner-husband's counsel arranging a conference for January 30, 1996, and informally requesting documents. Neither petitioner-husband nor his counsel attended the conference and they never rescheduled the conference. As a result respondent served petitioner-husband with interrogatories pursuant to Rule 71 and requests for the production of documents pursuant to Rule 72 on February 14, 1986. Petitioner-husband answered some of the interrogatories but in his response he indicated he would not provide the requested documents. On March 26, 1986, respondent moved to compel production of documents and responses to interrogatories. The Court granted the motion on April 16, 1986 and ordered petitioner-husband to produce the information sought on or before May 7, 1986. Petitioner-husband did not comply. In the motions filed March 26, 1986 respondent also sought the imposition of sanctions against petitioner-husband for failure to comply. The Court set a hearing on the imposition of sanctions for May 19, 1986. Respondent requested that the case be dismissed. The Court chose not to impose this ultimate sanction and instead prohibited petitioner-husband from introducing any documents into evidence which had not been provided to respondent per the terms of the this Court's order. ↩12. Petitioner-husband had also filed another protest and appeal on his own in response to the deficiency notice. ↩13. Luanne McCanless signed 5 separate consents to extend the statutory time limit. The 2 in which she added the statement were signed on May 14, 1983. ↩14. Petitioner-husband never claimed a bad debt deduction on his Federal income tax return. This issue of bad debts arose after respondent determined a deficiency in petitioner-husband's income. In his brief, petitioner-husband makes long winded arguments that these amounts were originally bad debts but after respondent changed petitioner-husband from the accrual method to the cash method these amounts were more properly exclusions from income. In the text we refer to these amounts as bad debts but do not find that respondent ever changed petitioner-husband's method of accounting. As with most issues in this case, petitioner-husband presented no evidence to substantiate this claim. ↩15. Petitioner-husband testified that the $ 4,816 was seized by law enforcement officers and turned over to the Internal Revenue Service. There is no evidence corroborating petitioner-husband's testimony, nor is there other evidence indicating what happened to the money. ↩16. In its judgment against petitioner-husband in State of Arkansas v. Tommy McCanless,↩ the State imposed a one year suspended sentence conditioned on the payment of a $ 2,500 fine. 17. Petitioner testified that he incurred $ 400 in legal expenses in 1979, $ 3,000 in legal expenses in 1980 and $ 1,500 in legal expenses in 1981. In his petition he claimed $ 5,000 in legal expenses in 1981 and he failed to claim any legal expenses on his 1979, 1980 or 1981 Federal income tax returns. ↩18. Since we have determined that Luanne McCanless did not file a joint return with her husband in 1978 and 1979, the "married filing separate return" tax rates would apply. In 1978 Luanne McCanless would be subject to income tax only if her income exceeded $ 1,600. Similarly, in 1979 she would only be subject to tax if her income exceeded $ 1,700. ↩19. Pickett v. Commissioner,T.C. Memo. 1975-33↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623369/	Trout-Ware, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentTrout-Ware, Inc. v. CommissionerDocket No. 14910United States Tax Court11 T.C. 505; 1948 U.S. Tax Ct. LEXIS 71; September 29, 1948, Promulgated 71 Decision will be entered for the petitioner. Corporation engaged in portrait photography, held, exempt as a personal service corporation as defined in section 725, I. R. C.W. Dean Hopkins, Esq., for the petitioner.Howard M. Kohn, Esq., for the respondent. Murdock, Judge. Black, J., dissenting. Turner, Leech, Tyson, and Disney, JJ., agree with this dissent. MURDOCK 505 The Commissioner determined deficiencies in excess profits tax of $ 8,475.33 for 1943 and $ 2,841.85 for 1944. The only issue for decision is whether the petitioner was a personal service corporation during the taxable years within the meaning of section 725 of the Internal Revenue Code.FINDINGS OF FACT.The petitioner, a corporation, filed its returns for the taxable years with the collector of internal revenue for the eighteenth district of Ohio.The petitioner is engaged in the business of portrait photography. Its outstanding stock during the taxable years consisted of 61 shares of no par value common stock, 45 of which were owned by Alice A. Trout, hereinafter called Alice.Alice and M. K. Ware organized the petitioner in 1929 and did all the work during the first years 72 of its existence. Ware took the pictures and both he and Alice were capable of doing most of the things necessary to produce a finished picture. Alice had studied art and for six years prior to the formation of the petitioner she had painted miniatures and done finish retouching for a photographer. Ware was in the military service during the taxable years and had not been very active in the petitioner's business for about ten years prior thereto.Alice was president and treasurer of the petitioner during the taxable years and held either one or the other of those offices at all times material hereto.Most of the petitioner's business is obtained through appointments made by telephone solicitation. Alice was responsible for the petitioner's first business contacts, she originated its method of telephone solicitation, and trained the other employees who make such solicitations.The petitioner employed two photographers, John Barkovich and Bernard Lombard. Barkovich worked chiefly in the studio of the petitioner and Lombard took pictures in customers' homes. Lombard started working for the petitioner in 1933 and Barkovich in 1937. Lombard had had prior experience in photographing73 children, but 506 Barkovich had had very little prior experience in photography. Both were trained for their work with the petitioner by Alice and she continued to criticize their photographs. The work of the photographers required a knowledge of lighting and posing subjects and a pleasant personality for dealing with customers. Alice never took any pictures herself.After a picture was taken by the photographers, the negatives had to be developed. That work required considerable skill in handling materials and was done by Ted Hall and his assistant, Carl Eysenbach. Hall entered the petitioner's employ about 1940. He had had prior experience.Various corrections such as softening heavy shadows and blocking out harsh lines and blemishes were then made with pencils on every negative. That work was done chiefly by Alice. Barkovich did some of it during rush hours and Alice was training a girl to assist her with it during the taxable years.Photographs called proofs were printed by Hall and Eysenbach from those corrected negatives and Alice made further corrections with pencils on those proofs. That work was a very important income-producing factor because the corrected74 proof was the thing on which a customer based his order and the guide or standard for the work of all the other employees. The proof correcting was done only by Alice, except in extreme situations, and in those cases the results were not as good as those obtained by her.The next step was to transfer to the negatives the corrections that had been made on the proofs by Alice. The finish retouching had to follow precisely the corrections indicated on the proofs. That work requires skill and some artistic talent. It was done by Barkovich and William Schnitzbauer. The latter was employed by the petitioner in 1931. Barkovich had had twelve years experience at finish retouching before coming with the petitioner, but Schnitzbauer had had none. Both men were taught the petitioner's methods of finish retouching by Alice and Ware, and Alice continued to supervise their work.Test prints were made from the negatives after they had been worked on and they were checked by Barkovich and Schnitzbauer to see if all the required changes had been made on the negative.A final print was then made and the last step was to make additional delicate corrections with brush and india ink on that print. 75 It took considerable artistic ability to do that work in such a fashion as to copy the changes indicated on the corrected proof and still make the finished portrait look natural. Alice hired girls from art schools and taught them how to finish the final prints. Florence Bene did that work during the taxable years.507 Alice did her work at a table in the reception room of the petitioner's studio so that she could help customers as they came in and so that people passing the studio window could see her at her work. Many of the petitioner's customers visited its studio only when they could talk to Alice personally. She was the only one who handled complaints. She did very little selling herself during the taxable years. The chief sales girl, bookkeeper, and office manager was Antoinette Sberna. Alice worked at the studio every day during the taxable years, took work home with her at night, and had not taken a vacation in five years.The following table shows the total salaries paid by the petitioner during the taxable years to its officers and all but one of its full time employees:19431944Alice Trout$ 4,244.00$ 4,500.00M.K. Ware (vice president)3,000.003,000.00John Barkovich3,113.133,833.92Bernard Lombard2,261.002,819.00Ted Hall3,041.633,410.70Florence Bene1,148.391,597.13Carl Eysenbach1,859.142,046.10Antoinette Sberna2,413.543,326.28Sadie Wurts (telephone solicitor and sales girl)774.971,528.44Marilyn Mulhern (telephone solicitor and sales girl)471.531,459.3976 Nine other employees were paid a total compensation of $ 4,934.62 during the taxable years.The petitioner's annual net income after income taxes for the years 1943 and 1944 was about $ 11,000. Its depreciable assets after depreciation were $ 358.94 for 1943 and $ 127.31 for 1944. Its physical assets consisted of furniture, cameras, paper, film, and holders. It had no borrowed capital.Capital was not a material income-producing factor in the petitioner's business during the taxable years.The petitioner did not derive any of its income during the taxable years from trading as a principal.The Commissioner gave the following explanation for determining the deficiency:In filing your returns for the years 1943 and 1944 you claimed to be a personal service corporation and elected not to be subject to the excess profits tax under Subchapter E of Chapter 2 of the Internal Revenue Code. It is held that you are not a personal service corporation within the provisions of Section 725 of the Internal Revenue Code and are subject to excess profits tax under Subchapter E of Chapter 2 of the Internal Revenue Code.The income of the petitioner for each of the taxable years is to be ascribed77 primarily to the activities of Alice A. Trout.508 The petitioner was a personal service corporation within the meaning of section 725 (a) of the Internal Revenue Code during the taxable years.OPINION.Section 725 exempts corporations from the excess profits tax under subchapter E if they so elect and come within the definition of a personal service corporation as defined in section 725 (a). The provisions of supplement S to chapter I then apply to the shareholders of the corporation. A personal service corporation is defined in (a) as "a corporation whose income is to be ascribed primarily to the activities of shareholders who are regularly engaged in the active conduct of the affairs of the corporation and are the owners at all times during the taxable year of at least 70 per centum in value of each class of stock of the corporation, and in which capital is not a material income-producing factor."The petitioner in this case made the election provided in section 725 (b). The respondent argues, feebly, that capital was an income-producing factor, but the evidence shows that it was not. The only other argument of the respondent is that the income of this corporation can78 not be ascribed primarily to the activities of Alice Trout. She was regularly engaged in the active conduct of the affairs of the petitioner and she owned during the taxable years in excess of 70 per centum of the stock. The other stockholder, Ware, was not regularly engaged in the active conduct of its affairs during the taxable years and had not been for several years. The contention of the petitioner is that Alice "controlled the quality of each portrait by her skillful work in retouching negatives and correcting proofs." The petitioner concedes that other employees had skill, but argues that they merely carried out her ideas, suggestions, and corrections in order to bring each finished photograph up to the standards which she set.This case presents a rather close question as to whether the petitioner has sustained its burden of proof, that is, whether it has shown that its income is to be ascribed primarily to the activities of Alice Trout. She and a number of the other employees of the petitioner testified, in effect, that she was the dominant personality in the organization, the correcting and retouching she did was the most important single step in giving the portraits79 quality and distinction, and she, by her criticisms and suggestions to her subordinates, caused them to do the work which was necessary to assist her in creating the finished product. There is also evidence that customers came to the petitioner because of the quality and distinction which Alice Trout gave to the photographs produced by the petitioner.On the other side there is the determination of the Commissioner that this was not a personal service corporation, evidence that a number 509 of the other employees were making substantial contributions to the success of the petitioner, and the amount of compensation paid to Alice and the other employees, which indicates that the corporation itself in fixing salaries did not regard Alice as so important as the testimony might indicate. However, after carefully analyzing all of the evidence, a finding has been made that this was a personal service corporation during the taxable years. The Commissioner made no effort to overcome the prima facie showing of the petitioner. He undoubtedly knows much of the affairs of many photographers in Cleveland and other cities of the United States, and if the activities of Alice were not relatively80 as important as the testimony in this case indicates, the Commissioner could have brought in countervailing evidence. This case, of course, must be decided upon the evidence in the record, and that evidence preponderates slightly in favor of the petitioner.Decision will be entered for the petitioner. BLACK Black, J., dissenting: I respectfully dissent from the majority opinion wherein it holds that petitioner was a personal service corporation within the meaning of section 725 (a) of the Internal Revenue Code during the taxable year. I readily agree with the majority opinion that the facts show that capital was not a material income-producing factor in petitioner's business. But I am unable to agree with the conclusion that petitioner's income in the taxable year is to be ascribed primarily to the activities of one of its stockholders, namely, Alice Trout.It is unnecessary, of course, to emphasize that the excess profits tax statute is a complicated one and Congress has conferred upon the Treasury Department authority to promulgate regulations in its enforcement. The Treasury has done that in Regulations 112, section 35.725-2 (c) of which reads in part as follows: 81 * If employees other than shareholders contribute substantially to the services rendered by a corporation, such corporation is not a personal service corporation unless, in every case in which services are so rendered, the value of and the compensation charged for such services are to be attributed primarily to the experience or skill of the shareholders and such fact is evidenced in some definite manner in the normal course of the business or profession. The fact that the shareholders give personal attention or render valuable services to the corporation as a result of which its earnings are greater than those of a corporation engaged in a like or similar business or profession, the shareholders of which are not regularly engaged in the activities of the corporation, does not of itself constitute the corporation a personal service corporation.So far as I am able to see the foregoing is a reasonable and valid regulation in the enforcement of section 725. I do not think that petitioner 510 has borne the burden of proof in bringing itself within the ambit of the foregoing regulation. In fact I would say that the facts as found in the majority report affirmatively show that82 petitioner does not bring itself within the foregoing regulation. Therefore, I think that the ultimate finding of the majority that "The petitioner was a personal service corporation within the meaning of section 725 (a) of the Internal Revenue Code during the taxable year" is not justified and therefore should not be made.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623374/	Ben Travis Everett, Sr. v. Commissioner. Glen A. King v. Commissioner. Glen A. King and wife, Kathleen King v. Commissioner. Ben Travis Everett, Sr., and wife, Annie Everett v. Commissioner.Everett v. CommissionerDocket Nos. 44014, 44015, 44025, 44026.United States Tax Court1954 Tax Ct. Memo LEXIS 298; 13 T.C.M. (CCH) 155; T.C.M. (RIA) 54055; February 17, 1954298 William Waller, Esq., American Trust Building, Nashville, Tenn., and Lawrence Dortch, Esq., for the petitioners. D. Z. Cauble, Jr., Esq., for the respondent. JOHNSON Memorandum Findings of Fact and Opinion JOHNSON, Judge: Respondent determined the following deficiencies in income tax: DocketPetitionerYearDeficiencyNo.44014Ben Travis Everett,Sr.1943$15,558.0319444,008.5119455,072.82194612,191.72194711,570.4944015Glen A. King194719,794.2644025Glen A. King andwife, KathleenKing194328,153.1019447,489.7919457,879.67194618,729.00194811,349.0744026Ben Travis Everett,Sr., and wife, AnnieEverett19485,428.18The sole issue is whether the partnership composed of Ben Travis Everett, Sr., and Glen A. King also included their respective children as partners. Findings of Fact Some of the facts are stipulated and are so found. Ben Travis Everett, Sr., and Annie Everett, husband and wife, reside at McKenzie, Tennessee. They filed separate individual returns for the years 1942 through 1947 and a joint return for 1948. Glen299 A. King and Kathleen King, husband and wife, also reside at McKenzie, Tennessee. They filed joint returns for the years 1943 through 1946 and for 1948. Glen A. King filed a separate return for the year 1947. All of the above returns were filed with the collector of internal revenue for the district of Tennessee. Ben Travis Everett, Sr., and Glen A. King will sometimes hereinafter be referred to as the petitioners. Petitioners from 1923 through 1941 were partners in the wholesale grocery business, retail grocery business, and milling business. The wholesale grocery business was operated under the name of "Cash Economy Wholesale Grocery Company"; the retail business, "U-Tote-Em Grocery Company"; and the milling business, "Keco Milling Company". At the time of the hearing there were 35 grocery stores in the business; however, during some of the years before us, there were 41 stores in the business. Petitioners were equal partners and operated under an oral agreement. King served as sales and advertising manager while Everett did most of the buying. Prior to 1938 each received an annual salary of $3,000. In addition to the salary, there was a distribution of profits in the ratio of the300 partners' capital accounts. However, in 1937, Everett, because of ill health, partially retired from the business and his salary was reduced to $2,400. Everett's salary remained at $2,400 through 1948 while King's salary was gradually increased so that in 1948 he received $10,152.10. Each of the petitioners has three children and the fathers planned that some day their children would take over the business. The three children of Ben Travis Everett, Sr., are: R. H. Freeman, a stepson; Ben Travis Everett, Jr., a son, and Sara Everett House, a daughter. Their ages in 1942 were, respectively, 37, 25 and 23. The three children of Glen A. King are: Adolph C. King, Jarrell V. King and Buford G. King. Their ages in 1942 were, respectively, 24, 22 and 16. In the early part of 1942 each father gave his children an interest in the partnership. Capital accounts were set up on the partnership books for each of the six children and each account was credited with $14,000; a corresponding debit amounting to $42,000 was made to each father's capital account. The balances in the capital accounts of each of the petitioners and the balances in the six capital accounts of each of the children for301 the years before us were as follows: PetitionersChildren(Two(Sixaccounts)accounts)December 31, 1941$187,805.19January 1, 1942145,805.19$14,000.00December 31, 1942158,601.7321,210.88December 31, 1943171,339.8630,370.72December 31, 1944171,339.8630,370.72December 31, 1945171,339.8630,370.72December 31, 1946206,882.8636,670.72December 31, 1947218,882.8640,670.72December 31, 1948249,315.0045,970.00The addition to the capital accounts for each year was based on a distribution of the net profit in the ratio of the parties' capital accounts. No salary was paid to the sons while they were in military service, or to the daughter. Additions were made to the personal accounts of the sons and daughter, but this money was used primarily for income tax payments. Sometime in 1942 Glen A. King happened to tell a lawyer, who did legal work for the partnership but was not on a retainer, of the new business arrangement. The lawyer advised him that written assignments to the children for their capital interests should be made. The lawyer was requested to and did prepare the documents. Each of the six assignments302 was executed by Ben Travis Everett, Sr., and Glen A. King; none were dated but each was "effective as of January 1, 1942." On June 4, 1952, Glen A. King filed for the partnership an "Employer's Application for Identification Number", Form SS-4, under the Federal Insurance Contributions Act. One of the questions on the application asked if the applicant had previously filed, and, if the answer was "Yes", to give the reasons for the new application. Glen A. King answered, "Yes", and then explained, "To reflect addition of new partners." On the application each of the fathers and the six children were named as partners. A new identification number was issued on June 13, 1942. Petitioners filed gift tax returns as of March 15, 1943. These returns reflected gifts of partnership interests valued at $14,000 to each of their sons and daughter. The two fathers, their sons and daughter reported as income and paid tax on their distributive share of the partnership net income for the years before us. In addition, partnership returns were filed for the business for each of these years. In the year 1942 petitioners and R. H. Freeman were the only ones authorized to sign checks or employ or303 discharge personnel. However, at a later date, sometime after 1946, the boys were authorized to make personnel changes. Sometimes petitioners were referred to as the "senior" partners, while the sons and daughter were referred to as "junior" partners. From January 1942 financial statements were prepared twice a year and distributed to petitioners and their sons and daughter. Copies of these statements were mailed to the boys while they were in military service. Because of the large inventory requirements, capital was important and necessary for the production of income from the business. There is no dispute concerning R. H. Freeman's relationship in the partnership. Respondent admits that he was a partner for the years before us. Respondent also admits that Adolph C. King and Ben Travis Everett, Jr., were partners in 1948. Adolph C. King, Jarrell V. King, Buford G. King and Ben Travis Everett, Jr., started working for the partnership in their early teens. They worked during vacations and on Saturdays because their fathers considered this work a necessary part of their early training. Up to the time of the hearing in 1953, except for the school periods and military service described304 below, each of the boys has devoted his full time to the business. Each has a responsible position, and each contributes a vital service to the business. Ben Travis Everett, Jr., attended the University of Tennessee and was graduated from Bethel College in 1938 or 1939. While in school he took courses in business administration and bookkeeping. After he was graduated he worked for the partnership on a full-time basis. He worked in the office and also as manager of one of the stores. In the early part of 1942 he entered the Army and was discharged in 1946. For three or four months after his discharge, and while recuperating from military service, he worked on his father's farm. Thereafter, he again worked as manager of one of the stores. In May 1947 he became general superintendent of 20 stores and continued in that capacity throughout 1948. Sara Everett House was married to Dee House. She did not work for the partnership but from 1937, which was after her marriage, her husband has continuously worked for the partnership. The petitioners considered that Dee House represented her interest in the business. Adolph C. King attended Riverside Military Academy in Georgia and later305 Vanderbilt University. While at Vanderbilt he received an appointment to the United States Naval Academy. In 1937 he entered the Naval Academy and was later graduated and commissioned. He was at Pearl Harbor when it was attacked and remained in the Navy on active duty until November 1946. Shortly before he was released from the Navy he took a correspondence course in bookkeeping. After his release he worked as assistant manager of the Jackson, Tennessee, store. Three months later he was promoted to manager of the store in Paris, Tennessee. He worked for the Paris store for three years and during this time he converted it into a supermarket. His salary on release from the Navy was in excess of $600 per month but his salary when he started working for the partnership, after his release from the Navy, was in the neighborhood of $35 a week. However, he also received a share of the net profits based on the ratio of the capital accounts. Jarrell V. King attended Vanderbilt University and majored in business economics. He was graduated in 1942. He entered the Army shortly after graduation and was discharged in 1946. Shortly after his release from service he attended a business university306 at Bowling Green, Kentucky, to renew his accounting ability. He remained in school for nine months and then went to work in the partnership office as assistant office manager. Because he was dissatisfied with the office work he was transferred to the milling department. He started as assistant mill superientendent but within two or three months he was given full charge of the milling department. Mill receipts increased in 1947 and 1948. The parties attribute some of the increase to his management. In 1942 Buford G. King was 16 years old and in high school. About a year later he entered the Navy and was discharged in July 1946. After his release he worked two or three months as assistant store manager. He then enrolled at Vanderbilt University in September 1946 and was graduated in 1950. During vacations he worked in the business. Petitioners and their respective sons, R. H. Freeman, Ben Travis Everett, Jr., Adolph C. King, Jarrell V. King and Buford G. King, and daughter, Sara Everett House, formed a partnership among themselves for the purpose of operating the business formerly operated by the two petitioners. It was the intention of the petitioners and their sons and daughter307 to join together in the beginning of 1942 in good faith for the purpose of carrying on a business and to share in the profits or losses. Opinion The issue is whether petitioners' sons and daughter may be recognized as valid members of the partnership in the years before us, 1942 through 1948. For these years R. H. Freeman was recognized by respondent as a partner and for 1948 respondent recognized Adolph C. King and Ben Travis Everett, Jr., as partners. There are many facts indicating the intention of the petitioners was to form a new partnership with their sons and daughter. The first and foremost of these facts was the gift of partnership capital which each of the fathers gave to his children. We think that there can be no doubt that there were valid gifts. The fathers testified as to the validity of the gifts and their intention to make them. The written assignments, the bookkeeping entries which properly recorded the transactions, the gift tax returns which were filed, and the distribution of partnership profits based on the gifts, indicate that the gifts were valid. Partnership intention was also manifested by the application for the social security identification number, 308 the partnership returns, and the payment of tax on the distributable share of each of the petitioners and their children. All of these actions were performed in the ordinary course of business, in good faith and without any evidence of sham or fraud. There is other evidence that indicates the bona fides of the petitioners' partnership intentions. The wives of petitioners and the spouses of the children were not included in the partnership arrangement. The fathers testified that they always wanted their children in the business and as proof of this the boys grew up in the business, worked in it on Saturdays and during summer vacations. Not only were the fathers' wishes that they wanted the children in the business a laudable parental trait, but it was also a very natural desire. See . The fact that the working partners received a salary and therefore participated in a more realistic distribution of partnership income supports the partnership intention more so than if the distribution was based solely on capital invested in the business. Further, there were no obstacles under state law which would preclude the business arrangement309 from being a partnership. Respondent does not dispute the fact that R. H. Freeman was a partner during all of the years before us. Nor does he dispute the fact that Adolph C. King and Ben Travis Everett, Jr., were partners in 1948. It is significant that the partnership interest of each of these three arose, as did the interest of the other children, in 1942. The only differentiating element between respondent's admitted partners and his disallowed partners is the individual's contribution of services. According to the respondent, where services were rendered, there was a partner; where services were not rendered, there was not a partner. In this case we doubt the validity of such a distinction. Here capital was material, important and necessary for the successful operation of the business, and here each of the children had capital invested in the business from 1942 through 1948. See . On the other hand, there is evidence or its absence which respondent contends refutes the existence of a partnership between petitioners, their sons and daughter. We do not think the absence of a written partnership agreement very important. Furthermore, 310 many partnerships are based on verbal agreements. Here the petitioners operated their various enterprises as a partnership for approximately 18 years without a written agreement. The inactivity of the sons and daughter during the first four years in the matters of management and policy making in the business does not disprove the existence of a partnership. The inactivity of the boys was due to the fact that they were in service; however, as we said before, while their personal services were absent their capital was active in the business. The same can be said for Sara Everett House. The fact that Buford G. King was only 16 years old in 1942 causes some difficulty in recognizing him as a valid partner, but, like the others, his capital was also invested in the business. Even though he was a minor, we believe that he was adequately represented by his father, his natural guardian. There might have been some question, because he was a minor, as to his liability for partnership obligations. However, such a question would not control the intention of the parties to form a partnership. After a careful review of the record and the evidence as a whole, we find that each of the petitioners311 and their sons and daughter contributed either services or capital, or both, in the formation of a partnership. Further, it is our opinion that each of the parties intended to join together in the present conduct of the business and that when they formed the partnership in January 1942 they acted in good faith with a valid business purpose. Because petitioners agreed to certain adjustments in the deficiency notices, a recomputation under Rule 50 is necessary. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623375/	KILLIAN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Killian Co. v. CommissionerDocket No. 37377.United States Board of Tax Appeals20 B.T.A. 80; 1930 BTA LEXIS 2203; June 16, 1930, Promulgated 2203 1. Neither the deduction of an item claimed by a corporation to be a business expense nor its disallowance depends upon whether it is a donation. 2. Items which may colloquially be called donations, because perhaps the recipient is a charity or the occasion is beneficent or the transaction is not approached in a formal manner with express legal consideration, may still have such a business significance as to justify their outlay and their recognition as business expenses, and their deduction is to be denied only when the evidence fails to establish that they are business expenses or that they are reasonably motivated by or related to the proper conduct of the business. 3. The revenue acts, beginning with the Act of 1916, have always provided for the deduction or ordinary and necessary business expenses of both individuals and corporations, and the provision authorizing the deduction by individuals of charitable contributions, added in 1917 and carried in subsequent acts, is to be construed as an enlargement of individual deductions and not as an implied denial to corporations of the deduction of any charitable contributions or donations however closely they may be identified2204 with the welfare of the business. 4. The business character of the item may not be proven by statements of the taxpayer's witnesses that in their judgment the donation is a business expense. There must be a more objective demonstration by reliable witnesses of the motive, character, and other circumstances of the payment or liability. 5. Where donations are made by a corporation as a consistent practice to numerous organizations, in varying amounts, and the evidence establishes such a direct relation to current business as to support their deduction, it is immaterial that some of the smaller items were prompted by a motive to build good will or to assure future trade. The test of the distinction between capital and expense should not be ruthlessly applied to small items which are sensibly charged off when made. George E. H. Goodner, Esq., for the petitioner. F. R. Shearer, Esq., for the respondent. STERNHAGEN 80 Respondent determined deficiencies in petitioner's income tax of $774.21 for 1923 and $1,422.43 for 1924. Among other items not in dispute, respondent disallowed for each year a list of deductions taken as ordinary and necessary2205 expenses and held by respondent to be donations and not deductible. FINDINGS OF FACT. The petitioner is an Iowa corporation organized in 1911, and ever since has conducted a department store at Cedar Rapids. Cedar 81 Rapids has a population of about 55,000. The store is the largest of its kind in the city and approximately one-half of its trade is drawn from the territory and villages within a radius of fifty miles. The petitioner's books are kept on the accrual basis. In 1911 the petitioner purchased the business, which was taken on the verge of bankruptcy, and the volume of business increased from $150,000 a year shortly after the business was acquired to from $2,000,000 to $2,250,000 in 1923 and 1924. In 1923 and 1924 the petitioner paid or incurred, among others, the following amounts which were charged to its general advertising account and the deduction of which was disallowed by the respondent: ItemAmount19231. P. Bailey, treasurer$ 3.002. Christmas Seals10.003. United Baptist Church5.004. C.R. Art Association25.005. Czech Reformed Church30.006. Convention Fund55.007. Bukele Concert20.008. T.P.A. Conv. Fund12.009. High School Band50.0010. Iowa Federation Colored Women25.0011. Marion Athletic Field25.0012. Iowa Conservation Assn10.0013. Jan Hus Church10.0014. Novak25.0015. Rock Island Shops5.0016. J. B. Brown (chairman)35.0017. Williamson, treasurer50.0018. Paris M.E. Church10.0019. Women's Club25.0020. St. Ludmillas School25.0021. Hiway Bureau100.0022. American Legion20.0023. First Baptist Church, Vinton25.0024. Mrs. H. F. Gresham10.0025. Coe College1,500.0026. A.M.E. Church5.00Total2,115.00192427. Mercy Hospital$ 499.9828. Engineer ladies2.2029. Valentine Party ticket1.1030. Employee Boys' Meeting10.0031. Sunshine Mission10.0032. Nemec. Treasurer25.0033. Music Com. tickets25.0034. L. H. Stubbs, treasurer50.0035. R. C. Toms, treasurer20.0036. Chatauqua tickets10.5037. Toddville Church5.0038. Burcanek, treasurer10.0039. Jan Hus Church16.3140. Drum Corps30.0041. Golden Rule100.0042. Clariec James, treasurer10.0043. Lenox College50.0044. Bertram Church15.0045. Fairfax Church10.0046. Walford Church5.0047. Palo Church5.0048. Volga Study Club10.0049. Stapanek, treasurer195.0050. St. James Church25.0051. Mrs. F. H. Floyd, president5.0052. John Ely, treasurer50.0053. St. Ludmillas10.0054. D. H. Kurtz, treasurer35.0055. Sundborg, treasurer10.0056. Coe College1,500.00Total2,750.092206 It was the general practice of the petitioner during the taxable years to make donations to a varied class of organizations and institutions. Donations to organizations of national scope, such as the Y.M.C.A., were charged to an account designated "Donations," and donations to organizations of a local character were charged to the general advertising account. The petitioner regarded donations of the latter class as a profitable method of advertising and they were a contributing factor in the rapid growth of the business and building up a valuable good will. Items 1-5, 7, 9, 10, 12-15, 18-20, 22-24, 26, 28, 30, 32, 33, 36-40, 42-48, 50, 51, 53, and 54, represent donations to, and purchases of 82 tickets for benefits and entertainments given by churches and church organizations in and about Cedar Rapids, and local public and private organizations such as social, literary, scientific, musical, athletic and fraternal organizations, and private schools. It is the custom of these organizations to solicit donations from the petitioner through their members or other interested persons. The solicitors and members and persons connected with the organizations or institutions2207 generally are customers of the petitioner and it is necessary for the petitioner to make the donation in order to retain their good will and avoid a loss of trade. The donations were made not only to maintain the business which petitioner already had, but also to create new business. Items 25 and 56 represent donations toward the support of Coe College, a private educational institution in Cedar Rapids. The college in 1923 and 1924 had a student body numbering about 900 and a faculty of 25 or 30. About 80 per cent of the students come principally from the State of Iowa and some from other States. The college is dependent, to a large extent, upon local support, and it is the practice to conduct a campaign for funds every four years. The merchants of the city support the campaign, and the amounts contributed by them are influenced by the amount contributed by the petitioner, which is the leading department store in the city. The purpose of the petitioner in making the contribution is to assure the continuation of the college in the community. The contributions are in the form of a five-year pledge - a nonnegotiable promise to pay the amount of the pledge in annual installments. 2208 These items represent payments in 1923 and 1924 on a five-year pledge of $7,500 made prior to those years, and it was the practice of the petitioner to enter the amount of each payment on its books only at the time of payment. The students and faculty generally were customers of the petitioner, and they and those visiting them add to the purchasing power of the community. During the ten months of the year when the college is in session the petitioner's business is greater. The petitioner regards this contribution as an inexpensive form of advertising and the resulting benefit is greater than that generally derived from the expenditure of an equivalent amount for newspaper advertising. The profit on business transacted annually with the students and faculty is difficult to approximate, but it is far in excess of $1,500 a year. The student body is a shifting personnel, and, in addition to the knowledge obtained by the students of the fact of this contribution through the work of students on the campaign and announcements of the campaign committee, the petitioner's store is recommended to the new students by the faculty. Item 52 represents a donation to a special fund raised2209 for the purpose of retaining the services of an assistant to the president of 83 Coe College. It was solicited by one of the members of the college board who was a customer of the petitioner. Item 27 represents the amount actually paid and payable in 1924 on a pledge toward a $200,000 fund for the expansion of the Mercy Hospital, which was a Catholic institution. About one-third of the population of Cedar Rapids is Catholic, and the petitioner has a large Catholic trade. The pledge was solicited in person by several sisters. The church itself rarely solicits donations, and this donation was comparatively large for the reason that the Catholic organizations had not solicited petitioner for a long time. Items 6, 8 and 16 represent contributions to funds raised for the purpose of bringing conventions to Cedar Rapids. The conventions attract many people to the city and during the sessions the dining room and other departments of the petitioner's store are well patronized by them. There is always a proportional increase in the business in excess of the amount of the contribution. Items 21 and 34 represent contributions to secure the improvement of roads leading into2210 Cedar Rapids. During the year 1923 the roads were unimproved and an organization was formed in the city to influence the authorities in having the roads paved. During 1924 the local chamber of commerce also raised a fund to promote the building of roads and influence the routing of them over certain districts. The petitioner made contributions to each of these funds. The unimproved roads were impassable during part of the winter months and at such times residents of the surrounding country were prevented from coming to Cedar Rapids to trade. After the improvements were made, the roads were kept open all the year round and, in the months corresponding to those in which the roads previously were impassable, the business of the petitioner was better. Item 11 represents a donation to a fund solicited by the community club of the town of Marion for a public baseball field. The town is five miles from Cedar Rapids and many of its citizens trade in the petitioner's store. Item 35 also represents a donation solicited by the Marion Community Club for another purpose. OPINION. STERNHAGEN: The respondent disallowed the deduction of all the items listed in the findings. He now2211 concedes that item 49 is deductible and petitioner concedes that items 17, 29, 31, 41 and 55 are not deductible. As to item 27, respondent questions its accrual in 1924. The petitioner contends that all of the items were ordinary and necessary expenses paid or incurred in the respective years in carrying 84 on its trade or business and hence deductions under sections 234(a)(1), Revenue Acts of 1921 and 1924. Respondent's explanation stated in the notice of deficiency is that the amounts are "donations." In our opinion, neither the deduction of an item by a corporation nor its disallowance depends upon whether it is a donation. The Board has frequently held that the deductibility of items such as this depends in each case upon the particular evidence to prove its relation to the proper conduct of petitioner's business. Items which may colloquially be called donations, because perhaps the recipient is a charity or the occasion is beneficent or the transaction is not approached in a formal manner with express legal consideration, may still have such a business significance as to justify their outlay and their recognition as business expenses. When by adequate evidence2212 they are shown to be such, they are deductible as any other ordinary and necessary expense; and when the evidence fails to establish this or shows in fact that the donations are not reasonably motivated by or related to the proper conduct of the business, the deduction must fail. We can not agree that because the statute expressly provides for their deduction by individuals in section 214(a)(11), Revenue Act of 1921 and section 214(a)(10), Revenue Act of 1924, it impliedly disallows to corporations the deduction of any charitable contributions or donations, however closely they may be identified with the welfare of the business. See ; ; . The statute has always provided for the deduction of ordinary and necessary business expenses of both individuals and corporations. This was true under the Act of 1916, sections 5 and 12. As to individuals, a new deduction was added by section 1201, Revenue Act of 1917, for charitable contributions or gifts not exceeding 15 per cent2213 of the individuals' taxable net incomes; and so the statute continued. This, we think, must be construed as an enlargement of individual deductions and not as a denial to corporations of the deduction of such of their ordinary and necessary business expenses as might be characterized as donations. The question in each case being one of evidence, the difficulty lies in the nature and quality of the evidence to prove the business character of the item. It can not be that the administration of this provision of the statute is to depend upon the taxpayer's statement that in his judgment the donation is a business expense nor upon the Commissioner's statement to the contrary. There must be a more objective demonstration by reliable witnesses of the motive, 85 character, and other circumstances of the payment or liability in order to establish its direct relation to current business. While the standard of such evidence can not be precisely described, it is controlled by substance to which the Board may devote its consideration and not by mere assertion. Upon a record containing reliable evidence of facts and circumstances, the Board is in a position to decide whether the2214 item is a business expense. In the present case, the record contains a full disclosure of the circumstances of each item in dispute. Other items of donations were not attempted to be deducted because petitioner regarded them as not closely enough related to current business to bring them within the statute, while some which were deducted were later withdrawn from dispute. Upon the whole record, we are of opinion that most of the disputed items were in fact so directly related to current business as to support their deduction. We say this despite the fact that there is some expression as to some of the smaller items that they were prompted by a motive to build good will or to assure future trade. Of course, a substantial outlay to secure or to build up good will might be of such a capital nature that it should not be charged off as a business expense against the income of a single year. Cf. . But such a test of the distinction between capital and expense should not be ruthlessly applied to small items which are sensibly charged off when made. We think, however, that the contributions to Coe College (Nos. 25 and 56) were*2215 not minor items. They were made for petitioner's lasting benefit and not as current advertising. As in , the deduction of $1,500 in each year to Coe College can not be sustained. Nor can item 27 to Mercy Hospital be deducted. The contributions to improved highways, items 21 and 34, are not ordinary and necessary expenses of the business of the year, but are of lasting benefit in common with the entire community. They may not be deducted. ; ; . We therefore hold that, except items 17, 21, 25, 27, 29, 31, 34, 41, 55 and 56, all the items listed in the findings were ordinary and necessary business expenses and proper deductions. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623377/	Jack Pershing Stanton and Virginia Gail Stanton v. Commissioner.Stanton v. CommissionerDocket No. 3135-66.United States Tax CourtT.C. Memo 1967-137; 1967 Tax Ct. Memo LEXIS 125; 26 T.C.M. (CCH) 618; T.C.M. (RIA) 67137; June 23, 1967Jack Pershing Stanton, pro se, 635 Val Lena, Houston, Tex., Thomas S. Loop, for the Respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined income tax deficiencies against petitioners for the years 1960 and 1962 in the respective amounts of $99.60 and $1,154.82. The only issue for decision is whether the petitioner, Jack Pershing Stanton, was engaged in a trade or business as an inventor so that certain expenditures pertaining to the construction of a "StormSafe" boat qualify for deductions as research and experimental expenses under the provisions of section 174, Internal Revenue Code of 1954. 1Findings of Fact Some126 of the facts were stipulated by the parties and are so found. Jack Pershing Stanton (hereinafter called petitioner) and Virginia Gail Stanton are husband and wife who resided in Houston, Texas, at the time they filed their petition herein. They filed their joint Federal income tax returns for the taxable years 1960, 1962, and 1963 with the district director of internal revenue at Austin, Texas. Petitioner attended the University of Illinois where he majored in chemical engineering. He obtained 126 of 135 hours of credits required for a degree. During the summer of 1942, while enrolled at the University of Illinois, the petitioner worked for General Motors Corporation in its research division. He has been a registered professional engineer since 1946. Upon leaving the University of Illinois in June 1943, the petitioner was employed by the Pure Oil Company for about 8 years. Five of these years he spent in the research department. From 1943 to 1948 he served as a research engineer; from 1948 to 1949 he was acting assistant superintendent of the gasoline plant at Van, Texas; and in 1949 and 1950 he was resident chemist at the sulfur recovery and gasoline plant in Worland, Wyoming. 127 From 1950 to 1952 he was employed as an engineer with the Commercial Testing and Engineering Company in Chicago. In 1952 he entered the employment of Nalco Chemical Company and its wholly owned subsidiary, Visco Products Company. He worked for these two companies for 10 years. Petitioner managed the new products department of Nalco and the corrosion control department of Visco. During most of this period he was a petroleum chemist. In 1960 the petitioner was sent by Nalco to South America where he served as regional manager for the countries of Argentina, Chile, Uruguay and Brazil. He resigned from Nalco Chemical Company in May 1962. In September 1962, petitioner began a business called American Coordinated Technologists in which he was an industrial representative for the sale of furnaces and air filters. He also became a manufacturer's representative for Holden Furnaces and Cleveland Hydraulic Cylinder Company. In October 1963, he began working for Oilfield Research Inc. where he stayed for four and one-half months. In February 1964, he went to work for Cochran Chemical Company in Oklahoma. About five months later he formed the Chemical Division of American Coordinated Technologists128 which manufactures, develops and markets oilfield chemicals. During his career the petitioner has had several special and technical assignments, i.e., special research engineer to the Technical Advisory Committee, Petroleum Administration for War; member of the Wright Air Force Base Committee on Thermal Stability of Jet Fuels; a lecturer at universities on "Corrosion and Its Control;" and a guest speaker for the National Association of Corrosion Engineers. Petitioner has written several technical articles for the following publications: Power, Petroleum Engineer and World Oil. Since college days the petitioner has had an interest in inventive activities. At the University of Illinois he collaborated with Dr. Thomas Baron or a project entitled "Improved Method of High-Speed Electroplating." In 1946 he disclosed by personal letter his electroplating idea to W. B. Ross of the Pure Oil Company. While employed by Pure Oil he filed disclosures with the company on a standard form covering: (1) an improved caster; (2) an improved method of sweetening mixtures of hydrocarbon oils; (3) mercaptan conversion in hydrocarbons; (4) purification of light hydrocarbons; and (5) an improvement in129 the mercapsol process. While with Pure Oil the petitioner obtained a patent on the removal of color from sweetened hydrocarbons. He had obtained no other patents. Beginning about 1950 the petitioner entered various ideas in a notebook (labeled by him as "Invention Record Book") which he considered as a potential source of various inventions. No ideas contained in the notebook have ever been developed or marketed. In July 1960 he discussed his invention ideas with Walter and Alice Church for the purpose of forming a joint venture to exploit such ideas. However, very little has been done since that time to pursue the objective. While employed by Nalco Chemical Company the petitioner made the following disclosures: (1) an improved chemical agent for stabilizing middle-distillate fuel oils against formation of objectionable color and sludge during storage and (2) an oil well circulator. With both Nalco and Visco the petitioner signed agreements obligating himself to assign his right, title and interest in any inventions arising out of his employment with those companies. No ideas which the petitioner formulated while employed by various corporations from 1943 through 1962 were released130 to him as his own property. Nor has the petitioner received any royalty or other income from any of his ideas. In early 1962, while on the island of Tierra del Fuego, the petitioner conceived the idea of the "StormSafe" boat, utilizing an unconventional design of hull construction. In March 1962 he drafted the first plans for the boat, which he called the "Cradle-Craft." In May, after resigning from Nalco, the petitioner visited various manufacturers of marine motors, such as the Gray Marine Motor Company. In July 1952, he and his sons began in the back yard of their Houston home the construction of a prototype of a "StormSafe" boat. 2 The hull construction process was unique in that metal sheets were used. Petitioner employed welders. He consulted an electromechanical engineer. He paid his younger son to construct a 48 inch scale model of the "StormSafe" hull concept. 131 After the experimental prototype of the "StormSafe" hull had been formed, square holes were cut in the side of the hull, hinged doors constructed and inserted in the holes and home-fabricated hydraulic equipment and wheels inserted in the hull and a watertight, retractable-wheel-cabinet built in the hull. The purpose of these fabrication steps was to determine the practicality of developing amphibious versions of the "StormSafe" hull concept. Petitioner contacted the United States Navy, the Small Business Administration, and a Thomas Matthews and others in attempts to obtain financial and other assistance in completing the "StormSafe" boat. He was unsuccessful. Petitioner made a preliminary patent search in Stillwater, Oklahoma, with respect to the features of the boat. He has never employed a patent attorney or filed a patent application covering the features of the boat. At the end of 1963 the "StormSafe" boat was not considered marketable. It was not proven to be operational in water during 1962 or 1963. It did not have anti-roll stability. In 1962 and 1963 the petitioner spent $5,935.16 and $1,148.92 on the construction of the boat. In 1962 and 1963 the amounts of $4,135.76132 and $1,969.88 were claimed by the petitioner in his income tax returns as research and experimental expenses incurred in carrying on a trade or business. Respondent disallowed the claimed losses with the following explanation: It is determined that the activities of "Storm-Safe Boat Builders" did not constitute the operation of a trade or business, and the loss claimed is disallowed. Petitioner was not engaged in the business of inventing or boat building for profit in the years 1962 and 1963. Opinion Petitioner seeks to deduct research and experimental expenditures made in constructing the "StormSafe" boat. He argues that he was an established inventor who was in the trade or business of "inventing for profit" during and prior to the years 1962 and 1963. Petitioner's position is summarized in the following two paragraphs contained in his original brief: The petitioners call the attention of the Court and the Commissioner to the importance of invention, research and development to national security an national progress. Failure of the Commissioner to recognize that invention, research and development are inherently of non-predeterminable duration and cost, and frequently133 produce processes or products of indeterminate life, leads to tax rulings which are stifling to such enterprise. The application, to inventing-for-profit, of the same criteria as applied to a business such as a grocery store establishment, which normally involves a shortterm, predictable period of "preparation to enter the business", is inimical to invention and can lead to great hardship for the ardent inventor. The normal tendency in invention, research and development is to pour all available funds into a promising development or idea (particularly because market-timing, and competition for earliest date of filing for patent protection, are vital to success). Also, the tendency is to be optimistic in estimating time-lapse to initial sales. Therefore, the individual, private or corporate, who expected to derive sales from, or to abandon, a project in a given year, frequently finds that time required to get results is longer than anticipated… or uncovers a new finding which advises expansion of the investigation before attempting marketing. Respondent, on the other hand, claims that the petitioner was not in the trade or business of inventing for profit or of building a boat134 for profit prior to or during the years in question. The specific provision for the deduction of research and experimental expenses was first enacted in 1954 as section 174.3 Under this section taxpayers may elect to deduct research and experimental expenditures which are paid or incurred during the taxable year in connection with a trade or business. It is clear that the benefits of section 174 are intended to be used in the realistic and practical sense of a going trade or business. See Martin Mayrath, 41 T.C. 582">41 T.C. 582 (1964), affd. 357 F. 2d 209 (C.A. 5, 1966); John F. Koons, 35 T.C. 1092">35 T.C. 1092 (1961); and 100 Cong. Rec. 3425 (1954).In order to prevail the petitioner has135 the burden of connecting such expenditures to an existing trade or business. From the entire record we think the petitioner has failed to establish that his activities which gave rise to the expenditures constitute the conduct of a trade or business of inventing preponderance of the evidence supports this conclusion. What constitutes a trade or business is, of course, a question of fact to be determined from all the facts and circumstances in each case. Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212 (1941); and Martin Mayrath, supra.Certainly one may be engaged in business as an inventor, with the expectation of profitable exploitation of one's inventions through royalties, sale of patents or otherwise. Cf. Harold T. Avery, 47 B.T.A. 538">47 B.T.A. 538 (1942), where the taxpayer, who for a period of 17 years procured 12 patents, sold or granted rights in 5 patents, and was determined to have held such patents in the ordinary course of his business. By contrast, however, see John F. Koons, supra, where the taxpayer was not in an existing business as an136 inventor; and Industrial Research Products, Inc. 40 T.C. 578">40 T.C. 578 (1963), in which this Court said that the "mere working on inventions during the year in question with no activity of offering them for sale or license would be insufficient to show engagement in an inventing business." Neither the petitioner's testimony 4 nor the documentary evidence persuades us that he was engaged in the business of inventing. All in all, there is simply insufficient proof to convince us otherwise. In our view the facts in this case lend themselves to that line of cases holding that expenditures made in investigating a potential new trade or business, or preparatory to entering into such business, are not deductible. McDonald v. Commissioner, 323 U.S. 57">323 U.S. 57 (1944); John F. Koons, supra; Eugene H. Walet, Jr. 31 T.C. 461">31 T.C. 461 (1958), affd. 272 F. 2d 694 (C.A. 5, 1959); and Morton Frank, 20 T.C. 511">20 T.C. 511 (1953). Although the petitioner had137 a conglomeration of ideas set out in his so-called "Invention Record Book," not a single idea has ever been developed and none has ever reached the market place. He has never received any income from any of these ideas. All disclosures of ideas and inventions made while petitioner was in the employment of Pure Oil Company, Nalco and Visco became the property of the corporations. None of these ideas or inventions were released to him as his own property. From the record it appears that from 1943 to May 1962 the petitioner was never selfemployed. With respect to the "StormSafe" boat we regard the petitioner's activities as sporadic and not of sufficiently sustained character to qualify as engaging in the trade or business of an inventor or as a boat builder. The petitioner had built only a rowboat prior to 1962. He never attempted to obtain a patent on the hull design of the "StormSafe" boat. He never consulted a patent attorney. He testified that the boat in its experimental stage was not marketable. Its feasibility has never been proven. None of petitioner's exhibits show that any attempt was made to market the boat, but only show unsuccessful attempts to raise investment capital. 138 Petitioner frankly admitted that he did not expect to realize a profit from the boat during the years in issue. He even conceded that it was not marketable at the time this case came to trial. In short, there has been no serious attempt by petitioner to profitably exploit the "StormSafe" boat or, for that matter, any other inventions, and any expectation of profit in his mind borders on the brink of pure speculation. See Lamont v. Commissioner, 339 F. 2d 377 (C.A. 2, 1964); and Margit Sigray Bessenyey, 45 T.C. 261">45 T.C. 261 (1965), affd. 379 F. 2d 252 (C.A. 2, June 1, 1967). Moreover, even if we were to assume that the petitioner is in the business of inventing, there is a point beyond which his propensity to experiment with the "StormSafe" boat must be viewed as taking on some of the characteristics of a hobby. Cf. Martin Mayrath, supra. Accordingly, in light of all the facts and circumstances disclosed by this record, we are constrained to hold that the petitioner has failed to prove he was in an existing trade or business of inventing or of boat building during the years 1962 and 1963. Cf. Myron Edwin Cherry, T.C. Memo. 1967-123139 (June 2, 1967). Decision will be entered for the respondent. Footnotes1. All references herein are to the Internal Revenue Code of 1954 and the regulations promulgated thereunder.↩2. In a letter to Gray Marine Motor Company dated July 30, 1962, the petitioner described the boat as follows: You will recall my stating that a major portion of the StormSafe hull is formed by an unusual process of winding two continuous sheets of hull-forming material into a futuristic, seabass-like shape. The boat itself is unusual in that all its surfaces, including its top deck, are smoothly curved for ideal distribution of applied stresses and in that a major portion of the hull is formed from two coil sheets without cutting to shape and with only two short seams (at the stern). We have decided to build our production prototype of aluminum and to propel it with an inboard-outboard drive. We are forming a 31 footer having a double wall with interior ribs of square aluminum tubing and insulated with polyurethane foam.↩3. SEC. 174. RESEARCH AND EXPERIMENTAL EXPENDITURES. (a) Treatment as Expenses. - (1) In General. - A taxpayer may treat research or experimental expenditures which are paid or incurred by him during the taxable year in connection with his trade or business as expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as a deduction.↩4. We do not doubt petitioner's credibility. He impressed us as a sincere and candid person.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623378/	The Stuart Company v. Commissioner.Stuart Co. v. CommissionerDocket No. 12473.United States Tax Court1950 Tax Ct. Memo LEXIS 160; 9 T.C.M. (CCH) 585; T.C.M. (RIA) 50171; June 30, 1950160 On the facts, held, that $75,000 paid by the petitioner to secure the cancellation of an onerous contract is properly deductible during the fiscal year 1943 as an ordinary and necessary business expense, and that $122,700 which the petitioner was obligated to pay for the purchase of a trade mark is a capital expenditure which is not deductible as an ordinary and necessary business expense. A. Calder Mackay, Esq., Arthur McGregor, Esq., and F. Edward Little, Esq., 728 Pacific Mutual Bldg., 523 West Sixth St., Los Angeles, Calif., for the petitioner. R. E. Maiden, Esq., for the respondent. HARRON Memorandum Findings of Fact and Opinion The Commissioner has determined deficiencies in the petitioner's income tax, declared-value excess profits tax, and excess profits tax161 for the fiscal years ended March 31, 1943, March 31, 1944, and March 31, 1945, as follows: Declared-ValueExcessExcessFiscal YearIncomeProfitsProfitsEndedTaxTaxTaxMarch 31, 1943$1,733.81$ 263.70$ 8,495.95March 31, 194452,808.66March 31, 1945287.136,591.8068,286.82The issue in this proceeding is whether certain payments made by the petitioner during the years in question were made, either in part or in whole, to secure the cancellation of an onerous contract; or whether they were made, either in part or in whole, for the purchase of a trade-mark. The respondent contends that the entire payments were capital expenditures made to purchase a trade-mark and has asserted the above deficiencies. The petitioner contends that the entire payments were ordinary and necessary business expenses made to secure relief from an onerous contract and claims an overpayment in his taxes for the years in question. The parties are in agreement on a number of other issues raised by the pleadings relative to adjustments in the petitioner's taxes for the years in question which are dependent upon the decision of the main issue162 in the proceeding. The petitioner filed its returns for the years in question with the collector for the sixth district of California. The record in this proceeding consists of oral testimony and various exhibits. Findings of Fact Sometime in the fall of 1940, Arthur Hanisch, who was the principal organizer and stockholder of The Stuart Company, which is the petitioner herein, decided to go into business in California. In December of 1940, Hanisch was introduced to Dr. Henry Borsook, who was a professor of biochemistry at the California Institute of Technology, and Maxwell H. Lewis, who was the vice president of The Vita-Food Corporation (hereinafter referred to as "Vita-Food") which had been organized under the laws of California in November, 1940. Dr. Borsook was interested in providing adequate vitamin concentrates to the greatest number of people at the lowest possible cost and had done a great deal of research in vitamins and in nutrition. He was a consultant to Vita-Food which manufactured and distributed locally at this time a vitamin concentrate which had been developed under the supervision of Dr. Borsook. Vita-Food was primarily interested in the manufacture of163 the vitamin concentrates and desired to associate itself with someone who would be willing to undertake national distribution of its vitamin products. Accordingly, on February 3, 1941, Hanisch entered into an informal agreement with Vita-Food which provided that Hanisch was to set up a sales and merchandising organization to distribute the vitamin concentrate produced by Vita-Food at stipulated retail prices. Hanisch agreed to purchase 3,000 gallons of the vitamin concentrate from Vita-Food and to market it under a trade name which would remain the property of Vita-Food. On March 8, 1941, Hanisch entered into a subsequent informal agreement with Vita-Food under which he agreed to purchase an additional 3,000 gallons of the vitamin concentrate. This agreement also provided that: "We [Vita-Food] understand that you [Hanisch] are in process of forming two corporations, one to be named 'The Shaler Food Products Company', which company will sell to food outlets, under the name 'Vitaplex' the concentrate purchased by you under our said letter of February 3rd, upon condition that such outlets sell the same to consumers at a price not in excess of $1.60 per 16 oz. bottle; and the other164 to be named 'The Stuart Company', whose sales will be confined to drug stores and allied outlets [under the name 'The Stuart Formula'] for resale at a price not in excess of $1.85 per 16 oz. bottle. "We further understand it is your desire, and it is agreeable to us that, as soon as these corporations have been organized, separate written contracts will be entered into between them and ourselves embodying the applicable matters above set out as well as the conditions of future purchases and sale by them of said product in accordance with understandings had at our recent conferences." By March 27, 1941, Hanisch had completed the organization of the two corporations; and The Stuart Company, which was named after Hanisch's younger son, was incorporated under the laws of California on that date. This corporation, which is the petitioner herein, was organized to distribute the vitamin concentrate manufactured by Vita-Food under the trade name "The Stuart Formula" by making a personal approach to doctors and inducing them to recommend the product to their patients. "The Stuart Formula" was never advertised to the public and was sold only in drug stores. During the years in question, 165 The Stuart Company kept its books and filed its returns on an accrual basis of accounting. Its fiscal year ended on March 31, of each year. Hanisch paid $1,000 to The Stuart Company in exchange for its entire authorized capital stock of 1,000 shares at a par value of $1 per share. Hanisch then transferred 250 shares of stock to two of his associates in the organizing of the corporation and transferred 150 shares to Maxwell H. Lewis, as the representative of Vita-Food. He retained 600 shares for himself. Between May 5, 1941, and November 28, 1942, Hanisch loaned $70,000 to The Stuart Company for working capital. The Shaler Food Products Company, named after Hanisch's older son, was also incorporated under the laws of California on March 27, 1941. It was organized to distribute through grocery stores a similar vitamin concentrate manufactured by Vita-Food under the trade names "Vitaplex" and "Calplex." "Vitaplex" and "Calplex" were advertised directly to the public. Hanisch paid $1,000 to The Shaler Food Products Company in exchange for its entire authorized capital stock of 1,000 shares at a par value of $1 per share. Hanisch then transferred 250 shares of stock to two of his166 associates in the organizing of the corporation and transferred 150 shares to Maxwell H. Lewis, as representative of Vita-Food. He retained 600 shares for himself. On May 5, 1911, The Stuart Company and The Shaler Food Productscompany as first parties, Vita-Food as second party, and Hanisch as third party, entered into a formal written contract which memorialized the prior informal agreements between Hanisch and Vita-Food. This contract provided, inter alia: "2. THE STUART COMPANY, one of first parties, agrees that the concentrate received by it under said contract of March 7, 1941, will be sold and distributed under second party's trademark or label 'THE STUART FORMULA' and/or under such other of second party's trademarks or labels as may be mutually agreed upon by first and second parties, to retail at $1.95 per pint bottle plus any applicable sales tax: "3. SHALER FOOD PRODUCTS COMPANY, one of first parties, agrees that the concentrate received by it under said contract of February 3, 1941, will be sold and distributed under second party's trademark or label 'VITAPLEX' and/or under such other of second party's trademarks or labels as may be mutually agreed upon by first and167 second parties to retail at $1.59 per pint and 69" per 5 fluid ounces, plus any applicable sales tax. "4. First parties shall, within a reasonable time, undertake and carry on at their sole expense, an appropriate and adequate sales campaign for the purpose of creating and maintaining a satisfactory market for such products. "5. Except as herein otherwise provided, the products of second party shall be sold for commercial use and resale only through first parties, but it is understood that second party can not economically operate its plant at an average production of less than 2,000 pints per day of all items and the prices to be paid to second party for its said products as hereinafter set out are based upon this fact. * * * "6. First parties shall have the exclusive right to sell said VITAPLEX and STUART FORMULA until November 1, 1941. Such right shall continue thereafter until and unless terminated by written notice from second party, provided, however, that such termination shall not become effective until and unless during any sixty day period between said November 1, 1941, and May 1, 1942, the combined purchases of such products by first parties from second party shall168 not have averaged fifteen hundred pints per day, or unless during any sixty day period after said May 1, 1942, such purchases shall not have averaged two thousand pints per day; and provided further, the date of any such termination shall be not less than sixty days from and after such notice of termination of said right. In determining performance hereunder consideration shall be given to purchases by first parties from second party of any other products on a dollar basis at the prices paid therefor. First parties shall not be held to strict performance hereunder if such failure is due to conditions beyond their control, such as adverse legislation, strikes and/or delays in transportation. "7. First parties shall handle no other products than those manufactured or produced by second party, and shall be the sole distributors of all products manufactured or produced by second party except as herein otherwise provided. * "10. Any and all trademarks or labels under which the concentrates hereinbefore specifically described or any other products manufactured by second party which may hereafter be marketed or distributed or offered for sale by first parties or either thereof, 169 shall at all times be and remain the sole and exclusive property of second party, and the right or rights of first parties to distribute and or market or offer for sale such products or any other product hereafter produced by second party shall continue only so long as this agreement is in full force and effect. "11. Second party shall not directly or indirectly sell any of its products to any person, firm or corporation other than first parties, save and except the product now being marketed under the name 'VITALL' in Los Angeles County. * * * "12. Second party agrees to fill all orders placed by first parties as promptly as possible consistent with the receipt of materials, conditions of labor, and other matters within its control. * * "19. This contract shall remain in full force and effect for the period of ten years from and after the date hereof, and may be extended at the option of first parties for an additional period of ten years by written notice to second party, * * provided, however, that this contract may be terminated by second party if for any sixty consecutive days, at any time after November 1, 1941, first parties shall not have purchased the minimum170 quantities of products hereinbefore specified in paragraph 6 (six) hereof, upon sixty days notice of intention so to do, unless during such sixty-day period any such deficiency shall be removed and the minimum quantities aforesaid ordered and paid for; otherwise, all rights of first and third parties hereunder shall cease at the expiration of the sixty-day period specified in such notice of termination." Vita-Food experienced certain difficulties during 1941 in the manufacture of the vitamin concentrates which it supplied to The Stuart Company and to The Shaler Food Products Company for distribution. The bottled product sometimes became gaseous from exposure to the sun and exploded or ran over the sides of the bottle. The total damage was less than 1 per cent of the gross sales of the vitamin concentrates. Vita-Food made complete restitution of all damage caused, and by the end of 1941 had solved the problem by making a minor change in the formula. On June 23, 1942, a certificate of registration of the trade-mark "The Stuart Formula" was issued to Vita-Food by the Secretary of State of California. On September 8, 1942, the United States Commissioner of Patents issued to Vita-Food171 a certificate of registration of the trade-mark "The Stuart Formula" in accordance with an application under the Trademark Act of 1920 which had been made by Vita-Food on May 15, 1941. The operations of The Shaler Food Products Company were never successful and that corporation was merged with the petitioner on July 3, 1942. The petitioner subsequently received permission from the Commissioner of Corporations to increase its capital stock by 1,000 shares, and these additional shares were issued to its original stockholders in proportion to their holdings. As early as February, 1942, the petitioner began negotiations with Vita-Food in order to modify the contract of May 5, 1941. Petitioner desired to acquire an express owner's interest in the trade-mark and wanted to obtain lower purchase quotas and lower purchase costs. In August, 1942, the petitioner informed Vita-Food that it would not undertake an extensive sales promotion campaign unless it was given an interest in the trade-mark. On August 10, 1942, Vita-Food submitted a redraft of the contract to the petitioner, in which the petitioner was given a conditional one-half interest in the trade-mark, provided its sales reached172 and maintained a certain level. The petitioner rejected this redraft because it was not given a one-half interest in the trade-mark in fee simple and because the cost and the purchase quotas were not satisfactorily adjusted. In September, 1942, Hanisch was informed that it was possible to obtain the vitamin products which were being supplied to The Stuart Company by Vita-Food for approximately one-half the price that Vita-Food was charging. Thereupon, Hanisch made an independent investigation of the price at which comparable products could be obtained from other manufacturers and discovered that they were available at substantially lower prices. The petitioner was never able to meet the purchase quotas called for by paragraph 6 of the contract of May 5, 1941, and on October 8, 1942, Vita-Food served written notice on petitioner that since "you have failed to meet your quotas for the 60-day period from and after August 1, 1942, * * your exclusive right to sell under the said contract is hereby terminated in accordance with paragraph 6 thereof. This termination shall be effective sixty (60) days after the service of this notice. In all other respects, the contract remains in full173 force and effect." On October 12, 1942, the petitioner informed Vita-Food that: "We shall endeavor to the best of our ability to reinstate the contract dated May 5, 1941 by removing the shortages in quotas. However, in fairness to you, we should inform you that we do not believe this will be possible. "If we are unable to reinstate the contract we shall regard it as terminated for all purposes, at the expiration of 60 days from date of notice, in accordance with the provisions of Paragraph 19 thereof which incorporates Paragraph 6 of the contract. "You having given notice of termination the same is accepted in accordance with the provisions of the contract and we do not concede the existence of any such intermediate procedure as you suggest. No attempt on your part to withdraw the notice will be recognized." The petitioner then consulted three trade-mark counsel on the question of the ownership of the trade-mark. "The Stuart Formula." Two of the opinions received were to the effect that the ownership of the trade-mark was in Vita-Food; one of the opinions declared that in so far as the contract of May 5, 1941, purported to invest in Vita-Food the title to the trade-mark it174 was a nullity, and that the registration of the trade-mark by Vita-Food was cancellable upon application by the petitioner to the United States Patent Office. The petitioner and Hanisch, acting individually, began a series of conferences with Vita-Food on November 18, 1942, in order to settle their differences. These conferences were unsuccessful, and on November 23, 1942, the petitioner and Hanisch sent to Vita-Food a notice of rescission of the contract of May 5, 1941, based upon fraud in the inception of the contract and failure of consideration in its performance. On November 25, 1942, Vita-Food filed suit in the Superior Court of the State of California for the County of Los Angeles, in which it asked that court to permanently enjoin the petitioner and Hanisch from using the trade-mark "The Stuart Formula" upon any product not manufactured by Vita-Food. On November 25, 1942, the court issued a restraining order temporarily enjoining the petitioner from using the trade-mark, as requested by Vita-Food, and ordered the petitioner to appear on a specified date and show cause why the restraining order should not be made permanent. Prior to the expiration of the time for the filing175 of an answer by petitioner, negotiations were resumed between petitioner and Vita-Food, and a settlement of the difficulties between the parties was reached. This agreement was entitled "Agreement of Settlement of Litigation and Cancellation of Contract," and provided: "It is hereby agreed by and between The Vita-Food Corporation, first party, The Stuart Company, second party, and Arthur D. Hanisch, third party, as follows: "Whereas an action is now pending in the Los Angeles County Superior Court by first party as plaintiff against second and third parties and others as defendants, being Action No. 482045, and Whereas the parties hereto did on May 5, 1941, execute an agreement in writing to which reference is hereby made for full details, and Whereas the parties hereto desire to settle and adjust all their disputes and differences against and with each other whether involved in said pending litigation or otherwise, so that said action can be dismissed, said contract cancelled and terminated, and Whereas said litigation involves the dispute, among other things, as to the claim of second party to the ownership of a trade mark, 'The Stuart Formula', which trade mark second party176 claims to own, and Whereas second party desires to maintain the continuity of the present market therefor, and Whereas first party in addition to the convenants of the second and third party herein and as a part thereof relies upon the personal ability of third party as managing agent of second party, "NOW THEREFORE IT IS AGREED: "1. First party agrees to dismiss with prejudice said Action No. 482045. All parties hereto agree that the said agreement of May 5, 1941, is hereby cancelled and terminated as fully and to the same extent as though the same had never been executed, and all parties hereto hereby waive and release any and all claims and demands of every kind, character or description which any thereof have, or may have or claim to have against any thereof, or the officers, agents, or employees of any of them, whether by reason of said contract or otherwise. * * * "2. First party quitclaims without warranty (except that it does warrant that it has not heretofore conveyed, assigned or encumbered any right therein) to second party the trade mark 'The Stuart Formula.' First party agrees to execute appropriate assignments, if requested, of registrations on file with the Secretary177 of State of the State of California and the U.S. Commissioner of Patents. "3. Second and third parties agree to pay to First Party the sum of $75,000.00 as follows: $35,000.00 upon the execution of this agreement, receipt of which is hereby acknowledged by first party, and $40,000.00 payable at the rate of $4,000.00 per month as per note executed concurrently herewith, which note shall be an obligation independent of but not in addition to the above amount. "4. Second party agrees to pay to first party on a royalty basis and as additional consideration for the execution of this agreement the sum of $122,700.00 which sum is additional to the above mentioned $75,000.00. The said $122,700.00 shall be paid at the rate of 7 1/2 cents per unit of vitamin concentrates as sold and marketed by second party beginning October 1, 1943, and continuing until the said sum of $122,700.00 is fully paid. * * Such payments shall be paid on the equivalent of the said unit of vitamin concentrates whether the same shall hereafter be sold and marketed in liquid, tablet, or in any other physical form or whatever the size of the package or packages by second party, whether sold under the trade mark The178 Stuart Formula or not. * "6. Second and third parties agree that if prior to full payment of the sums agreed to be paid to first party in accordance with paragraphs 3 and 4 hereof either (a) the business of second party is sold or (b) the good will of the business of second party is sold or (c) the trade mark 'The Stuart Formula' is sold or licensed by second party to any other person, firm or corporation, or (d) an attempt is made by second or third party to do any of the acts in this paragraph 6 specified, then, and in any such event, the balance remaining unpaid upon the obligations of second party set forth in par. 4 hereof shall become forthwith due and payable by second and third parties jointly and severally to first party. "7. In the event of the abandonment of said trade-mark 'The Stuart Formula' by second party or of the insolvency or bankruptcy of second party the trade mark 'The Stuart Formula' and all registrations thereof shall vest in and be the property of first party. * * "8. Arthur O. Hanisch third party covenants and agrees that until full payment of the sum specified in paragraph 4 hereof he will not pledge or assign his stock in second party so179 as to reduce his holdings to less than 51% of the capital stock of second party. Third party understands and agrees that his obligations herein set forth are primary upon him with reference to the provisions set forth in paragraphs 3, 5, 6 and 8 but not paragraph 4, except as referred to in paragraphs 5, 6, and 8, and not merely those of guarantor or surety. "9. Second and Third parties hereby waive and relinquish to and in favor of First party any claims or interest that they or either of them may have in and to the trade marks named as follows: 'Vitall', 'Calplex', 'Made by the Calplex Process', 'Buoyant B' and 'Vita-Diet'. * "12. First party hereby assigns to third party whatever capital stock of second party and/or Shaler Food Products Company now standing in the name of Max H. Lewis, which is represented by certificates now in possession of second party." * On November 30, 1942, Vita-Food delivered to the petitioner the certificates of registration of the trade-mark "The Stuart Formula $" which Vita-Food had obtained in its name. A formal assignment of Vita-Food's interest in the trade-mark to the petitioner was executed by Vita-Food on June 24, 1943. 180 From May 5, 1941, to October 31, 1942, the petitioner made gross sales of "The Stuart Formula" totalling $437,613.87. During that period 17,428 doctors were personally contacted and induced to recommend "The Stuart Formula" to their patients, and 6,746 drug stores were retailing "The Stuart Formula." From the date of its organization March 27, 1941, until October 31, 1942, the petitioner suffered net operating losses, as shown by its books, which totalled $15,451.56. On October 31, 1942, the petitioner had total assets of $62,159.47 and total liabilities of $82,489.98. Since November 28, 1942, the petitioner has distributed vitamin concentrates produced by other vitamin manufacturers under the trade name "The Stuart Formula." The shares of stock in the petitioner had no value on November 28, 1942. The petitioner was primarily obligated to pay $75,000 to Vita-Food under the contract of November 28, 1942, in order to secure the cancellation of an onerous contract, of which $35,000 was paid upon the execution of the agreement and $40,000 was paid from December 1942 through September 1943 in monthly installments of $4,000 each. The petitioner was also primarily obligated to181 pay $122,700 to Vita-Food under the contract of November 26, 1942, for the purchase of the trade-mark "The Stuart Formula," at the rate of 7 1/2 cents per unit of vitamin concentrates sold by the petitioner after October 1, 1943. Opinion HARRON, Judge: The issue in this proceeding is whether, considering all the facts, the payments made by the petitioner pursuant to the contract of November 28, 1942, were made, either in part or in whole, for the purpose of cancelling an onerous contract as contended by the petitioner; or whether they were made, either in part or in whole, for the purchase of the trade-mark "The Stuart Formula" as contended by the respondent. It is well settled that payments made to secure relief from an onerous contract are deductible as ordinary and necessary business expenses under section 23(a) of the Internal Revenue Code. Helvering v. Community Bond & Mortgage Co., 74 Fed. (2d) 727; affirming 27 B.T.A. 480">27 B.T.A. 480; Alexander J. Cassatt, 47 B.T.A. 400">47 B.T.A. 400; aff'd., 137 Fed. (2d) 745; Cleveland Allerton Hotel, Inc. v. Commissioner, 166 Fed. (2d) 805.182 And it is equally well settled that the purchase of a trade-mark is a capital expenditure, no part of which is deductible as a business expense. Seattle Brewing & Malting Co., 6 T.C. 856">6 T.C. 856; aff'd., per curiam, 165 Fed. (2d) 216; Coca-Cola Bottling Co., 6 B.T.A. 1333">6 B.T.A. 1333; cf. Rainier Brewing Co., 7 T.C. 162">7 T.C. 162; aff'd., per curiam, 165 Fed. (2d) 217. Upon careful consideration of the terms of the contract of November 28, 1942, the conduct of the parties in the execution of its provisions, their statements, the testimony of disinterested witnesses, and our examination of the various other contracts and exhibits placed in evidence at the trial, we have concluded that the petitioner, which was on an accrual basis, was obligated to pay $75,000 to Vita-Food to secure cancellation of the contract whereby it was bound to buy vitamin products exclusively from Vita-Food, and that the petitioner was obligated to pay $122,700 to Vita-Food for the purchase of the trade-mark "The Stuart Formula." The evidence discloses that the petitioner183 desired to abrogate the contract under which it was bound to buy all the vitamin products which it distributed from Vita-Food because it could obtain similar vitamin concentrates at substantially lower prices from other manufacturers. It therefore entered into negotiations with Vita-Food to effect a settlement of the contract. These negotiations were finally successful, and we have found as a fact that, as part of the settlement agreement, the petitioner agreed to pay $75,000 to Vita-Food to cancel the contract. Examination of the evidence also discloses that the remainder of the consideration called for by the contract is properly allocable to the purchase of the trade-mark "The Stuart Formula." The petitioner desired to continue in the business of distributing vitamin concentrates to retail outlets. Much good will had been built up for "The Stuart Formula" through the extensive merchandising campaign conducted by the petitioner during 1941 and 1942. Prior to November 28, 1942, the petitioner made a number of attempts to purchase an interest in the trade-mark, but was unable to achieve a satisfactory agreement with Vita-Food. From May 5, 1941, to October 31, 1942, the petitioner184 made gross sales of "The Stuart Formula" totalling $437,613.87. During that period, 17,428 individual doctors had been personally contacted and induced to recommend "The Stuart Formula" to patients who were in need of additional vitamins, and vitamin concentrates under the name "The Stuart Formula" were being retailed by 6,746 different drug stores. From our examination of all the evidence, we have found as a fact that the petitioner purchased the trade-mark "The Stuart Formula" for $122,700, to be paid at the rate of 7 1/2 cents per unit of vitamin concentrates sold by the petitioner after October 1, 1943. As part of the settlement agreement between the petitioner and Vita-Food, Vita-Food assigned to Hanisch 300 shares of stock of the petitioner which had been issued to Maxwell H. Lewis as representative of Vita-Food. The petitioner introduced competent evidence that this stock had no value on November 28, 1942, and respondent has made no contention that it did have any value. We have found as a fact that the 300 shares of stock assigned by Vita-Food had no value, and no part of the total consideration paid by the petitioner under the contract of November 28, 1942, with Vita-Food*185 is properly allocable to the purchase of these shares of stock. In accordance with our findings of fact, it is held that $75,000 paid by the petitioner to secure the cancellation of an onerous contract is properly deductible during the fiscal year 1943 as an ordinary and necessary business expense, and that $122,700 which the petitioner was obligated to pay for the purchase of a trade-mark is a capital expenditure which is not deductible as an ordinary and necessary business expense. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623379/	CHARLES D. MISSIMER AND BETTY MISSIMER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; J. ARMSTRONG CROSS AND ESTATE OF JUDITH A. CROSS, DECEASED, J. ARMSTRONG CROSS AND KATHERINE A. BURKE, CO-EXECUTORS, and ESTATE OF RICHARD F. BURKE, DECEASED, KATHERINE A. BURKE, EXECUTRIX, AND KATHERINE A. BURKE, and KNOX L. CLARKE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMissimer v. CommissionerDocket Nos. 6800-75, 7221-75.United States Tax CourtT.C. Memo 1979-48; 1979 Tax Ct. Memo LEXIS 477; 38 T.C.M. (CCH) 192; T.C.M. (RIA) 79048; February 7, 1979, Filed 477 Certain of petitioners in docket No. 7221-75 transferred their controlling stock in a corporation to the petitioners in docket No. 6800-75. The sellers received $ 143,825 in cash from the buyer and the corporation transferred to the sellers real property and a building owned by it for $ 12,000 paid by the sellers to the corporation. The $ 12,000 was considerably less than the fair market value of the real property and building. Held, based on the transaction as a whole, the excess value of the real property and building over the sale price thereof was a constructive dividend to the buyer of the corporate stock. Gerald A. Dechow and Cordell M. Parvin, for petitioners in docket No. 6800-75. Frank W. Rogers, Jr. and Alton L. Knighton, Jr., for petitioners in docket No. 7221-75. Robert A. Johnson, for respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: Respondent determined deficiencies in petitioners' income tax as follows: Docket No.PetitionerYearDeficiency6800-75Charles D. and1972$ 30,612.00Betty Missimer7221-751. Knox L. Clarke19723,393.352. Estate of Richard19726,026.20F. Burke, deceased,Katherine A. Burke,Executor, and KatherineA. Burke, survivingspouse3. Estate of Judith A.19726,985.47Cross, deceased, J.Armstrong Cross andKatherine A. Burke,co-executors, and J.Armstrong Cross,surviving spouseThe only issue for resolution is whether the sale of corporate-owned real property by the corporation for less than its fair market value to the sellers of the controlling interest in the corporation on the same day as the sale of the controlling stock interest479 to a minority stockholder is a constructive dividend to the sellers of the controlling interest or to the buyer. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioner J. Armstrong Cross is the surviving spouse of Judith A. Cross. J. Armstrong Cross and Katherine A. Burke are the coexecutors of the estate of Judith A. Cross. At the time the petition was filed, J. Armstrong Cross resided in Salem, Va. The Crosses filed a joint income tax return for 1972 with the Office of Internal Revenue Service at Memphis, Tenn. Petitioner Katherine A. Burke is the surviving spouse of Richard F. Burke, who died during 1972. Katherine A. Burke is the executrix of the estate of Richard F. Burke. At the time the petition was filed, Katherine A. Burke resided in Salem, Va. The Burkes' joint income tax return for 1972 was filed with the Office of Internal Revenue Service at Memphis, Tenn. Petitioner Knox L. Clarke resided in Salem, Va., at the time the petition was filed. Her income tax return for 1972 was filed with the Office of Internal Revenue Service at Memphis, Tenn. Petitioners Charles D. Missimer and Betty Missimer resided in Roanoke, Va., at480 the time their petition was filed. Their joint income tax return for 1972 was filed with the Office of Internal Revenue Service at Memphis, Tenn.Albert Brothers Contractors, Inc. (hereinafter the corporation), is a road building and heavy grading company which was founded by the father of Katherine A. Burke (hereinafter Burke) and Judith A. Cross (hereinafter (Judith), and the adopting father of Knox L. Clarke (hereinafter Clarke). Immediately prior to May 19, 1972, 966 shares of common stock of the corporation were outstanding. Of the 966 shares, Burke owned 190 shares, Clarke owned 126 shares, Judith owned 190 shares, and J. Armstrong Cross owned 17 shares. Burke, Clarke, and Judith (hereinafter referred to collectively as the sisters) had owned their stock since inheriting it from their father in 1951. The sisters were members of the board of directors. Burke worked for the corporation for part of 1971 and 1972, but otherwise the sisters were not active in the actual operation of the corporation during the taxable year at issue. Charles D. Missimer (hereinafter Missimer), who had been an officer and director of the corporation for some time, owned 72 shares of the corporation. 481 Missimer had acquired these shares in 1970 as a gift from his father, Linc Missimer, who was president and general manager. 1In early 1972 a disagreement arose between the sisters and the Missimers over dividend policy. The sisters discussed with their attorney, John Thornton, the possibility of liquidating the corporation or selling their stock. Thornton did not favor liquidation and suggested that the sisters sell their stock. Missimer was interested in purchasing the stock. In April and May of 1972 serious negotiations were commenced by the sisters and Missimer concerning Missimer's acquisition of the sisters' stock in the corporation. Missimer originally proposed acquiring enough of the sisters' stock to control the corporation, but the sisters would sell all of their stock or none of it. The book value of the stock was approximately $ 500482 per share. The sisters set a minimum price of $ 350 to $ 375 per share for the stock. Missimer, however, offered only $ 275 per share. Negotiations came to a standstill. At that point in the negotiations, Elaine Vaughn, bookkeeper and secretary of the corporation, suggested that the sisters acquire the building in which the corporation operated and the land on which the building stood and on which equipment was stored. This would assure them of receiving full value for their stock as well as a steady income. The sisters were agreeable to this suggestion. Missimer at first declined to consider the proposal but changed his mind upon reflection that the corporation did not require ownership of the building and property in order to conduct its operations and a leaseback from the sisters would provide the corporation with income tax deductions. The fair market value of the real property was $ 76,101. 2 Apparently, the depreciated value of the property on the books was approximately $ 12,000. 483 Once this tentative agreement was reached, Thornton suggested that the transactions be structured as a sale of 393 shares to Missimer for $ 143,825 followed by a purchase of the real property for $ 11,562 and the delivery to the corporation for redemption of 130 shares of stock. Although this form was agreeable to the sisters, Missimer objected to it and it was abandoned. Consequently, on May 19, 1972, the following transactions occurred. The sisters and Cross transferred to Missimer all of their shares of stock for $ 143,825 cash. Broken down, Burke received $ 52,250, Clarke received $ 34,650, Judith received $ 52,250, and Cross received $ 4,675. The sisters and Cross resigned as directors of the corporation and Linc Missimer, Charles Missimer, and Robert Buchanan were elected as the directors of the corporation. The new directors thereupon adopted a resolution authorizing the sale of the land and building to the sisters for $ 12,000. The sisters then paid the corporation $ 12,000, upon receipt of which the corporation transferred to them by deed a parcel of land located in Salem, Va., and described as Lots 1 through 16, Section 26, Salem Improvement Co., and the building484 thereon (hereinafter referred to as the building or the property). Conveyance of the building was done after Missimer had acquired the stock and he and his designees were members of the board of directors that authorized the sale of the property for $ 12,000. Thereupon the sisters and the corporation executed a lease agreement whereby the sisters leased the real property to the corporation at a rental charge of $ 900 per month for a term of 5 years, with the corporation having an option to renew the lease for an additional 5 years at a rental charge to be renegotiated. Neither the sisters nor Cross at any time agreed to transfer all of their stock to Missimer solely in return for the $ 143,825 payment from Missimer, and they did not agree to make the stock transfer without the contemporaneous transfer of the real property to them. The sisters would not have sold their stock for $ 275 per share alone. The balance sheet of the corporation reflected retained earnings of $ 442,498 as of December 31, 1971. Nothing occurred between that date and May 19, 1972, which reduced this amount. In the notice of deficiency mailed to Missimer on July 14, 1975, respondent determined that485 the "bargain sale of corporately owned property was in lieu of cash and/or consideration for the Albert Sisters' stock. Therefore, the excess fair market value of $ 64,101 constitutes a constructive dividend to Charles D. Missimer." In the notices of deficiency mailed to the other petitioners respondent determined that "the excess value of said real estate over the cash paid is a bargain purchase from the corporation * * * which constitutes constructive dividend income to the shareholders." It is stipulated that the only issue being contested by the petitioners is whether the transfer of the real property was a constructive dividend and, if so, who received that dividend. OPINION Respondent, who is essentially a stakeholder in this action, has determined that the acquisition by the sisters of the corporation's real property and building for less than its fair market value was a constructive dividend to the extent the fair market value thereof exceeded the purchase price of the property. At the trial and on brief neither group of petitioners quarrel with this determination. They do quarrel, however, over whether the dividend was received by the sisters or by Missimer. 486 We find that under the circumstances of this case the difference between the fair market value of the property and the price paid therefor could be determined to be a constructive dividend to either the sellers or the purchaser. It is clear from the evidence that the sale of the stock and the acquisition of the building by the sisters were both integral parts of the same transaction; neither would have taken place unless both were consummated. As pointed out in Century Electric Co. v. Commissioner, 15 T.C. 581">15 T.C. 581, 592 (1950), an integrated transaction should not be separated into its component parts for tax purposes. The tax consequences of the transaction must depend on what actually was intended and accomplished rather than on the separate steps taken to reach the desired end. And since both transfers were consummated at the one closing meeting, we do not give too much weight to the sequence of events, except as hereinafter mentioned. Section 316(a), I.R.C. 487 1954, 3 provides, in part, that a dividend is any distribution of property made by a corporation to its shareholders out of its earnings and profits. While technically speaking the sisters may not have been stockholders at the time the property was transferred to them, the transfer of the real estate to them was an agreed-upon fact prior to the closing and they could have exercised their control as stockholders to cause the corporation to transfer the property to them for less than its value. Such has been recognized as giving rise to a constructive dividend to the selling shareholders. West v. Commissioner, 37 T.C. 684 (1962). On the other hand, payment by a corporation of a part of the purchase price of property acquired by a stockholder in his own name has been held to result in a constructive dividend to the buyer. Lacy v. Commissioner, 341 F. 2d 54 (10th Cir. 1965). Since petitioners do not dispute that the sale of the real estate for488 less than its fair market value gave rise to a constructive dividend to either the buyer or the sellers, the only question for us to decide is which group received the dividend. Respondent takes the position in his brief that since the facts as to who received the dividend are unclear he will rest on his alternative positions. We agree with respondent that there is a definite conflict in the evidence presented, but the Court must "bite the bullet" and decide the issue. In doing so, we keep in mind the maxim that in tax matters the economic substance of a transaction will usually prevail over its form. Commissioner v. Cort Holding Co.,324 U.S. 331">324 U.S. 331 (1945). We have no magic formula to decide this issue; it is a question of whose version of the transaction we find most realistic and convincing, which is a factual conclusion. If the sisters agreed to sell their stock to Missimer for $ 143,825 cash and the building, and the building was conveyed to the sisters as part of the purchase price, there was a constructive dividend to Missimer. Christensen v. Commissioner, 33 T.C. 500">33 T.C. 500, 506 (1959).489 But if, as claimed by Missimer, he agreed to buy all 523 shares of stock of the sisters and Cross for $ 275 per share, and the sisters, as majority stockholders, caused the corporation to sell them the building for less than its fair market value, there was a constructive dividend to the sisters. Coffey v. Commissioner,14 T.C. 1410">14 T.C. 1410, 1417 (1950). Although the record is not as complete as we would like, 4 in our opinion the sisters' version of the transaction is more convincing than Missimer's. The only evidence presented, in addition to the stipulated facts, was the testimony of Burke and Missimer, and two letters written by Thronton, the sisters' attorney, several days before the transaction was finalized. The May 12 letter of Thornton, addressed to all of the directors of the corporation, outlined the procedure to be followed at the closing if Thornton's plan was agreed upon but, as heretofore noted, his plan was not agreed to by Missimer. For some reason, there was no written memorandum of the transaction in its final form. 490 As we analyze the situation, Missimer was most anxious to gain control of the corporation. He apparently was the managing officer of the business and thought it prudent to retain the earnings of the business in the corporation. On the other hand the sisters, who were the controlling stockholders but were not salaried employees of the corporation, insisted on the corporation paying out its earnings in dividends. So Missimer opened negotiations to acquire controlling interest in the corporation from the sisters. Missimer first offered to pay $ 150 to $ 200 per share for the sisters' stock (including Crosses' 17 shares) and finally offered a maximum of $ 275 per share, which he testified was all he could afford to pay. But the sisters would not sell for less than $ 350 to $ 375 per share, the stock having a book value of about $ 500 per share. To break the impass, it was suggested that the building be transferred to the sisters to sweeten the pot and provide them with a source of income. Thornton suggested that the sisters and Cross sell 393 shares of their stock to Missimer for $ 143,825 (which was the total Missimer would have had to pay for all 523 shares at $ 275 per share),491 and that the corporation sell the building to the sisters in exchange for the remaining 130 shares of their stock and about $ 12,000 cash. e8It is unclear how or why the $ 12,000 came into the picture but that apparently was about the book value of the building on the books of the corporation.) Missimer would not agree to this so the final form in which the transaction was cast was for the sisters and Cross to transfer all 523 shares of their stock to Missimer and then resign as directors of the corporation, Missimer was to give them a check for $ 143,825, and the newly elected directors were to authorize the corporation to sell the building to the sisters for $ 12,000; and that is the form in which the transaction was carried out. As a result of the transaction, all of the individuals received about what they wanted. Missimer acquired all 523 shares of the sisters' stock, thereby eliminating them as dissident shareholders and giving him control of the corporation, for a cash outlay of $ 143,825. Cross received $ 4,675 cash for his shares. The sisters received $ 139,150 in cash and the building for a cash out-lay of $ 12,000, the net of which (when the assumed excess of the492 fair market value of the building over what they paid is taken into consideration) gave them a value received of about the $ 350 to $ 375 per share they insisted on receiving for their stock. The only participant in the transaction that did not fare so well was the corporation, which transferred a property worth $ 76,000 for $ 12,000. Missimer claims that he paid $ 275 per share for the 523 shares of stock of the corporation with the building eliminated as a corporate asset. However, there is no evidence that at any time during the negotiations he made such an offer or that it was accepted by the sisters. Missimer was also the only net beneficiary of the arrangement whereby the corporation transferred the building to the sisters for less than its fair market value. The value of the building added to the cash they received only gave the sisters their asking price for their stock. On the other hand, Missimer acquired all 523 shares of the stock for just $ 275 per share, which he could not have done without having the building thrown in to the purchase price. Of course, the corporation's assets were decreased by the value of the building, but its book value probably still exceeded493 $ 375 per share. Missimer also became the owner of about two-thirds of the outstanding stock of the corporation instead of only slightly more than the 55 percent had he acquired only 393 shares. And finally, it was Missimer and his nominees on the board of directors who actually adopted a resolution authorizing the sale of the building to the sisters for $ 12,000. Missimer could control the board only after he acquired the sisters' stock. This clearly suggests that Missimer had the corporation carry out a part of his obligation to the sisters incurred in connection with his acquisition of their stock. This could be accomplished only with the acquiescence of the non-participating stockholders who were friendly to Missimer. There are other factors that would support the sisters' version of the transaction as well as some that would support Missimer's version. But on balance, we have concluded that the weight of the evidence and circumstances favors the conclusion that the excess value of the building was part payment for the stock Missimer acquired in his own name and that he was, in fact, the beneficiary of the corporate action. He was therefore the recipient of a constructive494 dividend from the corporation in the amount of $ 64,101. Both parties rely on cases which seem to support their arguments. However, on an issue such as this each case must be decided on its own facts and circumstances, and other cases are not conclusive. The petitioners-sisters rely principally on Christensen v. Commissioner,supra;Lacy v. Commissioner,supra;Stephens v. Commissioner,60 T.C. 1004">60 T.C. 1004 (1973), affd. 506 F. 2d 1400 (6th Cir. 1974); and Glenn-Minnich Clothing co., Inc. v. Commissioner,T.C. Memo. 1960-207. In each of those cases the Court found that the purchaser of corporate stock had caused the corporation to apply certain of its assets to the purchaser's obligations under the agreement for purchase of the stock, and that this gave rise to a taxable dividend to the purchaser. On the other hand, petitioners Missimer rely principally on Gilmore v. Commissioner,25 T.C. 1321">25 T.C. 1321 (1956); Coffey v. Commissioner,supra; and West v. Commissioner,supra, all being cases in which the Court concluded that the assets received495 from the corporation by the sellers were not part of the sale price of the stock but were dividends to the sellers. In Gilmore and Coffey, however, the agreements entered into by the buyers and sellers spelled out what the purchase price of the stock would be and provided separately for distribution of certain corporate assets to the sellers. That was not done in the instant case; there was no agreement on the purchase price until it was agreed that the sisters could buy the building for less than its fair market value. And in Coffey, the Court found it "quite significant" that the sellers did not transfer their stock until a resolution was adopted by the directors of the corporation authorizing the transfer of certain corporate assets to the sellers. Here, such a resolution was adopted after the stock was transferred by the new board of directors. In West the sellers received a tax refund due the corporation after their stock had been transferred. However, the Court found that the value of the refund had been eliminated as an asset of the corporation in negotiating the sales price of the stock. In our case Missimer testified that he had offered to pay $ 275 per share*496 for the stock with the building eliminated as an asset of the corporation. But so far as we can determine from the record his "final" offer for the stock was $ 275 per share before transfer of the building was ever discussed. Burke testified that the sisters agreed to take the building as part of their selling price of $ 365 - $ 375 per share. In each of the above opinions it is clear that the Court was struggling to determine from all the evidence before it just what the actual transaction between the parties was--and the tax consequences evolved from that conclusion. We have done the same thing here and have concluded that the transaction as finally agreed upon by the parties placed an obligation on Missimer to pay the sellers $ 143,825 in cash and cause the corporation to transfer the building to the sisters in exchange for the 523 shares of stock. The transfer of the building was therefore in partial satisfaction of Missimer's obligation, and he was the one who benefited therefrom. Decision will be entered for respondent in docket No. 6800-75. Decision will be entered under Rule 155 in docket No. 7221-75. Footnotes1. The remaining 371 shares were owned by Robert Buchanan, J. Abernathy, W. D. Beasley, L. B. Albert, and Linc Missimer. Prior to May 19, 1972, the board of directors of the corporation was comprised of the three sisters, J. Armstrong Cross, Linc Missimer, Charles Missimer, Buchanan, and Abernathy, as long as he was active.↩2. This figure was stipulated. The sisters reported a total of $ 45,045 in addition to their shares of the cash received as the selling price of the stock on their 1972 returns. Presumably the $ 45,045 represented what they thought to be the fair market value of the property at the time of the sale.↩3. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩4. We gather from the record that Linc Missimer, Robert Buchanan, Judith Cross, and John Thornton were all deceased at the time of the trial. Charles Missimer apparently had no counsel representing him in the negotiations or at least at the closing.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623381/	Fawn Lake Ranch Company, Petitioner, v. Commissioner of Internal Revenue, RespondentFawn Lake Ranch Co. v. Comm'rDocket No. 11341United States Tax Court12 T.C. 1139; 1949 U.S. Tax Ct. LEXIS 151; June 27, 1949, Promulgated 151 Decision will be entered under Rule 50. 1. The gains realized by petitioner from the sale of cattle from its breeding herd in the taxable year 1943 are to be considered long-term capital gains, pursuant to the provisions of section 117 (j) of the Internal Revenue Code, as added by the Revenue Act of 1942.2. I. T. 3666 and I. T. 3712, as applied to the facts here involved, are invalid. Albright v. United States, 173 Fed. (2d) 339, followed. W. C. Fraser, Esq., for the petitioner.Gene W. Reardon, Esq., for the respondent. Leech, Judge. Turner, J., dissenting. 152 Disney, J., agrees with this dissent. LEECH1139 This proceeding involves deficiencies in income tax in the sum of $ 1,670.71 and excess profits tax in the sum of $ 4,774.82 for the taxable year 1943. The issue presented is whether the respondent erred in treating the gain from the sale of cattle from a breeding herd as ordinary gain, where the number of raised cattle added to the breeding herd in the taxable year exceeds the number of cattle sold from such herd.FINDINGS OF FACT.Petitioner was incorporated in 1907, under the laws of the State of Nebraska. It is engaged in operating a large cattle ranch, consisting of approximately 50,000 acres in western Nebraska.Petitioner filed its Federal income and excess profits tax returns for the year 1943 with the collector of internal revenue for the district of Nebraska.Petitioner produces and raises all its livestock, except a few registered bulls purchased for breeding purposes. Petitioner maintains two basic accounts. The cows and bulls are classified under the breeding cattle account. The steers and the heifers, until the latter reach the age of two years, are classified in the ordinary cattle account. When the heifers153 are two years old, those intended to be used for breeding purposes are transferred to the breeding cattle account. Such heifers are actually separated from the other cattle and placed with the breeding herd. All animals are branded with a definite year brand which identifies their age. The heifer calves are born in the spring and are inventoried by petitioner in its ordinary cattle account at the end of that year at $ 27.50 per head. At the end of the next year the yearling heifers are again inventoried in the ordinary cattle account at the value of $ 40 per head and that increased valuation is reported as ordinary income. The steers raised by petitioner are inventoried in the ordinary cattle account until sold. The profits 1140 realized from sales of the livestock classified in the ordinary account are reported as ordinary income.Some of the heifers are sold for slaughter or feeder animals and the balance, consisting of the best selected heifers after they become two-year-olds, are placed in pastures with the breeding herd. About June 15 of each year the bulls are placed in the breeding-herd pasture with the cows and remain there for a period of about three months. 154 Petitioner generally keeps about 50 per cent of its better heifers for breeding purposes. The number retained is dependent on various factors, i. e., the conditions of the market concerning the price of beef cattle, the scarcity or abundance of winter feed, and weather conditions which might result in the loss of animals. The two-year-old heifers, upon being placed in the breeding herd, are transferred from the ordinary cattle account to the breeding cattle account at an inventoried value of $ 48.50 per head, at which valuation they remain until sold. The increase in value of these heifers from $ 40 to $ 48.50 is reported as ordinary income for that year.The number of animals produced and raised by petitioner which were transferred from the ordinary account to the breeding account (475 two-year-old heifers) exceeded the number sold (346 cows) from the breeding cattle account during the taxable year. The number of cattle in the breeding herd varies from year to year. In the taxable year 1943, there were 105 more animals in the breeding herd at the end of the year than at the beginning of the year.During the taxable year, animals from the breeding herd, together with animals 155 from the ordinary cattle account, were sold on the market for slaughter or feeder animals, under the normal practice and in the regular course of petitioner's business. Animals sold from the breeding cattle account consisted of both cows that had ceased to produce calves and cows that had never produced any calves. These cows which have proved unsatisfactory for breeding purposes are sold without being transferred back to the ordinary cattle account from the breeding cattle account.The net proceeds from the sales of animals from both cattle accounts were reported in petitioner's original income and excess profits tax returns for 1943 as ordinary income. In amended returns filed by petitioner for 1943, the profits realized from the sale of animals from the breeding cattle account were reported as long term capital gains, resulting in the elimination of the excess profits tax and a decrease in the amount of the income tax originally reported.The excess profits tax thus eliminated and the decrease in the amount of the income tax reported in petitioner's original returns so resulting were abated by a collector's abatement claim stamped upon the face of the amended returns. The respondent, 156 in his notice of deficiency, 1141 determined that the profits realized from the sale of the animals from the breeding cattle account constituted ordinary income, subject to both income and excess profits taxes.OPINION.The only question presented is whether the respondent erred in determining that the gain realized by petitioner in the taxable year 1943 from the sale of certain cattle from its breeding herd was taxable as ordinary gain. Petitioner contends that the sales from its breeding herd are to be treated as sales of capital assets under the provisions of section 117 (j) of the Internal Revenue Code. 1158 The respondent relies solely upon two department rulings contained in I. T. 3666 and I. T. 3712, the material parts of which are set forth in the margin. 2 While in I. T. 3666 it is recognized that livestock used for draft, breeding, or dairy purposes is property used in a trade or business of a character subject to depreciation within the meaning of 1142 section 117 (j) of the code, if held for more than six months, it provides that "culls" from the breeding herd in the regular course of business are considered to be "property held by the taxpayer primarily 157 for sale to customers in the ordinary course of his trade or business," and, therefore, the sale of such animals is not to be treated as the sale of a capital asset.159 I. T. 3712 amplifies the phrase "culled from the breeding herd" and prescribes a prima facie test. If the number sold from the breeding herd exceeds the number of raised animals added during the same year, it will be presumed that the excess number sold consisted of animals held for breeding purposes and, if held for more than six months, the gain or loss is subject to section 117 (j); but, if the number of raised animals added to the breeding herd is greater than the number sold during the year from the breeding herd, none of the animals sold will be considered capital assets subject to the provisions of section 117 (j).By letter dated August 4, 1947, the respondent issued a special ruling explaining that:The prima facie presumption that sales made from the breeding or dairy herd which do not reduce the size of the herd because of addition of raised animals result in ordinary income is always subject to rebuttal and should not be applied arbitrarily. The classification of "culls" was intended to include all animals sold from the breeding herds that represent regular sales made from such source in the ordinary operation of the taxpayer's business.In the case of Albright v. United States, 173 Fed. (2d) 339,160 these departmental rulings were directly involved, and the court concluded that, as applied to the facts there involved, they were "contrary to the plain language of section 117 (j) and to the intent of the Congress expressed in it."In the Albright case, the taxpayer maintained a dairy herd of 36 dairy cattle, of which an average of 18 to 20 head were producers of milk which was sold to local creameries. Calves which were not needed for the maintenance of the dairy herd at the desired number were sold on the market. Dairy cows which, by reason of age, injury or disease, were unfit for use in the dairy herd or which, because of decreased milk production, were economically less desirable for that purpose than available young stock, were sold and replaced by young stock raised by the taxpayer. He regularly maintained also a breeding herd of 10 sows and 1 boar. Each year the taxpayer sold his breeding herd, replacing it with an equal number of young sows raised by him and with another boar purchased from a neighboring farmer. The evidence was that this was the usual practice in the hog-raising industry. During 1945 the taxpayer sold 6 cows, 10 sows, and 1 boar. In 1946 he 161 sold 8 cows, 2 bred heifers, 10 sows, and 1 boar. In his income tax returns the taxpayer treated the amounts received from the 1143 sale of cows removed from the dairy herd and from the sale of his breeding herd of swine as capital gains. The respondent ruled that such sales were productive of ordinary income, and determined deficiencies for each year. The taxpayer paid the deficiencies and sued for a refund. From a judgment in favor of the United States, an appeal was then taken. The Circuit Court reversed, with directions to enter judgment for the taxpayer.In the instant case the basic operation of petitioner is the raising of cattle. It maintains complete and accurate records. It keeps two basic accounts, separately classifying its breeding cattle and cattle held for sale in the ordinary course of its business. It does not sell heifer calves. A heifer calf born in the spring is valued at the end of the year at a price of $ 27.50; a yearling heifer is valued at $ 40, and the increased value is reported as ordinary income. When the heifers are two years old, petitioner selects the better ones to be placed with its breeding herd. Those selected are then transferred162 from the ordinary cattle account to the breeding cattle account and given a value of $ 48.50, which value they retain. This $ 8.50 increase is reported as ordinary income for that year. The remaining heifers not selected for the breeding herd remain in the ordinary cattle account and if sold at a price in excess of the value at which they are then carried, such excess is returned as ordinary income. Because of the various factors which enter into the selection of heifers to be transferred to the breeding herd, and those factors which enter into the determination of the cattle to be sold from the breeding herd, the size of the breeding herd varies from year to year. Some years the breeding herd is reduced and sometimes increased. In the taxable year the number of heifers added to the breeding herd exceeded the number sold therefrom. Because of such circumstances the respondent determined that all the sales from the breeding herd constituted property held by petitioner for sale to customers in the ordinary course of petitioner's business, and that petitioner is not entitled to the benefits of section 117 (j) of the code.Petitioner contends that when, in the normal course of its163 business, it transfers the two-year-old heifers into its breeding herd, they are being held for breeding purposes and are to be considered capital assets under the pertinent statute; that, having become part of the breeding herd, they are not held primarily for sale to customers in the ordinary course of business.In the Albright case, supra, the Circuit Court said:Section 117 (j) was intended as a relief measure applicable alike to all taxpayers within its provisions, Leland Hazard v. Commissioner, 7 T.C. 312">7 T. C. 312. That it was so intended is clearly expressed in the report of the Committees of the House of Representatives and of the Senate in charge of the bill. See H. Rep. No. 2333, 77th Cong., 2d Sess., pp. 53-54 (1942-2 Cum. Bull. 372, 415) and S. Rep. 1144 No. 1631, 77th Cong., 2d Sess., p. 50 (1942-2 Cum. Bull. 504, 545). The section provided an entirely new method of reporting gains and losses on the sale of noncapital assets used in the trade or business of the taxpayer. * * The Commissioner has ruled that livestock held by a farmer for dairy, breeding, or draft purposes164 are, while so held and used, depreciable assets, not primarily held for sale to customers in the ordinary course of his business. Nothing in the language of the section justifies the inference that a farmer should be denied the right to treat the profits received from the sale of such livestock when they are no longer profitable or fit for use in the farmer's business as productive of capital gains and not of ordinary income. This, however, is the effect of the ruling relied on by the Government.It may be argued that in the Albright case the taxpayer was on a cash basis, while petitioner actually did, in the tax year, inventory its cattle, and respondent accepted its computation of income on that basis. It inventoried them in two categories -- breeding herd and ordinary cattle account. From this premise the contention might be made that, because of the fact that petitioner did inventory its cattle, it is precluded from the benefits of section 117 (j) of the Internal Revenue Code, because of condition (1) (A) in that statute, which bars its benefits in the case of "property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close165 of the taxable year." Since cattle held for breeding purposes are treated as property "used in a trade or business," as distinguished from "property held primarily for sale to customers," such cattle, of course, would not ordinarily "properly" be includible in the inventory of the taxpayer. The inclusion of such cattle in inventory has been solely by a ruling of the respondent and then only for convenience in accounting. I. T. 3666, 1944 C. B., p. 270. And that ruling, in order to prevent a farmer who uses the inventory method of accounting and reporting income from thereby losing the benefits of section 117 (j) of the code, included the specific provision that the fact that livestock may be so inventoried "does not render such live stock 'property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year' so as to deprive the farmer of the benefits of section 117 (a) or section 117 (j) of the Internal Revenue Code."We conclude on this record that the respondent erred in treating the gain realized by petitioner in the taxable year 1943 from the sale of cattle from its breeding herd as ordinary166 income. We, therefore, sustain petitioner.Decision will be entered under Rule 50. TURNER Turner, J., dissenting: It is my opinion that the petitioner, by the plain language of section 117 (j), is barred from the relief here sought. 1145 As shown by the findings of fact, the petitioner engaged in the operation of a cattle ranch of approximately 50,000 acres in western Nebraska, and while the facts, as found, do not show the size, or approximate size, of the petitioner's cattle herd, it may be assumed from the size of the ranch itself that the petitioner's cattle ran into numbers so substantial as to make it difficult or impossible to maintain its accounts with respect to the individual animals, as appears to have been done in Albright v. United States, 173 Fed. (2d) 339. 1 At any rate, the facts show that the petitioner has regularly and consistently kept its accounts and reported its income by the inventory method and that its breeding herd has consistently been included in that inventory.167 The problems of farm and ranch accounting have always been very difficult in that the operations seldom ever lend themselves to the exactness of the accounting methods established and maintained in commercial and industrial enterprises. To the rancher, the breeding herd is obviously quite comparable to the plant of the industrial concern, and, if such operations were readily susceptible of the methods of accounting applied in industrial concerns, there would appear to be no occasion for using the inventory method of accounting and of reporting income in so far as it relates to the breeding herd.The Commissioner has been given wide latitude by Congress in determining whether a taxpayer's method of accounting will clearly reflect income and, by section 22 (c) of the Internal Revenue Code, he has been given specific authority to require the use of inventories where necessary clearly to determine the income of the taxpayer, and where so found to be necessary, they are to be taken on the basis which the Commissioner prescribes as conforming as nearly as may be to the best accounting practice in "the trade or business." The Commissioner's staff and members of the accounting profession168 occupied with farm and ranch accounting have, over the years, undertaken to devise better methods for farm and ranch accounting, but they have regularly come back to the conclusion that in large operations, such as we have here, some form of inventory accounting is the best available solution, even though the form used be the rather unorthodox farm market method.When Congress, in enacting section 117 (j), supra, involved herein, decided to grant an advantage to taxpayers sustaining losses from the sale of property "used in the trade or business," it did so, with certain limitations and restrictions. In defining property used "in the trade or business," it specifically excluded "property of a kind which would 1146 properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year." Some suggestion has been offered that that exclusion from the definition of property used in a trade or business, for the purposes of section 117 (j), does not apply to a breeding herd, because, in logic, a breeding herd being comparable to the plant of an industrial concern, is not property of a kind which would "properly be includible in the inventory of the169 taxpayer." The simple answer, in my opinion, is that the breeding herd of a rancher is not the plant of an industrial concern and that the regularly accepted method of dealing with a breeding herd in the accounts of ranching operations and the reporting of income therefrom has been by the inventory method. In that situation, I am unable to conclude that Congress did not legislate with regard to existing and established methods of accounting in the various forms of enterprise and that it did not intend to exclude, as property "used in the trade or business," the breeding herd of a ranching operation.In the circumstances, it does not seem to me that we may say that the petitioner's breeding herd was not properly includible in its inventory. It is accordingly my view that by the interpretation here placed on the definition of property "used in the trade or business," for the purposes of applying section 117 (j), supra, we are revising and amending an act of Congress. For that reason, I note my dissent. Footnotes1. SEC. 117. CAPITAL GAINS AND LOSSES.* * * (j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. --(1) Definition of property used in the trade or business. -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. * (2) General rule. -- If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. * ↩2. I. T. 3666, reported in 1944 C. B., p. 270, states in part:"The sale of animals culled from the breeding herd as feeder or slaughter animals in the regular course of business is not to be treated as the sale of a capital asset."I. T. 3712, reported in 1945 C. B., p. 176, states in part:" * * The phrase 'culled from the breeding herd' refers to the normal selection for sale of those animals which, due to injury, age, disease, or for any other reason (other than that of changing the breed or the quality of the offspring) are no longer desired by the livestock raiser for breeding purposes, and also the normal selection for sale of animals for the purpose of maintaining the herd at a regular size. The primary factor is normal practice in the case of the particular taxpayer involved."Since in many cases it will be found impractical to determine accurately the number of animals sold from the breeding herd, the following prima facie test is provided for the guidance of livestock raisers. If the number of animals sold from the breeding herd during a taxable year exceeds the number of raised animals added to the breeding herd during the same year, it will be presumed that the excess number sold consisted of animals held for breeding purposes, the gain or loss from which (if held for more than six months) is subject to the provisions of section 117 (j) of the Code. Such sales effect a reduction in the livestock raiser's breeding herd. * * * If the number of raised animals added to the herd is greater than the number of such animals found unfit for breeding purposes and sold during the year, none of the animals sold will be considered capital assets subject to the provisions of section 117 (j)↩ of the Code."1. In the Albright↩ case, there is some slight suggestion that the court might have found some difference between the case of a dairy farmer and one engaged in raising and selling beef cattle.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623383/	David Mavity, Petitioner, v. Commissioner of Internal Revenue, RespondentMavity v. CommissionerDocket No. 2422-62United States Tax Court42 T.C. 283; 1964 U.S. Tax Ct. LEXIS 112; April 22, 1964, Filed 112 Decision will be entered for the respondent. Held, an $ 8,600 payment made by petitioner to his wife in 1958 in settlement of arrearages in alimony or separate maintenance is not deductible by petitioner under section 215, 1954 Code, for the reason that such payment is not taxable to petitioner's wife under the provisions of section 71(a), 1954 Code. Edmund C. Grainger, Jr., for the petitioner.Robert A. Trevisani, for the respondent. Kern, Judge. KERN 283 OPINIONRespondent determined a deficiency of $ 8,316.22 in petitioner's Federal income tax for the year 1958. Petitioner has not 284 assigned error to all of respondent's determinations. In the petition it is alleged that respondent erred in disallowing a deduction claimed by petitioner for alimony in the amount of $ 8,600, and that respondent erred in increasing petitioner's business income in the amount of $ 7,029.77. Petitioner has not presented any evidence nor made any argument on brief with respect to the latter assignment of error. Accordingly petitioner is deemed to have abandoned that issue. The only issue presented for our decision is whether petitioner is entitled to a deduction for alimony payments 114 pursuant to section 215 of the Internal Revenue Code of 1954 in excess of the amount allowed by respondent.All of the facts have been stipulated and are found accordingly.Petitioner, David Mavity, is an individual and a resident of Greenwich, Conn. He filed an individual Federal income tax return for the year 1958 with the district director of internal revenue for the Upper Manhattan district of New York on August 17, 1959.Petitioner and his former wife, Mary Mavity, were married on April 7, 1931, and ceased living together as husband and wife in 1939. On June 30, 1949, petitioner wrote the following letter to his wife:Dear Mary:I understand that your doctors have suggested that our complete separation is advisable at this time and furthermore that you are to dispose of the apartment in Pelham.In line with this I will undertake to place in your account, beginning August 1st, $ 300. each month, which amount it is to be understood will cover all your expenses.I trust that this arrangement will prove agreeable to you and that you will soon be feeling much better.Sincerely,(S) DavidThe payments called for in the June 30, 1949, letter were made regularly by petitioner up to and including115 December 1953. In January 1954 petitioner, through his attorney, sent his wife $ 300. In August 1954 he sent her $ 1,000. He made no further payments.On May 1, 1955, petitioner's wife commenced an action against him in the Court of Common Pleas, Fairfield County, Conn. In that action petitioner's wife sought the recovery from him of a total of $ 3,500, representing $ 300 per month from the period petitioner had ceased paying her until the date of commencement of the action, less the two payments totaling $ 1,300. The action was tried on February 6, 1957, and resulted in a decision for petitioner's wife. Judgment was entered against petitioner on March 14, 1957, for $ 3,500 plus interest and costs, making a total of $ 4,030.83.285 Petitioner appealed the decision to the Supreme Court of Errors of the State of Connecticut. In the meantime petitioner's wife, on April 25, 1956, commenced a separate action against him in the U.S. District Court for the Southern District of New York seeking to recover $ 300 per month from May 1, 1955 (the period at which the Connecticut action stopped), to the date of the filing of the complaint. Petitioner's attorneys advised him that the116 decision of the court in Connecticut would be binding on a court in New York. Thereupon petitioner and his wife entered into a separation agreement. The agreement was signed by petitioner's wife on August 12, 1958, and by petitioner on August 15, 1958. The agreement provided in pertinent part as follows:4. Immediately upon the request of the husband, the wife agrees to execute a waiver of dower of any interest she may have because of her having been his wife, satisfactory to the lender for the purpose of inducing the loan by the lender of $ 8,000. on the unimproved property owned by the husband in Parrish Township, Benton County, Indiana, and upon receipt thereof, the husband agrees to borrow from the lender $ 8,000. and to mortgage such property as security therefor and upon receipt of such $ 8,000. forthwith but in no event later than August 1st, 1958, to pay that sum of money to Buckley and Buckley, the attorneys for the wife, and upon receipt of such payment the wife agrees to acknowledge the receipt thereof and to accept the aforesaid sum of $ 8,000. from the husband as and for a satisfactory, reasonable and sufficient provision for her support and maintenance past, present117 and future and for the discharge and payment of any and all debts or obligations owed by the wife up to and including the date of which such payment is made, in connection with which in particular she agrees as follows: --(a) to deliver to the husband a general release in a form satisfactory to discharge him from any claims of any kind or character against him which she may have or any third persons may claim through her because of services rendered to her; but such release shall specifically exclude a release from the payment of $ 300.00 per month from the 1st day of January, 1958, pursuant to this agreement and/or any other or prior agreement, including the agreement sued upon by the wife in the State of Connecticut. The wife agrees, however, that she will upon receipt by Buckley and Buckley of the $ 8,000 referred to in Paragraph 5 hereof, deliver a general release to her husband for all claims she has against him for support and maintenance for each of the months of January, February, March, April and May in the year 1958, and that upon receipt by Buckley and Buckley of checks in the amount of $ 300 each she will also execute a general release covering any claims by her for 118 the support and maintenance by her husband for the months of June and July, 1958.(b) to acknowledge the payment and satisfaction of any judgment she may have against the husband in the State of Connecticut and to execute a satisfaction piece, or such other legal document as shall reflect such payment and satisfaction of any such judgment and to have such legal document recorded so that the payment and satisfaction of such judgment is recorded as a matter of public record;(c) to pay and discharge the fees of any firm of attorneys which has acted for her, or on her behalf, in the State of Connecticut, by virtue of which that firm has any claim against her or her husband, and to deliver to the husband a written acknowledgement by any such firm of the receipt of such payment.286 (d) to secure the release of any attachment of any real property which has been levied in the State of Connecticut, or elsewhere, against any property, real or personal, belonging to the husband and to record such release as a matter of public record.(e) to cease and discontinue any actions or proceedings against the husband in any Court other than in the State of Connecticut and to record such discontinuance119 as a matter of public record;(f) to pay and discharge to Buckley and Buckley any and all monies due them for legal services to be rendered for the wife up to the date of this agreement and for one year thereafter;(g) in the event that the wife shall commence any proceedings for divorce, to pay and discharge from the aforesaid sum any fee or costs which may be incurred or required for any such divorce proceedings.5. Buckley and Buckley agree to the application of the $ 8,000. as aforesaid and that they will be paid by the wife out of such $ 8,000. any fees and disbursements incurred by the wife and owed by the wife or the husband up to the date of this agreement, and for a period of six months thereafter, and to hold such sum as shall remain after the payment of the items hereinbefore described in escrow, so that in the event the wife shall have procured a divorce within six months of the date of the execution of this agreement, then and in that event Buckley and Buckley are authorized to pay over to the wife any monies thus held in escrow; but should such a divorce not have been procured by the wife, then and in that event Buckley and Buckley are instructed to pay such monies to120 the husband, with the exception that the husband agrees as follows: -To pay to the wife each month commencing with the month of January, 1958, for the wife's support and maintenance during her natural life the sum of $ 300. per month so that $ 1,500. of the aforesaid $ 8,000. is and shall be constituted as payments on account of the aforesaid monthly indebtedness of $ 1,500., $ 300. for the months of January, February, March, April and May respectively, and after the execution of this agreement and the payment of the $ 8,000. as aforesaid, and commencing with the first of June, 1958, the husband shall pay to the wife on the first of each month thereafter the sum of $ 300. until such time as the wife shall die or remarry, in either of which events the obligation of the husband to pay shall thereupon cease and terminate. In the event the husband predeceases the wife, the husband does hereby agree for himself, his heirs, distributees and representatives that the said $ 300. per month shall be paid to the wife until such time as she shall die or remarry. Such payments are to be made by the Executors or Administrators of the husband, or, in the event that a Trustee or Trustees are designated121 and appointed for such purpose, such payments are to be made by such Trustee or Trustees, and the same shall be a charge upon all of the estate, real and personal, of which the husband may die seized.6. The wife agrees to accept and hereby accepts the aforesaid payments as and for a satisfactory, reasonable, and sufficient provision for her support and maintenance, past, present and future and for the discharge of any debts or obligations which she may have incurred, or may incur, and in full discharge, settlement and satisfaction of any claim for support she may have for the rest of her life or until she shall remarry. The wife agrees, therefore, that should the husband at any time thereafter be required to pay to any third person any monies on account of a debt incurred by the wife which the creditor establishes as a debt also of the husband, that the husband may deduct and charge against any monies that may be due or become due hereunder from the husband to the wife the amount of any such payment, after reasonable notice, in writing, of the creditors' claim to the wife, so as to afford the wife an opportunity to dispute the same if such claim is unwarranted.287 It is stipulated122 that the $ 8,600 here in issue was paid by petitioner, in accordance with the terms of the above agreement, as follows:July 25, 1958$ 8,000.July 25, 1958300 for June.July 25, 1958300 for July.Petitioner's wife obtained an absolute divorce on February 13, 1959, in the District of Columbia where she then resided.On his Federal income tax return for 1958 petitioner claimed as an alimony deduction the sum of $ 10,100 which he paid to his wife in 1958. Of this amount respondent allowed as a deduction $ 1,500 representing payments of $ 300 per month made by petitioner pursuant to the separation agreement for the months of August through December 1958. Respondent disallowed the remainder, $ 8,600, which was paid by petitioner to his wife on July 25, 1958. Of this amount $ 1,500 was paid in satisfaction of petitioner's obligation to support and maintain his wife during January, February, March, April, and May of 1958, $ 600 was paid in satisfaction of petitioner's obligation to support and maintain his wife during June and July of 1958, and the balance was paid in satisfaction of, among other things, the Connecticut judgment and all other arrearages owed by petitioner123 to his wife.The question presented for our decision is whether the sum of $ 8,600 paid by petitioner to his wife on July 25, 1958, in settlement of arrearages in alimony or separate maintenance, pursuant to an agreement between petitioner and his wife executed in August 1958, is deductible by petitioner as alimony and separate maintenance payments. Petitioner contends that the payments he made are deductible under sections 2151124 and 71(a) 2 of the Internal Revenue Code of 1954, as periodic 288 payments received by his wife pursuant to a written separation agreement and/or as periodic payments received by his wife under a decree entered after March 1, 1954, requiring petitioner to make the payments for his wife's support or maintenance.125 Respondent argues that since the $ 8,600 paid by petitioner to his wife in 1958 in settlement of arrearages for alimony would not have been deductible if paid when due, the deduction is not allowable when payment was subsequently made in a lump sum.Section 215 of the Internal Revenue Code of 1954 allows as a deduction to petitioner amounts paid to his wife which are includable under section 71 in the gross income of his wife. Alimony and separate maintenance payments are includable in a wife's gross income if the payments come within the provisions of section 71(a)(1), (2), or (3).Section 71(a)(1) provides that periodic payments made by a husband under a decree of divorce or separate maintenance are includable in the wife's gross income. Petitioner does not claim that the payments would have been includable in his wife's gross income under this section, and the record herein shows that the payments were not made under a decree of divorce or separate maintenance.Petitioner first contends that the payments made pursuant to the separation agreement in August 1958 are includable in his wife's gross income under the provisions of section 71(a)(2). That section provides that the gross126 income of a wife who is separated from her husband includes periodic payments received because of the marital relationship and under a written separation agreement. The payments must be received after the execution of the agreement, and the agreement must be executed subsequent to August 16, 1954, the date of the enactment of the pertinent statute.The separation agreement between petitioner and his wife which was executed by petitioner on August 15, 1958, and by his wife on August 12, 1958, provided that petitioner was to pay over to his wife's attorneys $ 8,000 no later than August 1, 1958. Petitioner also agreed to pay to his wife $ 300 for each of the months of June and July 1958, and $ 300 per month for the remainder of his wife's life or until she died or remarried. In consideration for the payment of $ 8,000 and two checks in the amount of $ 300 each, 3 petitioner's wife agreed, among other things, to accept such sums as "a satisfactory, reasonable, and sufficient provision for her support and maintenance, past, present and future." She agreed to deliver a general release to petitioner for all claims she had against him for support and maintenance for the months January127 through July 1958, to acknowledge the payment and satisfaction of the judgment she had against petitioner in Connecticut, 289 and to discontinue the court proceedings she commenced against her husband in the U.S. District Court in New York.Respondent has allowed a deduction for the payments made for August 1958 and for all subsequent months, and such payments are not here in issue. It has been stipulated that petitioner paid $ 8,600 on July 25, 1958, in accordance with the terms of the separation agreement. This agreement was not signed by the petitioner until August 15, 1958, and by the petitioner's wife until August 12, 1958. Inasmuch as these payments were not received after the agreement was executed, the payments are not includable in the gross income of petitioner's wife under the terms of section 71(a)(2), and hence they are not deductible by petitioner. 4 Deductions are a matter of legislative grace and "a taxpayer seeking128 a deduction must be able to point to an applicable statute and show that he comes within its terms." New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435. See also John W. Furrow, Jr., 34 T.C. 931">34 T.C. 931, 935, affd. 292 F.2d 604">292 F. 2d 604.Even if petitioner had made the payments here in issue in due course he could not have deducted them pursuant to section 71(a)(2). It is a well-settled rule, which petitioner states on brief, that a lump sum paid in settlement of arrearages in alimony retains the characteristics the original payments would have had if made in due course. Virginia B. Adriance Davis, 41 T.C. 815">41 T.C. 815; Sarah Dalton, 34 T.C. 879">34 T.C. 879;129 Margaret O. White, 24 T.C. 452">24 T.C. 452; Antoinette L. Holahan, 21 T.C. 451">21 T.C. 451, affd. 222 F. 2d 82; Jane C. Grant, 18 T.C. 1013">18 T.C. 1013, affd. 209 F.2d 430">209 F. 2d 430; Elsie B. Gale, 13 T.C. 661">13 T.C. 661, affd. 191 F.2d 79">191 F. 2d 79. Prior to July 25, 1958, the date on which petitioner made the payments in issue, there was no such written separation agreement between petitioner and his wife as required in section 71(a)(2). The letter written by petitioner to his wife on June 30, 1949, if it be a written separation agreement within the meaning of the statute, does not qualify under the statute because it was executed prior to August 16, 1954. See John W. Furrow, Jr., supra.Assuming that the agreement made in August 1958 between petitioner and his wife was an alteration or modification of the "agreement" of June 30, 1949, petitioner's letter cannot be treated as an agreement executed after August 16, 1954, with respect to payments made prior to the date of alteration or modification. See sec. 1.71-1(b)(2)(ii), 130 Income Tax Regs.5290 Petitioner also relies on section 71(a)(3) which requires a wife to include in her gross income periodic payments received by the wife after August 16, 1954, which the husband is required to make for the wife's support or maintenance under a decree entered after March 1, 1954. Petitioner argues that pursuant to this section the payments amounting to $ 8,600 made by petitioner to his wife are deductible under the decree entered in Connecticut131 on March 14, 1957, awarding petitioner's wife $ 4,030.83, and under the action commenced in the U.S. District Court in New York in which petitioner was advised by his attorneys that the Connecticut action would control.Section 71(a)(3) is designed to make taxable to a wife and deductible to a husband alimony payments "where a wife is separated from her husband if she receives periodic payments from him under any type of decree (entered after the date of enactment of this bill) requiring the husband to make payments for her support and maintenance." (Emphasis supplied.) S. Rept. No. 1622, 83d Cong., 2d Sess., p. 10. It would appear that the judgment entered by the Connecticut court does constitute a decree entered after March 1, 1954, requiring petitioner to make a payment for his wife's support or maintenance, within the meaning of section 71(a)(3). See Constance B. Kirby, 35 T.C. 306">35 T.C. 306. However, the judgment of that court, pursuant to which petitioner's wife was awarded $ 4,030.83 in damages, does not constitute a decree requiring petitioner to make periodic payments to his wife. Payments made in discharge of an obligation to pay a principal sum132 specified in a decree (where the period for payment is less than 10 years) do not constitute periodic payments. See sec. 71(c), I.R.C. 1954; Lounsbury v. Commissioner, 321 F. 2d 925, affirming 37 T.C. 163">37 T.C. 163; John W. Furrow, Jr., supra; and Ellert v. Commissioner, 311 F. 2d 707, affirming a Memorandum Opinion of this Court.Petitioner argues that although the judgment entered in the Connecticut court required petitioner to pay a lump sum, such lump sum was paid in settlement of arrearages in alimony which retain the characteristics the original payments would have had in due course. Petitioner relies on Elsie B. Gale, supra;Antoinette L. Holahan, supra;Jane C. Grant, supra; and Margaret O. White, supra. See also Virginia B. Adriance Davis, supra; and Sarah Dalton, supra.However, it should be noted that in each of these cases it was held that the payments in issue would have been133 includable in the wife's gross income under the applicable statutes if they had been received when they were due and payable, while in the instant case, as we have demonstrated above, if the payments had been made in due course they would not have been includable in the gross income of petitioner's wife as payments made pursuant to a decree of divorce or separate 291 maintenance, a written separation agreement, or a decree for support within the meaning of any provision of section 71(a).The amounts here in issue do not qualify as amounts includable in the gross income of petitioner's wife under section 71(a). Therefore, petitioner is not entitled to deduct such amounts.Decision will be entered for the respondent. Footnotes1. SEC. 215. ALIMONY, ETC., PAYMENTS.(a) General Rule. -- In the case of a husband described in section 71, there shall be allowed as a deduction amounts includible under section 71 in the gross income of his wife, payment of which is made within the husband's taxable year. No deduction shall be allowed under the preceding sentence with respect to any payment if, by reason of section 71(d) or 682↩, the amount thereof is not includible in the husband's gross income.2. SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS.(a) General Rule. -- (1) Decree of divorce or separate maintenance. -- If a wife is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such decree in discharge of (or attributable to property transferred, in trust or otherwise, in discharge of) a legal obligation which, because of the marital or family relationship, is imposed on or incurred by the husband under the decree or under a written instrument incident to such divorce or separation.(2) Written separation agreement. -- If a wife is separated from her husband and there is a written separation agreement executed after the date of the enactment of this title, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such agreement is executed which are made under such agreement and because of the marital or family relationship (or which are attributable to property transferred, in trust or otherwise, under such agreement and because of such relationship). This paragraph shall not apply if the husband and wife make a single return jointly.(3) Decree for support. -- If a wife is separated from her husband, the wife's gross income includes periodic payments (whether or not made at regular intervals) received by her after the date of the enactment of this title from her husband under a decree entered after March 1, 1954, requiring the husband to make the payments for her support or maintenance. This paragraph shall not apply if the husband and wife make a single return jointly.↩3. Plus petitioner's agreement to make periodic payments in the future.↩4. The case of B. R. DeWitt, 31 T.C. 554">31 T.C. 554, revd. 277 F. 2d 720, is obviously distinguished from the instant case in that in the DeWitt case the payments were received subsequent to↩ the decree of divorce.5. Sec. 1.71-1 Alimony and separate maintenance payments; income to wife or former wife.(b) Alimony or separate maintenance payments received from the husband -- * * (2) Written separation agreement. * *(ii) For purposes of section 71(a)(2)↩, any written separation agreement executed on or before August 16, 1954, which is altered or modified in writing by the parties in any material respect after that date will be treated as an agreement executed after August 16, 1954, with respect to payments made after the date of alteration or modification.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623384/	Eileen D. Cohen, 1 Petitioner v. Commissioner of Internal Revenue, RespondentCohen v. CommissionerDocket No. 7174-87United States Tax Court92 T.C. 1039; 1989 U.S. Tax Ct. LEXIS 67; 92 T.C. No. 65; May 15, 1989; As corrected May 18, 1989; As corrected June 6, 1989 May 15, 1989, Filed 67 Decision will be entered for the respondent. P made interest-free demand loans to family trusts. Held, R's method of valuing the gifts made to the trusts reflects the reasonable value of the use of the money lent. Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984). Phillip H. Martin and Michael J. McDonnell, for the petitioner.John C. Schmittdiel, for the respondent. Williams, Judge. WILLIAMS1040 OPINIONThe Commissioner determined deficiencies in petitioner's Federal gift tax in the following taxable periods and amounts:Calendar period endingDeficiencySept. 30, 1980$ 15,599Dec. 31, 198019,782Mar. 31, 198120,515Jun. 30, 198130,096Sept. 30, 198132,379Dec. 31, 198275,140Dec. 31, 1983142,033Dec. 31, 19842,954Total deficiencies 338,498The issue we must decide is the appropriate interest rate to use in valuing the gift that results from an interest-free demand loan pursuant to Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984).The facts of this case have been fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure, and are68 so found. Eileen D. Cohen, petitioner, is an individual who resided in Eau Claire, Wisconsin, during the period involved and when her petition was filed.The Alyssa Marie Alpine Trust (First Trust) is an irrevocable trust formed by petitioner and Melvin S. Cohen, petitioner's spouse, pursuant to a trust agreement for the Benefit of Alyssa Marie Alpine dated October 19, 1977, which designates Alyssa Marie Alpine (Alyssa) as its principal beneficiary. Alyssa is petitioner's granddaughter. The Alyssa Marie Alpine Trust No. 2 (Second Trust) is an irrevocable trust formed by Edith Phillips (Edith), petitioner's mother, pursuant to a trust agreement dated March 13, 1980, which designates Alyssa as its principal beneficiary. The 1983 Cohen Family Trust (1983 Trust) is an irrevocable trust Edith formed pursuant to a trust agreement creating the 1983 Cohen Family Trust dated June 3, 1983, which designates certain lineal descendants of Edith as its principal beneficiaries. (Hereinafter, the First Trust, the Second Trust, and the 1983 Trust are referred to collectively as the Trusts.) For Federal income tax purposes, petitioner and the 1041 Trusts reported on the cash basis method69 of accounting and used the calendar year as their taxable years.Subsequent to and in reliance upon the court's decision in Crown v. Commissioner, 585 F.2d 234">585 F.2d 234 (7th Cir. 1978), affg. 67 T.C. 1060">67 T.C. 1060 (1977), petitioner (a resident of the Seventh Circuit) made non-interest-bearing demand loans to the First Trust, the Second Trust, and the 1983 Trust. All of the loans were evidenced by non-interest-bearing demand notes. Petitioner filed a Form 709, United States Quarterly Gift Tax Return, for the calendar periods ended December 31, 1980, and December 31, 1981, reporting certain gifts of cash and property which were excludable from taxable gifts under section 2503(b) 2 as in effect during the calendar years 1980 through 1984. Petitioner inadvertently filed Form 709, United States Quarterly Gift Tax Return, on an annual basis for the calendar years ended December 31, 1980, and December 31, 1981, instead of on a quarterly basis. Petitioner made no taxable gifts during the calendar year ended December 31, 1982, and December 31, 1983, other than the gifts made by the non-interest-bearing demand loans at issue herein, and petitioner70 originally filed no gift tax returns for these periods.Petitioner did not report as taxable gifts the transfer of the value of the non-interest-bearing loans to the Trusts relying on the Crown decision that such non-interest-bearing loans did not give rise to taxable gifts. On August 16, 1984, after the Supreme Court's decision in Dickman v. Commissioner, supra, petitioner filed an amended Form 709, United States Quarterly Gift Tax Return, for the calendar quarters ended December 31, 1980, and December 31, 1981, and filed an (amended) Form 709, United States Gift Tax Return, for the calendar years ended December 31, 1982, and December 31, 1983, reporting values for the non-interest-bearing demand loans made by petitioner to the Trusts as taxable gifts. After the Supreme Court's decision in Dickman, petitioner also filed Form 709, United States Gift71 Tax Return, for the calendar year ended December 31, 1984, reporting a value for the non-interest-bearing demand loans made by petitioner to the Second Trust and the 1983 Trust 1042 as taxable gifts. Petitioner determined the value of the gifts by using the interest rates specified in sections 25.2512-5(e) and 25.2512-9(e), Gift Tax Regs. The rates were 6 percent from the beginning of the period at issue until November 30, 1983, and 10 percent from December 1, 1983, until the end of the period at issue. Although the returns for the calendar years ended December 31, 1982, and December 31, 1983, were marked "Amended," petitioner had not filed original returns for these periods.For the calendar periods ended September 30, 1980, December 31, 1980, March 31, 1981, June 30, 1981, September 30, 1981, December 31, 1982, December 31, 1983, and December 31, 1984, respondent concedes that petitioner is entitled to treat all gifts made by petitioner as being made one-half by petitioner and one-half by petitioner's spouse in accordance with section 2513.In the notice of deficiency, respondent determined that the non-interest-bearing demand loans made by petitioner to the Trusts resulted72 in taxable gifts. Respondent further determined that the value of each taxable gift is calculated by applying the following interest rates to the loan balances outstanding during each calendar year (simple interest):Taxable yearInterest rate19796.0%198011.5 198112.0 198210.6 19838.6 1984 9.9 These rates are set forth in Rev. Proc. 85-46, 2 C.B. 507">1985-2 C.B. 507.The statutory interest rates applicable to refunds and deficiencies of tax pursuant to section 6621 for the calendar years ending December 31, 1979, through December 31, 1984, are as follows:PeriodInterest rateFeb. 1, 1978 -- Jan. 31, 19806%Feb. 1, 1980 -- Jan. 31, 198212 Feb. 1, 1982 -- Dec. 31, 198220 Jan. 1, 1983 -- June 30, 198316 July 1, 1983 -- Dec. 31, 198411 1043 The average annual rates of interest for three-month Treasury bills for the calendar years ending December 31, 1979 through December 31, 1983, used by the Treasury Department in developing Rev. Proc. 85-46, supra, are as follows:YearInterest rate197910.041%198011.506 198114.029 198210.686 19838.63 73 Generally, the interest rate on a demand loan does not exceed the interest rate on a term loan that is identical in all other respects.From January 1, 1980, through December 31, 1984, the trustees of the First Trust invested the proceeds of the non-interest-bearing loans at issue primarily in short-term tax-exempt investments. From March 13, 1980 (the date of formation of the Second Trust), through December 31, 1984, the trustees of the Second Trust invested the proceeds of the non-interest-bearing loans at issue primarily in short-term tax-exempt investments and tax-exempt money market funds. From June 3, 1983 (the date of formation of the 1983 Trust) through December 31, 1984, the trustees of the 1983 Trust invested the proceeds of the non-interest-bearing loans at issue primarily in short-term tax-exempt investments. The weighted average annual percentage returns realized by the First Trust, the Second Trust and the 1983 Trust during the periods at issue are as follows:First TrustReturn19793.26%1/1/80 -- 6/30/80 8.29 Total5.76 Second Trust19804.69 19817.05 19827.20 19835.50 1/1/84 -- 3/1/84 13.61 Total6.45 1983 Trust1983.84 1/1/84 -- 3/1/8417.89 Total5.63 74 1044 In determining the gift tax deficiencies for the periods involved here, respondent redetermined the total amount of taxable gifts for periods prior to the period at issue here. In this redetermination of prior gifts, respondent included an amount for the taxable gift attributable to non-interest-bearing demand loans made by petitioner prior to the period at issue here. Petitioner concedes that respondent's valuation of the prior period interest-free loans is consistent with his valuation of the interest-free loans for the periods before the Court.The parties agree that in determining the value of the gifts petitioner made during the periods at issue here, the applicable interest rate the Court determines shall be applied to the average annualized loan amount of the loans made to the Trusts during the appropriate periods as follows:PeriodCalendarFirstSecond1983quarter ended:trusttrusttrust6/30/79$ 56,0179/30/79356,64412/31/79423,5543/31/80554,643$ 57,2126/30/80449,311465,5309/30/80972,37512/31/80992,8753/31/811,076,8236/30/811,355,6649/30/811,400,93712/31/811,403,713Year 1982 7,004,1741983 5,589,432$ 2,831,5471984 322,2761,116,17075 The parties stipulated to the hypothetical rate of return which would have been realized on the loans at issue using the interest rates specified in sections 25.2512-5(e) and 1045 25.2512-9(e), Gift Tax Regs. A summary of the parties' stipulation is as follows:ApplicableactuarialReturnFirst trustTotal loansrate(rate X loans)6/15/79 -- 6/30/80$ 7,057,4716%$ 423,448Second trust3/14/80 -- 11/30/8351,418,8226%3,085,12912/1/83 -- 3/1/84673,81710 67,3821983 trust6/6/83 -- 11/30/835,879,2346%352,75412/1/83 -- 3/1/844,003,46510 400,34669,032,8094,329,059Overall yield for all of the loans: 6.271%The issue before us is how to value the gift that results from an interest-free demand loan. 3 Petitioner loaned money interest-free to trusts created for the benefit of family members. Petitioner loaned the funds to the trusts after the Seventh Circuit Court of Appeals held, in Crown v. Commissioner, 585 F.2d 234 (7th Cir. 1978), affg. 67 T.C. 1060">67 T.C. 1060 (1977), that no gift tax liability would result. After the Supreme Court reversed the Crown outcome, 76 Dickman v. Commissioner, supra, petitioner filed gift tax returns on August 14, 1984, reporting the gifts for 1980 through 1983, and timely filed a gift tax return reporting the gifts for 1984. Petitioner valued the gifts relying on Rev. Rul. 73-61, 1 C.B. 408">1973-1 C.B. 408. Respondent used the interest rates in Rev. Proc. 85-46 to determine the deficiencies against petitioner.Petitioner argues that the appropriate rates are those found in section 25.2512-5 or 25.2512-9, Gift Tax Regs., as applicable to each taxable period pursuant to Rev. Rul. 73-61.77 Petitioner argues alternatively that the actual yields generated by the funds in the trust should determine the value of the gifts. In any event, petitioner contends that section 483 and the regulations thereunder provide an upper limit for the appropriate interest rate. Respondent contends that the interest rates in Rev. Proc. 85-46 are reasonable in 1046 light of the market interest rates and thus satisfy the Dickman requirement.Interest-free demand loans result in taxable gifts of the reasonable value of the use of the money lent. Dickman v. Commissioner, 465 U.S. 330">465 U.S. 330 (1984). Section 2501 imposes a tax on the transfer of property by gift. The tax applies whether the transfer is in trust or otherwise, direct or indirect. Sec. 2511(a). The amount of a gift of property is the fair market value of the property at the date of the gift. Sec. 2512(a); sec. 25.2512-1, Gift Tax Regs. The value of the interest-free loan is measured by the cost the donee would have incurred in borrowing the same funds.Dickman v. Commissioner, supra, provides the starting point for 78 determining the value of the gift. Prior to Dickman, respondent had attempted, unsuccessfully, to impose the gift tax on interest-free demand loans. See Crown v. Commissioner, 585 F.2d 234">585 F.2d 234 (7th Cir. 1978), affg. 67 T.C. 1060">67 T.C. 1060 (1977); Johnson v. United States, 254 F. Supp. 73">254 F. Supp. 73 (N.D. Tex. 1966). In Dickman, the Supreme Court held that interest-free demand loans result in "taxable gifts of the reasonable value of the use of the money lent." (Fn. ref. omitted.) Dickman v. Commissioner, supra at 344. The Court reasoned that the right to use money is a valuable right, "readily measurable by reference to current interest rates * ." Dickman v. Commissioner, supra at 337. In Dickman, respondent had determined the value of the gift by utilizing the interest rates applicable to a deficiency pursuant to section 6621.Valuation, however, was not at issue in the appeal before the Supreme Court. Following the Supreme Court's decision in Dickman, respondent issued a revenue procedure for determining the interest rate to value 79 the gift resulting from an interest-free demand loan. Rev. Proc. 85-46, 2 C.B. 507">1985-2 C.B. 507. 4 This revenue procedure sets the interest rate for valuation at the lesser of (1) the statutory interest rate for refunds and deficiencies in section 6621 or (2) the annual average rate for three-month Treasury bills. Respondent used the Rev. Proc. 85-46 rates to value the gifts in the present case.1047 The Dickman opinion alludes to use of a market rate of interest to value the loans. Three-month Treasury bills and the section 6621 rates both reflect market rates of interest for short-term loans. Treasury bills are auctioned and issued weekly on the public market. Section 6621 provides for an adjustable interest rate based on the prime rate in all of the years before us.Petitioner argues that Rev. Proc. 85-4680 can be justly ignored because Rev. Rul. 73-61 required taxpayers to use sections 25.2512-5 and 25.2512-9, Gift Tax Regs., in valuing the gift resulting from interest-free demand loans. Because petitioners used the rates required by Rev. Rul. 73-61, they argue respondent should not be permitted to apply a different and higher set of rates to their gifts retroactively.Rev. Rul. 73-61 discusses the gift tax consequences to a parent who lent $ 250,000 interest-free to his son's wholly owned corporation, $ 200,000 payable on demand and $ 50,000 payable in ten years. The ruling concludes that the parent gave the use of the money to his son. Rev. Rul. 73-61, supra at 409. The 1973 ruling also states that the value of the term gift loan can be ascertained by accepted actuarial methods when the loan is made and is, therefore, subject to the gift tax at that time, citing section 25.2512-5, Gift Tax Regs. 1973-1 C.B. at 409. Section 25.2512-5, Gift Tax Regs., provides for actuarial81 valuation of annuities, life estates, terms for years, remainders, and reversions. With respect to the demand loan, however, the ruling states that the value of the gift was not ascertainable until the end of each calendar quarter during which the corporation had the use of the money. The valuation method for the demand loan was not specified in the ruling. The revenue ruling, therefore, provides no direct support for petitioner's argument.Petitioner, however, points to the Supreme Court's acknowledgment that a demand loan, because of its inherently uncertain term, will bear a lesser interest rate than a term loan identical in other respects. Dickman v. Commissioner, 465 U.S. at 337. She argues, therefore, that a demand loan cannot bear a rate higher than the rate that respondent approved for the term loan in Rev. Rul. 73-61. Petitioner's 1048 reliance on the interest rate utilized in Rev. Rul. 73-61 is, nevertheless, misplaced.First, the interest rates prevailing in 1973 may well have been reflected by section 25.2512-5, Gift Tax Regs., but there is no 82 doubt that, in the years before the Court, prevailing interest rates were much higher. Consequently, we can say that the regulation does not apply the market interest rate standard articulated by the Supreme Court in Dickman. Second, respondent applies in this case the lesser of Treasury bill rates or section 6621 rates. As a result, the interest rates applied by respondent in this case are comparable, if not identical, to the rates respondent used in Dickman which were not criticized by the Supreme Court. Finally, because the rates that respondent utilizes in valuing the gifts in this case are market rates extant while the loans were outstanding, there is no "retroactive" application of unforeseeable interest rates to petitioner's prejudice.Respondent's "lesser of" three-month Treasury bills and section 6621 rates standard allows taxpayers to use a relatively low interest rate to compute gift values. The U.S. Government is the debtor with the lowest credit risk; its interest rates, therefore, should be lower than other market interest rates payable by other debtors whose credit worthiness is not so firm as that of the United States. See Goldstein v. Commissioner, 89 T.C. 535 (1987).83 It is highly improbable that a donee of an interest-free demand gift loan could borrow the funds at a lower interest rate than the one payable by the United States. Respondent, therefore, has selected a fair method of determining the reasonable value of the gifts that result from interest-free demand loans. Rev. Proc. 85-46 is based on a readily ascertainable yield on funds and provides a reliable method to determine the reasonable value of the use of the funds. In short, it satisfies the standards of valuation anticipated in Dickman v. Commissioner, supra at 344 n. 14.Petitioner also argues that the actual yield of the loan proceeds is the proper measure of the gift if section 25.2512-5, Gift Tax Regs., does not apply. The issue, however, is not what the donee of an interest-free loan could have made if it invested the funds. On this point of 1049 valuation, the Supreme Court commented that "the Commissioner need not establish that the funds lent did in fact produce a particular amount of revenue; it is sufficient for the Commissioner to establish that a certain yield could readily be secured and84 that the reasonable value of the use of the funds can be reliably ascertained." Dickman v. Commissioner, supra at 344 n. 14. The cost of the use of the funds (i.e., market interest rate), which is the measure of the value of the gift, does not depend on the soundness of the debtor's use of the loan proceeds. A lender does not usually reduce the rate of interest because the debtor experiences a relatively low rate of return on investing the proceeds. The relevant inquiry is at what interest rate the donee could have borrowed the funds. See Dickman v. Commissioner, supra at 335 and n. 5. Petitioner's argument, therefore, fails.Petitioner also contends that, in any event, the interest rates in section 483 provide a cap on the interest rate respondent may impute for gift tax purposes, based on the Seventh Circuit's decision in Ballard v. Commissioner, 854 F.2d 185 (7th Cir. 1988), revg. a Memorandum Opinion of this Court. 5 Respondent argues that section 483 is irrelevant because this case does not involve a sale or exchange of property.85 Section 483 6 generally provided in the years at issue that 1050 interest would be imputed in installment sales contracts at an "unstated interest" rate if the contract did not provide for a "safe harbor" test rate of interest. The "safe harbor" test rates during the periods at issue were 6-percent simple interest until June, 30, 1981, and 9-percent simple interest thereafter. Sec. 1.483-1(d)(1)(ii), Income Tax Regs. The unstated interest rates during the periods at issue were 7 percent compounded semiannually through June 30, 1981, and 10 percent compounded semiannually thereafter. Sec. 1.483-1(c)(2)(ii), Income Tax Regs.86 The Seventh Circuit Court of Appeals, to which an appeal would lie in this case, recently considered section 483 in a gift tax context in Ballard v. Commissioner, supra. In Ballard, the taxpayer sold property to her children for a price less than fair market value on the installment method at a 6-percent interest rate. The taxpayer reported the difference between fair market value and the purchase price as a gift. The Commissioner determined that the 6-percent interest rate on the purchase price gave rise to an additional gift. He determined a deficiency in gift tax using an 18-percent market rate of interest to discount the purchase price even though the contract provided for interest at 6 percent, the section 483 "safe harbor rate."This Court held that the section 483 "safe harbor" interest rate could not be relied on for gift tax valuation purposes. The Seventh Circuit reversed and held that section 483 applies to the gift tax provisions of the Code as well as to the income tax provisions. Ballard v. Commissioner, supra at 188. The court based its holding on the introductory language of section 483 which 87 states that section 483 applies, "for purposes of this title," i.e., to all provisions of the Code. The court reasoned that,1051 although valuation of property, for purposes of gift taxes, is not directly related to the imputation of taxes on installment contracts for purposes of income taxation; a taxpayer who complies with Sec. 483 and charges a "safe harbor" rate of interest on an installment sales contract, should not be penalized if the "safe harbor" rate of interest is below the market rate of interest for purposes of gift tax valuation.Ballard v. Commissioner, supra at 187.The taxpayer in Ballard sold property on the installment method. Section 483, therefore, applied by its terms to the taxpayer in Ballard. The Ballard court held that when a taxpayer complies with the section 483 safe harbor rules in an installment sale, respondent cannot impute a higher market rate of interest to find a gift. The section 483 safe harbor protects taxpayers who sell property using the installment method for purposes of the gift tax as well as the income tax.Section 483 by its terms, however, does not apply to transactions other than88 contracts for the sale or exchange of property. We look, therefore, to the purpose of section 483 to determine what effect it might have on transactions other than installment sales. Section 483 was designed by Congress to prevent sellers from converting ordinary income into capital gain by agreeing to deferred payment of the purchase price without stating how much of the deferred payments constituted interest. H. Rept. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2) 196. In the same transaction, buyers of depreciable property were able to depreciate the acquired property using an inflated basis. Section 483 was designed to provide a basis rule for installment sales by recharacterizing part of the stated principal payments as interest. The purposes underlying section 483 had nothing to do with valuation. In promulgating regulations that established "safe-harbor" and "imputed" interest rates, the Treasury Department did not peg the rates to any market interest rate. We conclude that section 483 does not provide appropriate interest rates under the Dickman standard for use in valuing the gift resulting from an interest-free demand loan. 89 Like section 483, section 482 also provides an imputed interest rate. We consider section 482 because, unlike section 483, it provides a rule specifically for imputing 1052 interest rates on interest-free demand loans in transactions between certain related taxpayers.In general, section 482 7 provides for the allocation of income and deductions among taxpayers. The purpose of section 482 is to place transactions of controlled taxpayers dealing with each other on a tax parity commensurate with the dealings between uncontrolled taxpayers dealing at arm's length. Sec. 1.482-1(b)(1), Income Tax Regs. The section 482 regulations require an arm's-length interest rate to be imputed if a taxpayer loans money to a controlled taxpayer in a business setting and charges no interest. Sec. 1.482-2(a)(1), Income Tax Regs. The regulations provide a safe harbor interest rate that taxpayers may use to avoid imputation of interest on loans between controlled taxpayers.90 During the period at issue prior to July 1, 1981, the safe harbor rate was between 6 and 8 percent per annum simple interest. Sec. 1.482-2(a)(2)(iv), Income Tax Regs. For the remaining period at issue, the safe harbor rate was between 11 and 13 percent per annum simple interest. Sec. 1.482-2(a)(2)(iii), Income Tax Regs. These safe harbor rates applied to interest-free loans unless the taxpayer established a more appropriate rate under the circumstances.The section 482 rates were changed occasionally to reflect market interest rates. The rate changes during the periods at issue, however, lagged considerably behind actual market changes. 8Dickman requires us to measure the economic value associated with the use of the money; this value is "readily measurable by reference to current interest rates." Dickman v. Commissioner, supra at 337. The regulations, which did not provide current interest rates, therefore, do not provide an appropriate rate to determine value for gift tax purposes. Moreover, we note, the rates chosen administratively 1053 by respondent in Rev. Proc. 85-46 and applied in 91 this case are more beneficial to petitioner than the section 482 rates for the years at issue.Petitioner also argues that the rates chosen by respondent in Rev. Proc. 85-46 are not theoretically correct and, consequently, that we should disregard them. Petitioner points out that any interest chargeable to the trusts on their loans would have turned on many factors, including the loan mix of the lender, availability and cost of funds to the lender, prevailing interest rates locally, local economic conditions, the credit status and history of the debtor, the debtor's reputation in the community, etc. -- i.e., all the variables that go into a financial institution's decision on what to charge for lending money to a specific borrower on a given92 day. While respondent's approach may not have been theoretically pure, we commend respondent for promulgating easily administrable, readily ascertainable, comprehensible standards that, in our view, seem generous in their application to petitioner.Decision will be entered for the respondent. Footnotes1. The parties in docket Nos. 7172-87 and 7690-87 (the petitioners are Melvin S. Cohen, and Edith Phillips, respectively) have stipulated that they will be bound by our decision in docket No. 7174-87 as if each of the petitioners were the petitioner in docket No. 7174-87.↩2. All section references are to the Internal Revenue Code of 1954 as in effect for the years at issue, unless otherwise indicated.↩*. Date of repayment of all loans.↩3. Congress resolved the issue for interest-free and low-interest demand gift loans outstanding after June 6, 1984, unless the loan was repaid or the interest rate was modified before Sept. 17, 1984. Sec. 7872. All of the loans at issue in this case were repaid on Mar. 1, 1984, prior to the time the new rules were in effect.↩4. The revenue procedure restates the method described in Information Release IR 84-60↩, dated May 11, 1984.5. T.C. Memo. 1987-128↩.6. Sec. 483 provides, in pertinent part:SEC. 483. INTEREST ON CERTAIN DEFERRED PAYMENTS.(a) Amount Constituting Interest. -- For purposes of this title, in the case of any contract for the sale or exchange of property there shall be treated as interest that part of a payment to which this section applies which bears the same ratio to the amount of such payment as the total unstated interest under such contract bears to the total of the payments to which this section applies which are due under such contract.(b) Total Unstated Interest. -- For purposes of this section, the term "total unstated interest" means, with respect to a contract for the sale or exchange of property, an amount equal to the excess of -- (1) the sum of the payments to which this section applies which are due under the contract, over(2) the sum of the present values of such payments and the present values of any interest payments due under the contract.For purposes of paragraph (2), the present value of a payment shall be determined, as of the date of the sale or exchange, by discounting such payment at the rate, and in the manner, provided in regulations prescribed by the Secretary. Such regulations shall provide for discounting on the basis of 6-month brackets and shall provide that the present value of any interest payment due not more than 6 months after the date of the sale or exchange is an amount equal to 100 percent of such payment.(c) Payments to Which Section Applies. -- (1) In general. -- Except as provided in subsection (f), this section shall apply to any payment on account of the sale or exchange of property which constitutes part or all of the sales price and which is due more than 6 months after the date of such sale or exchange under a contract -- (A) under which some or all of the payments are due more than one year after the date of such sale or exchange, and(B) under which, using a rate provided by regulations prescribed by the Secretary for purposes of this subparagraph, there is total unstated interest.↩Any rate prescribed for determining whether there is total unstated interest for purposes of subparagraph (B) shall be at least one percentage point lower than the rate prescribed for purposes of subsection (b)(2).7. SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS.In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.↩8. TRA 1984, in sec. 44(b)(2) of Pub. L. 98-369, 98 Stat. 559, 1984-3 C.B. (Vol. 1) 67, provided for modification of the sec. 482 safe harbor rates by using the applicable Federalrate pursuant to sec. 1274 (d).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623385/	David Dab and Rose Dab, Petitioners, v. Commissioner of Internal Revenue, RespondentDab v. CommissionerDocket No. 58808United States Tax Court28 T.C. 933; 1957 U.S. Tax Ct. LEXIS 126; July 30, 1957, Filed 126 Decision will be entered for the respondent. Held: (1) A 99-year leasehold cannot be amortized or depreciated over the shorter estimated life of a building located on the leased property when acquired; (2) a 99-year lease with options to terminate at the end of 25, 50, and 75 years is not the equivalent of a lease for a 25-year original term with options to renew. Howard A. Rumpf, Esq., for the petitioners.Jules W. Breslow, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 934 The Commissioner determined deficiencies in income tax and computed additions to tax in the returns of David Dab and Rose Dab for the years 1950 and 1951 in the following amounts:Additions to taxYearAmountSec. 294 (d)Sec. 294(1) (A)(d) (2)1950$ 2,613.78$ 345.84$ 230.5619512,101.70Total4,715.48345.84230.56127 Two questions are presented. First, can a 99-year lease be amortized or depreciated over 20 years, the estimated remaining life of a building located on the leased property when acquired? Second, is a leasehold for 99 years, with options to terminate after 25, 50, and 75 years, the legal equivalent of a lease for a 25-year original term with options to renew?FINDINGS OF FACT.Some of the facts are stipulated and are so found, the stipulation being incorporated herein by this reference.Petitioners, David Dab and Rose Dab, are husband and wife. Their joint individual income tax returns for the years 1950 and 1951 were filed with the collector of internal revenue for the fourteenth district of New York. Rose Dab is involved only because the returns were filed jointly. David Dab will hereinafter be referred to as the petitioner.By an agreement dated June 7, 1948, the Second Presbyterian Church in the city of New York leased to the B. R. D. Realty Corporation certain property located at 360 Central Park West, New York, New York, hereinafter sometimes referred to as the leasehold. The B. R. D. Realty Corporation assigned the leasehold to the partnership of Ryan, Duberstein, Duberstein, 128 and Berkman on July 2, 1948. On October 1, 1948, Ryan, Duberstein, Duberstein, and Berkman entered into a contract to assign the lease to Roosevelt Gabriel. Gabriel assigned this contract to the 360 Central Park West Partnership, hereinafter sometimes referred to as the partnership, and the lease was assigned on January 5, 1949.The leasehold contained a building erected in 1928 by a predecessor of the lessor. The term of the lease was 99 years with the right given to the lessee and his assignees to terminate the lease at the end of the 25th, 50th, and 75th year, by giving 1 year's notice to the lessor, the provisions reading as follows:2. The term of this indenture shall be for a period of ninety-nine (99) years, commencing at midnight on the 30th day of June, 1948 and ending at midnight on the day which shall be ninety-nine years thereafter.935 The Tenant shall have the option of terminating this indenture of lease at the last day figured on a fiscal year basis on the 25th year, the 50th year and 75th year of the term of this lease, which options shall be exercised as to such respective dates of termination, by notice by the Tenant to the Landlord at least one year prior129 to said respective termination dates. It is understood and agreed that the failure to exercise any one of said options shall not conclude or prevent the Tenant from exercising the options to terminate as to the subsequent terminable years above expressed.On January 5, 1949, petitioner entered into the 360 Central Park West Partnership. His contribution to the partnership gave him a 15 per cent interest therein.The partnership reported income on the basis of a fiscal year ending July 31. Using the declining balance method the partnership depreciated the leasehold over a period of 20 years. Twenty years was an estimation of the remaining life of the building contained in the leasehold.The respondent allowed a deduction for amortization on the straight-line method based on the remaining term of the lease which, for the fiscal year ending July 31, 1950, was 97 years 11 months, and for the fiscal year ending July 31, 1951, was 96 years 11 months. The petitioner stipulates that the straight-line method is the proper method to use.In the statement attached to the notice of deficiency the respondent determined that the corrected amortization increased partnership ordinary net income130 in fiscal 1950 and 1951. This adjustment resulted in a further determination of a proportionate increase in petitioner's distributive share of partnership income.OPINION.The first question presented is whether a leasehold for 99 years can be depreciated or amortized over 20 years, the estimated remaining life of a building contained thereon.Petitioner was a partner in a group which acquired by assignment a leasehold on property at 360 Central Park West, New York City, on January 5, 1949. During the years 1950 and 1951 the partnership depreciated the leasehold on the declining balance method over a period of 20 years -- 20 years being an estimation of the remaining life of a building contained thereon.The respondent computed and allowed amortization of the leasehold by the straight-line method over the full term of 99 years.The petitioner concedes that the straight-line method is the correct method to use but contends that the use of 20 years as the period for depreciation was correct.We agree with the respondent. The 20-year period had no relevance to the length of the leasehold. It was merely an estimate of the remaining 936 useful life of the building. The partnership131 had no depreciable interest in the building, it did not erect the building, nor did it own it; the building was contained on the leasehold at the time of consummation of the lease.It has been held that a taxpayer who has a leasehold on land and improvements but no depreciable interest in the improvements as such can neither deduct depreciation for a building contained on the leasehold nor use the life of the building as a base period over which to depreciate the entire leasehold. City National Bank Building Co., 34 B. T. A. 93, affd. 98 F. 2d 216 (1938); cf. Weiss v. Wiener, 279 U.S. 333 (1929).Section 29.23 (a)-10 of Regulations 111 1 allows a taxpayer to take an aliquot part of the purchase price of a leasehold as amortization or exhaustion each year, based on the number of years the lease has to run. This regulation also provides that when the useful life of buildings and improvements erected by the lessee is less than the unexpired term of the lease, the lessee may depreciate these buildings and improvements over their respective lives. The regulation makes no 937 allowance132 for depreciation by the lessee of buildings and improvements existing on the land at the time of consummation of the lease.133 The petitioner cites various cases, 2 all of which are concerned with the depreciation of leaseholds and improvements over original lease periods or original and renewal periods. In each, the improvements were erected by the lessee rather than being in existence at the time of writing of the lease, as in the instant case.We are of the opinion that the use of 20 years, the remaining life of a building, as a base period for the amortization or exhaustion of the leasehold was clearly erroneous.The second question is whether the partnership should be allowed to depreciate or amortize its 99-year leasehold over134 a period of 25 years, the interval between inception of the lease and the first opportunity to terminate.The petitioner alleges that for all legal and practical purposes a lease for 99 years with options to terminate at the end of the 25th, 50th, and 75th years is the same as a lease for a 25-year original term with stated rights to renew. 3We cannot agree. A lease for 99 years with options to terminate before expiration is an entity for 99 years. If no affirmative action is undertaken to end or alter it, it will remain in effect until the term expires.A lease for a shorter period with options to renew is an entity only for its original term. If no affirmative action is undertaken135 to alter or renew it, it remains in effect only until expiration of its original period. The two types of instruments cannot be equated.Section 29.23 (a)-10 of Regulations 111, supra, footnote 1, allows depreciation or amortization of the cost of a leasehold over the original or original and renewal period of the lease, depending upon the facts. The regulation makes no specific provision for depreciation of a leasehold over less than the full term of a lease incorporating an option to terminate prior to expiration of the term. However, were we to assume petitioner's premise that the two types of leases are equivalents, the conclusion would still be against petitioner. There is no evidence to justify a conclusion that the lessee intended to terminate the lease at the end of 25 years.Respondent's contention that the leasehold must be depreciated over the entire 99 years is upheld.938 The petitioner has introduced no evidence and has, therefore, failed to show why additions to tax imposed by the Commissioner under section 294 (d) (1) (A) and (d) (2) should not be assessed. Therefore, these additions should be added to the deficiencies.Decision will be entered136 for the respondent. Footnotes1. Sec. 29.23 (a)-10. Rentals. -- If a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an aliquot part of such sum each year, based on the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.In cases in which the lease contains an unexercised option of renewal, the matter of spreading such depreciation or amortization over the term of the original lease, together with the renewal period or periods, depends upon the facts in the particular case. As a general rule, unless the lease has been renewed or the facts show with reasonable certainty that the lease will be renewed, the cost or other basis of the lease or the cost of improvements shall be spread only over the number of years the lease has to run, without taking into account any right of renewal. However, if the taxpayer for any taxable year ending prior to December 31, 1939, has been allowed such depreciation or amortization on the basis of spreading the cost or other basis of such lease or improvements over the number of years the lease has to run, including any exercised or unexercised renewal period or periods, and such taxable year has been closed on that basis and the tax for that year cannot be redetermined, then the taxpayer may for subsequent taxable years take deductions on such basis if within 90 days after the approval of Treasury Decision 4957↩ (approved December 6, 1939) or within such later period as may be specified by the Commissioner, he files Form 969, in duplicate, with the Commissioner of Internal Revenue, Washington, D. C., attention of the Income Tax Unit, Records Division, signifying his election to have deductions in respect of such items determined upon such basis, and expressly waives his right to claim or receive the benefits of any reduction in his tax liability which would result from the allowance of deductions for such items on the basis of only the number of years the lease has to run, without taking into account any right of renewal, or on any basis other than that set forth in his election. If, in any case, the life of the improvements is less than the number of years the lease has to run, including the renewal period if properly to be considered, the deduction for depreciation with respect to such improvements shall be spread only over such life.2. Sheffield Hardware Company v. United States, 48 A. F. T. R. 1382, 54-1U. S. T. C. par. 9337 (1954); 353 Lexington Avenue Corporation, 27 B. T. A. 762 (1933); 379 Madison Avenue v. Commissioner, 60 F. 2d 68 (1932); and Strand Amusement Co., 3 B. T. A. 770↩ (1926).3. Petitioner cites Webster's dictionary definitions for the words "terminate" and "renew", as follows: Terminate -- to set or form a term or spatial limit -- to found -- limit -- to come to a limit in time. Renew -- to grant or obtain an extension of, as in the case of a renewal of a note, or to make a renewal, as in the case of a lease.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623386/	D. L. WHEELOCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wheelock v. CommissionerDocket No. 7974.United States Board of Tax Appeals10 B.T.A. 540; 1928 BTA LEXIS 4085; February 6, 1928, Promulgated 4085 A contracting partnership keeping its books on the closed-job basis should deduct operating expenses from gross income when such expenses are taken into profit and loss on its books. Ray G. Ransom, C.P.A., for the petitioner. P. M. Clark, Esq., for the respondent. LANSDON 540 In his notice of deficiency the respondent asserted deficiencies in income tax for the years 1920 and 1921 in the respective amounts of $522.27 and $1,518.33, and an overassessment for the year 1922 in the amount of $122.33. The petitioner seeks a redetermination of the deficiencies and asserts that the respondent erred in overstating his income for the taxable years by including therein certain amounts that are deductible as operating expenses of a partnership of which he was a member. The parties filed a stipulation which the Board accepts and from which we make the following findings of fact. 541 FINDINGS OF FACT. The petitioner is an individual, residing at Clay Center, Kans. During the taxable years he was a member of the partnership of Reed and Wheelock, Municipal Contractors, of Clay Center, Kans., and had a 50 per cent interest in the business4086 and profits thereof. During the years 1920 and 1921 the partnership kept its books and made its income-tax returns on the "closed job" basis. Certain expenditures such as interest, traveling and office expenses, when paid during the year, were charged to the respective appropriate accounts and were so classified on the books until the close of the year, when such expenses were allocated to various jobs under construction, such allocation being the result of an approximate estimate of the proportionate share of such expenses chargeable to each job. The amounts of such expenses so charged were not closed into profit and loss until the jobs were completed. During the year 1920 the partnership paid the following expenses, which were allocated to jobs completed in the year 1921 and closed to profit and loss on the books in the year 1921: (a) Interest on borrowed money for the year 1920 in the sum of $732.84. (b) Traveling expenses of the partners and general office employees for the year 1920 in the sum of $1,275. (c) Office expense of the general office of the partnership for the year 1920 in the sum of $527. The above expenses, totaling $2,535.54, were allowed as deductions4087 by the Commissioner for the year 1921. During the year 1921 the partnership paid the following expenses, which at the close of the year 1921 were arbitrarily allocated to jobs completed in subsequent years and closed to profit and loss on the books in the years in which the respective jobs were completed: (a) Interest on borrowed money for the year 1921 in the sum of $2,804.79. (b) Traveling expenses of the partners and general office employees for the year 1921 in the sum of $1,994. (c) Office expense of the general office of the partnership for the year 1921 in the sum of $2,404.13. The above expenses, totaling $7,202.92, were allowed by the Commissioner as deductions in 1922 and subsequent years as the respective jobs to which the expenses were allocated were completed. The petitioner waives the contention contained in paragraph 5(b) of the petition. OPINION. LANSDON: The only controversy here relates to the year in which operating expenses which the parties agree are deductible from gross income shall be so deducted. There is no dispute over the 542 facts. The petitioner is a member of a contracting partnership that keeps its books on the closed-job*4088 basis, as set forth in our findings of fact. The respondent contends that the expenses in question should be deducted from gross income in the respective years in which they are charged to profit and loss. The petitioner maintains that regardless of the methods of bookkeeping employed by the partnership, expenses are deductible from income in the year in which they are paid or incurred. The administrative regulations permit contractors to make their returns on the so-called closed-job or long-time-contract basis, on the theory that it is only when a project is completed and payment therefor received that income can be determined. The petitioner's contention in effect is that the partnership is entitled to deduct expenses as incurred, regardless of when resulting income is realized. We are not able to adopt this view. The partnership, having decided to keep its books on a basis that takes income into profit and loss only as and when projects are completed, we think that the expenses incident to the production of such income are deductible at the same time. Reviewed by the Board. Judgment will be entered for the respondent.STERNHAGEN concurs in the result only.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623387/	GREAT NORTHERN RAILWAY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Great N. Ry. v. CommissionerDocket Nos. 8433, 11850.United States Board of Tax Appeals8 B.T.A. 225; 1927 BTA LEXIS 2933; September 22, 1927, Promulgated 2933 1. In its income-tax return for 1917 the petitioner deducted from gross income the entire expense of operating its transportation service trains, including $422,677.80 appearing upon its books as a credit to "Transportation for Investment-Cr.," and representing the estimated cost of transporting on such trains men engaged in and material used in construction work, which deduction was disallowed by the Commissioner. A revised estimate of such cost is $41,799.45. Held, on the evidence, that no part of the $422,677.80 is deductible from gross income. 2. In 1917 the petitioner paid $4,587.02 as penalties for violating Federal regulatory statutes. Held, that the penalties paid are not ordinary and necessary expenses incident to the conduct of its business. 3. In 1918 the petitioner owned all of the capital stock of the Great Northern Express Co., an affiliated corporation. During the year the Express Company was required by the Customs authorities to pay a penalty of $28 for violation of the Customs Regulations, one-half of which was assumed by the Great Northern Express Company and the other half by the Adams Express Company. Held, that the penalty paid was not2934 a legal deduction from gross income. 4. During the years 1917, 1918, and 1919 the petitioner owned interest-bearing obligations of a number of corporations which, under the Regulations of the Interstate Commerce Commission, it was not permitted to accrue upon its books for the reason that the corporations were operating at a deficit and there was no certainty that they would ever be able to pay interest on their obligations. Held, that the petitioner derived no income from interest upon the obligations during the taxable years and that the amount thereof was improperly accrued by the respondent in computing deficiencies. 5. In determining the cost of property scrapped during the taxable years the Commissioner correctly adjusted the March 1, 1913, value by the amount of allowable depreciation on such assets which was deducted from gross income in income-tax returns. 6. Amount of loss sustained on shares of stock of the Spokane & Inland Empire Railroad Co. which became worthless in 1918, determined. 7. Profit on sale of parcels of land determined. 8. Contributions received for construction of spur tracks and farm crossings held not to constitute taxable income. 2935 9. Compensation and interest due the petitioner from the Director General was income for each of the accounting periods for which the compensation was allowed. Appeal of Illinois Terminal Co.,5 B.T.A. 15">5 B.T.A. 15, followed. 10. The petitioner and the Farmers Grain & Shipping Co. held not to be affiliated. 11. One of the subsidiaries of the petitioner entered into a contract in 1918 for the sale of a steamship at the price of $600,000. No part of the purchase price was received in 1918 and $200,000 was paid in 1919, during which year the contract was canceled and the subsidiary permitted to retain the $200,000 paid on account. Held, that the $200,000 received was income of 1919. 12. Under the Federal Control Act and the Revenue Act of 1918 the petitioner was required to pay income taxes at the rate of 10 per cent for 1918 and 8 per cent for 1919. These statutes release the petitioner from liability for two-twelfths of the taxes that would otherwise be due from it for the year 1918 and two-tenths of the taxes due for the year 1919. The additional taxes due for those years are assessable against the petitioner at the rates of 10 per cent and 8 per2936 cent, respectively. Appeal of New York, Ontario & Western Railway Co.,1 B.T.A. 1172">1 B.T.A. 1172, followed. 13. Deductible amount of depreciation on ore docks for 1918 and 1919 determined. 14. In 1919 the petitioner made a contribution to the "Association of Railway Executives" which it is alleged by the respondent is not deductible from gross income in its income-tax return for 1919. For lack of evidence as to whether the amount was taken as a deduction in the return, held that the net income of the petitioner should not be increased by any disallowance of the contribution. J. P. Plunkett, Esq., and F. G. Dorety, Esq., for the petitioner. M. N. Fisher, Esq., for the respondent. SMITH 227 These are proceedings for the redetermination of deficiencies in income tax for the years 1917, 1918, and 1919 as follows: 1917$121,149.591918529,249.86191926,643.55The petitioner alleges that the taxes in controversy for the several years are as follows: 1917$130,056.131918536,739.06191932,030.40The assignments of error with respect to the year 1917 are as follows: 1. The2937 failure of the Commissioner to allow as a deduction from the gross income of the taxpayer ordinary and necessary expenses incurred, in the amount of $422,677.80, said failure resulting in proposed additional taxes of $25,360.67. 2. The failure of the Commissioner to allow as a deduction from the gross income of the taxpayer the sum of $4,587.02 paid to the United States Government as fines for the violation of Federal Statutes and Regulations, such failure resulting in proposed additional taxes of $275.22. 3. The error of the Commissioner in determining that interest to the amount of $1,572,100.07, due the taxpayer for the year 1917, but not received or accrued on its books, on interest-bearing obligations of the Spokane, Portland and Seattle Railway Company held by the taxpayer, constituted taxable income of the taxpayer for that year, such error resulting in proposed additional taxes of $94,326.00. 4. The error of the Commissioner in determining that interest to the amount of $29,558.61 due the taxpayer for the year 1917, but never received or accrued on its books, on advances made to the Glacier Park Hotel Company by the taxpayer, constituted taxable income of the taxpayer2938 for that year, such error resulting in proposed additional taxes of $1,773.52. 5. The error of the Commissioner in determining that interest to the amount of $3,518.97 due the taxpayer for the year 1917, but never received or accrued on its books, on advances made to the South Butte Mining Company by the taxpayer, constituted taxable income of the taxpayer for that year, such error resulting in proposed additional taxes of $211.14. 6. The error of the Commissioner in determining that interest to the amount of $90,000.00, due the taxpayer for the year 1917, but never received or accrued 228 on its books, on notes of the Washington & Great Northern Townsite Company held by the taxpayer, also interest on unpaid installments of interest on such notes, amounting to $14,085.58, likewise never received or accrued on the taxpayer's books, constituted taxable income of the taxpayer for that year, such error resulting in proposed additional taxes of $6,245.13. 7. The failure of the Commissioner to allow as a basis of deduction from the gross income of the taxpayer, the fair market value as of March 1, 1913, of certain equipment acquired by the taxpayer prior to March 1, 1913, and2939 scrapped or otherwise disposed of during the year 1917, such failure resulting in excess taxes for the year of $1,864.45. The assignments of error for the years 1918 and 1919 are as follows: 1. The failure of the Commissioner to find that capital stock of the Spokane and Inland Empire Railroad Company, held by taxpayer and ascertained to be worthless in the year 1918, had a value on March, 1, 1913, equal to the cost thereof, and his failure to use such value as a basis of ascertaining the loss sustained, such failure resulting in proposed additional taxes of $216,689.70. 2. The failure of the Commissioner to find that certain parcels of land, sold by the taxpayer in 1918, had a value on March 1, 1913, in excess of cost and equal to the selling price received in 1918, and his failure to use such value as a basis of ascertaining gain or loss, such failure resulting in proposed additional taxes of $274.59. 3. The error of the Commissioner in determining that interest due the taxpayer for the years 1918 and 1919, but never received or accrued on its books, on interest-bearing obligations of the Spokane, Portland and Seattle Railway Company held by the taxpayer, constituted2940 taxable income of the taxpayer for those years, such error resulting in proposed additional taxes of $151,978.47 for the year 1918 and $121,458.17 for the year 1919. 4. The error of the Commissioner in determining that the value of labor and material furnished, free, by various individuals and corporations, and of cash reimbursements made by such individuals and corporations during the years 1918 and 1919 in connection with the construction of private and public crossings, industry spur tracks and other facilities under agreements providing that the title to such facilities would be in the taxpayer, constituted taxable income of the taxpayer, for those years, such error resulting in proposed additional taxes of $2,811.60 for the year 1918 and $1,530.32 for the year 1919. 5. The error of the Commissioner in reducing the taxable income of the taxpayer for each of the years 1918 and 1919 in the amount of $53,635.77, to agree with a certificate issued by the Interstate Commerce Commission under date of January 5, 1922, reducing the annual compensation of the taxpayer under the Federal Control Act in that amount, such error resulting in proposed reduction of taxes for the year 19182941 of $5,363.58 and for the year 1919 of $4,290.86 and in proposed additional taxes for the year 1921 of $10,727.15. 6. The error of the Commissioner in determining that the taxable income of the taxpayer for the year 1918 should be increased in the sum of $693,005.39 and that the taxable income for the year 1919 should be decreased in the sum of $1,218,434.89 in order that the account representing interest due from the Director General of Railroads for those years might correspond with what is alleged to have been allowed by the Director General in final settlement, such error resulting in proposed additional taxes for the year 1918 of $69,300.54, in proposed reduced taxes for the year 1919 of $97,474.79, and proposed additional taxes for the year 1921 of $52,542.95. 229 7. The refusal of the Commissioner to permit the taxpayer and the Farmers Grain and Shipping Company to file a consolidated income tax return for the years 1918 and 1919 and his error in determining that interest due the Brandon, Devils Lake and Southern Railway Company, a corporation, affiliated with the taxpayer, for the years 1918 and 1919, but never received or accrued on its books, on bonds of the2942 Farmers Grain and Shipping Company held by the Brandon, Devils Lake and Southern Railway Company, constituted taxable income of the taxpayer for those years, such error resulting in proposed additional taxes of $2,628.00 for the year 1918 and $2,190.00 for the year 1919. 8. The failure of the Commissioner to allow as a deduction from the gross income of the Great Northern Express Company, a corporation affiliated with the taxpayer, in the year 1918, the amount paid to the U.S. Government in that year as a fine for the violation of a customs regulation, such failure resulting in proposed additional taxes of $1.68. 9. The error of the Commissioner in determining that the Northern Steamship Company, a corporation affiliated with the taxpayer, had sold its steamship "Northland" to the Davie Shipbuilding and Repair Company in 1918 at a profit of $65,207.13, and in increasing the taxable income of the taxpayer for the year 1918 in that amount, such error resulting in proposed additional taxes for that year of $7,824.85 and in a proposed reduction of taxes for the year 1919 of $2,173.57. 10. The error of the Commissioner in increasing the taxable income of the Duluth and Superior2943 Bridge Company, a corporation affiliated with the taxpayer, for each of the years 1918 and 1919 in the sum of $325.00 to agree with a certificate issued by the Interstate Commerce Commission under date of May 4, 1921, increasing the annual compensation of that company under the Federal Control Act in that amount, such error resulting in proposed additional taxes for the year 1918 of $32.50 and for the year 1919 of $26.00, and in a proposed reduction in taxes for the year 1921 of $65.00. 11. The error of the Commissioner in reducing the taxable income of the Duluth Terminal Railway Company, a corporation affiliated with the taxpayer, for each of the years 1918 and 1919 in the sum of $16,068.00, to agree with a certificate issued by the Interstate Commerce Commission under date of May 4, 1921, reducing the annual compensation of that company under the Federal Control Act in that amount, such error resulting in a proposed reduction in the taxes for the year 1918 of $1,606.80 and for the year 1919 of $1,285.44, and in proposed additional taxes for the year 1921 of $3,213.60. 12. The error of the Commissioner in reducing the taxable income of the Watertown and Sioux Falls Railway2944 Company, a corporation affiliated with the taxpayer, for each of the years 1918 and 1919 in the sum of $21,115.08, to agree with a certificate issued by the Interstate Commerce Commission under date of September 12, 1921, reducing the annual compensation of that company under the Federal Control Act in that amount, such error resulting in a proposed reduction in the taxes for the year 1918 of $2,111.51, for the year 1919 of $1,689.21 and in proposed additional taxes for the year 1921 of $4,223.02. 13. The error of the Commissioner in computing the additional tax due from the taxpayer for the year 1918 at the rate of 12 per cent. instead of 10 per cent. and for the year 1919 at the rate of 10 per cent. instead of 8 per cent. such error resulting in proposed additional taxes for the year 1918 of $88,118.33 and for the year 1919 of $4,745.39. 14. The failure of the Commissioner to allow as a basis of deduction from the gross income of the taxpayer for the years 1918 and 1919, the fair market value as of March 1, 1913, of certain equipment acquired by the taxpayer prior 230 to March 1, 1913, and the cost of certain equipment acquired by the taxpayer subsequent to February 28, 1913, and2945 scrapped or otherwise disposed of during the years 1918 and 1919, such failure resulting in excess taxes for the year 1918 of $5,130.85 and for the year 1919 for $3,038.50. 15. The failure of the Commissioner to allow as a basis of deduction from the gross income of the Glacier Park Hotel Company, a corporation affiliated with the taxpayer, for the year 1919, the cost of 28 row boats acquired by the Glacier Park Hotel Company subsequent to February 28, 1913, and destroyed during the year 1919, such failure resulting in excess taxes of $54.08. 16. The failure of the Commissioner to allow as a basis of deduction from the gross income of the Cottonwood Coal Company, a corporation affiliated with the taxpayer, for the years 1918 and 1919, the cost of certain buildings and other facilities acquired by the Cottonwood Coal Company subsequent to February 28, 1913, and destroyed during the years 1918 and 1919, such failure resulting in excess taxes of $9.00 for the year 1918 and $16.07 for the year 1919. 17. The failure of the Commissioner to allow as a basis of deduction from the gross income of the Somers Lumber Company, a corporation affiliated with the taxpayer, for the years2946 1918 and 1919, the fair market value as of March 1, 1913, of various facilities acquired by the Somers Lumber Company prior to March 1, 1913, and the cost of various facilities acquired by the Somers Lumber Company subsequent to February 28, 1913, and scrapped or otherwise disposed of during the years 1918 and 1919, such failure resulting in excess taxes of $20.84 for the year 1918 and $5,885.74 for the year 1919. Upon leave being granted, the petitioner amended its petition on December 13, 1926, by adding the following assignment of error, to wit: 18. The failure of the Commissioner to allow as a deduction from the gross income of the taxpayer for the years 1918 and 1919, depreciation on ore dock property of the taxpayer at Allouez Bay, Wisconsin, such failure resulting in excess taxes of $18,868.64 for the year 1918 and of $15,094.91 for the year 1919. The answer of the Commissioner was filed April 14, 1926, alleging as new matter the following: 19. Alleges that there was erroneously allowed as a deduction from gross income an amount of $17,985.57 for 1919 which represented the proportion of the Great Northern Railway Company and its subsidiaries of an assessment levied2947 by the Association of Railway Executives for the promoting of railway legislation. At the hearing before the Board on December 13-15, 1926, the appeals were consolidated and tried as one case. FINDINGS OF FACT. 1. The petitioner is a Minnesota corporation with its principal office at St. Paul. 2. The petitioner is a common carrier engaged in the transportation of passengers and freight by steam railroad and as such is under the control of the Interstate Commerce Commission. 231 3. In pursuance of the provisions of the Interstate Commerce Act the Interstate Commerce Commission prescribed a uniform system of accounts to be observed by carriers subject to the Act. Said uniform system of accounts is comprised in part of three classifications issued by the Commission, effective July 1, 1914, namely: Classification of investment in road and equipment of steam roads. Classification of income, profit and loss and general balance sheet accounts for steam roads. Classification of operating revenues and operating expenses of steam roads. 4. Petitioner's accounts for the years 1917, 1918, and 1919 were kept in accordance with said uniform system of accounts. 2948 5. Petitioner's income-tax returns for the years 1917, 1918, and 1919 were made upon the basis upon which its accounts were kept. 6. During the years 1918 and 1919 the petitioner was affiliated with the following corporations and filed consolidated income-tax returns for itself and such corporations and paid the taxes assessed upon such consolidated returns: Brandon, Devils Lake & Southern Railway Co. Great Northern Express Co. Northern Steamship Co. Duluth & Superior Bridge Co. Duluth Terminal Railway Co. Watertown & Sioux Falls Railway Co. Glacier Park Hotel Co. Cottonwood Coal Co. Somers Lumber Co.Allouez Bay Dock Co. Billings & Northern Railroad Co. Columbia & Red Mountain Railway Co. Dakota & Great Northern Railway Co.Duluth, Mississippi River & Northern Railroad Co. Duluth, Superior & Western Railway Co. Duluth, Watertown & Pacific Railway Co. Eastern Railway Co. of Minnesota. Great Northern Office Building Co.Minneapolis Union Railway Co. Minnesota & Great Northern Railway Co.Montana Central Railway Co. Park Rapids & Leech Lake Railway Co. St. Paul, Minneapolis & Manitoba Railway Co. Seattle & 2949 Montana Railroad Co. Spokane Falls & Northern Railway Co. Washington & Great Northern Railway Co.Willmar & Sioux Falls Railway Co. Dakota & Great Northern Townsite Co. Skagit Coal & Coke Co. Cholan Electric Co. Northern Land Co. Great Northern Steamship Co. Washington & Great Northern Townsite Co. 232 Transportation for Investment - Cr.7. The "classification of investment in road and equipment," prescribed by the Interstate Commerce Commission, contained the following instructions: Cost of Construction. - It is intended that the accounts for fixed improvements and equipment shall include the cost of construction of such property. The cost of construction shall include the cost of labor, materials and supplies work-train service, special machine service, transportation, contract work protection from casualties, injuries and damages, privileges, and other analogous elements in connection with such work. The several items of cost here referred to are defined as follows: Cost of Transportation includes the amounts paid to other companies or individuals for the transportation of men, materials and supplies, special machine outfits, 2950 appliances, and tools in connection with construction. Freight charges paid foreign lines for the transportation of construction material to the carrier's line shall be included, so far as practicable, as a part of the cost of the material, when such charges are borne by the carrier. A fair allowance representing the expense to the carrier of such transportation in transportation service trains over the carrier's own line also shall be included. When the cost of such transportation is not assignable to specific work, it shall be included in account No. 43, "Other expenditures - Road." Amounts thus charged for transportation service over the carrier's line shall be credited to operating expense general account VIII, Transportation for Investment - Cr. 8. The "classification of operating revenues and operating expenses," prescribed by the Interstate Commerce Commission, contained the following instructions: General Account VIII, Transportation for Investment - Cr. This account shall include fair allowances representing the expense to the carrier of transporting in transportation service trains men engaged in and material used for construction. Amounts credited to this account2951 shall be concurrently charged to the appropriate property investment accounts. 9. In compliance with the foregoing instructions of the Interstate Commerce Commission, the petitioner made entries on its books in and for the year 1917 charging to its investment account and crediting to the account "Transportation for Investment - Cr." under operating expenses the sum of $422,677.80, representing the expense to the petitioner of transporting in its transportation service trains, men engaged in, and material used for construction purposes. Of this amount, $32,219.12 represented the expense of transporting men, computed at the rate of one cent per man per mile, and $390,458.68 represented material, computed at the rate of six mills per ton mile. 10. The number of men transported for construction purposes on petitioner's transportation service trains during the year 1917 was the equivalent of 3,220,609 men one mile. These men were carried 233 on the ordinary passenger trains operated by the petitioner. No extra trains were run to carry them, no extra cars were put on the passenger trains to accommodate them and no extra service was performed for them. They averaged approximately2952 one man to every four passenger trains and constituted approximately .48 of 1 per cent of the total passengers carried on such trains. At all times many more passengers could have been carried on such trains without increasing the number of trains or cars run. 11. The quantity of material transported for construction purposes on petitioner's transportation-service trains during the year 1917 was the equivalent of 65,076,446 ton-miles. This material was carried on the ordinary freight trains, operated by the petitioner. The material was carried in small amounts at various times during the year. No extra trains were run to carry this material and it did not displace any revenue freight. It being within the control of the petitioner, such material was transported at the petitioner's convenience on trains that did not have capacity tonnage. A large part of the material was carried on local freight and branch-line trains that operate with light tonnage. The material averaged 5 1/2 tons per train and constituted .67 of 1 per cent of the total tonnage of freight carried by petitioner during the year. The prevailing tonnage on petitioner's line of railway is east-bound and empty2953 cars must be moved west-bound at all times of the year to supply sufficient cars for east-bound traffic. Approximately one-half of the material transported for construction purposes during the year 1917 was moved west-bound and the cars in which it was carried would have had to be moved west whether this material was transported or not. The cost of loading and unloading, if performed by petitioner's employes, was not charged to petitioner's operating expense account but to the investment account as a part of the cost of the material. If large quantities of material had to be moved a work train was run for that purpose, the expense of which was charged to the investment account. In such cases no part of the overhead expense of operating the railway was charged to the work train. 12. The petitioner claimed a deduction of $59,409,664.35 for ordinary and necessary expenses incurred in the maintenance and operation of its business and properties during the year 1917. The Commissioner reduced the deduction claimed by the petitioner in the amount of $422,677.80, and in the determination of the proposed deficiency for that year added that amount to the income of the petitioner. 2954 234 Federal fines paid by petitioner.13. During the year 1917 the petitioner incurred penalties for violating Federal statutes or customs regulations, as follows: Violation of Safety Appliance Acts$3,388.17Violation of Hours of Service Act517.63Violation of 28-Hour Live Stock Act536.22Violation of customs regulations145.004,587.0214. These violations were the result of negligence or inadvertence on the part of petitioner's employes. 15. Compared with other years, the amounts paid in 1917 were not unusual either in character or amounts. 16. The respondent reduced the amount claimed by the petitioner for ordinary and necessary expenses for the year 1917 in the amount of $4,587.02, and in the determination of the proposed deficiency for that year added that amount to the income of the petitioner. Federal fine paid by Great Northern Express Co. (an affiliated corporation).17. The Great Northern Express Co. is a corporation organized under the laws of the State of Minnesota. During the year 1918 all of its capital stock was owned by the petitioner, and the petitioner filed a consolidated income-tax return for the2955 year 1918 for itself and the Great Northern Express Co. and paid the tax assessed upon such consolidated return. 18. During the year 1918 the Great Northern Express Co. received a shipment of freight, consigned in bond, and transferred it to the Adams Express Co. The latter company delivered it direct to the consignee, in violation of the customs regulations, and was required by the customs authority to pay a penalty of $28, one-half of which was assumed by the Great Northern Express Co. because of the difficulty of ascertaining which company was at fault. 19. This payment resulted from negligence of the Great Northern Express Co. in failing to keep its records in such a manner that the error would not occur. 20. The Commissioner reduced the amount claimed by the petitioner for ordinary and necessary expenses for the year 1918 in the amount of $14 and in the determination of the proposed deficiency for that year added that amount to the income of the petitioner. 235 Interest due from Spokane, Portland & Seattle Railway Co.21. During all of the years 1917, 1918, and 1919 the petitioner and the Northern Pacific Railway Co. owned in equal shares the entire2956 capital stock of the Spokane, Portland & Seattle Railway Co., amounting to $40,000,000 par value. This stock was acquired at par. 22. During the same period the petitioner held first and refunding bonds of the Spokane, Portland & Seattle Railway Co. in the amount of $36,855,000. The Northern Pacific Railway Co. held bonds to the amount of $31,855,000, and the Northwestern Improvement Co., a subsidiary of the Northern Pacific Railway Co., held bonds to the amount of $5,000,000. 23. During the same period the petitioner, the Northern Pacific Railway Co., and the Northwestern Improvement Co. held notes of the Spokane, Portland & Seattle Railway Co. in varying amounts and had open accounts with that company representing advances made from time to time. 24. The bonds, notes, and advances bore interest at various rates. The interest due the petitioner on these obligations for the years in question was as follows: 191719181919On bonds$1,474,200.00$1,474,200.00$1,474,200.00On notes92,872.5945,383.3542,449.53On advances5,027.48201.331,577.58Total1,572,100.071,519,784.681,518,227.1125. No part of the interest due2957 on these obligations was paid during the years 1917, 1918, and 1919. 26. The Spokane, Portland & Seattle Railway Co. had never earned the interest on its obligations. No interest had been paid prior to 1917, but notes had been taken in payment of interest due for certain years prior to 1917. The payment of such interest was not assured by past experience, guaranty, anticipated provision or otherwise. 27. The "classification of income, profit and loss, and general balance sheet accounts for steam roads," prescribed by the Interstate Commerce Commission in accordance with section 20 of the Act to Regulate Commerce, effective July 1, 1914, and in effect during the years 1917, 1918, and 1919 provides what Account No. 514 shall include: Income from Funded Securities. - This account shall include interest on bonds and other funded securities and on debenture stocks of other companies the income from which is the property of the accounting company, whether such securities are owned by the accounting company and held in its treasury, or 236 deposited in trust, or are controlled through lease or otherwise. Interest accrued shall not be credited prior to actual collection2958 unless its payment is reasonably assured by past experience, guaranty, anticipated provision, or otherwise. 28. In compliance with the foregoing provision the petitioner did not accrue in its income accounts interest due from the Spokane, Portland & Seattle Railway Co. for the years 1917, 1918, and 1919 for the reason that the same was not paid and payment was not reasonably assured by past experience, guaranty, anticipated provision, or otherwise. It made entries upon its books, however, debiting a deferred asset account and crediting a deferred liability account for the amount of the interest, in order that it might have a record of the amount. 29. On December 31, 1917, 1918, and 1919 the assets and liabilities of the Spokane, Portland & Seattle Railway Co., in condensed form, were as follows: Dec. 31, 1917Dec. 31, 1918Dec. 31, 1919ASSETSInvestment in road and equipment$59,962,532.42$60,301,347.04$60,439,494.09Investments in affiliated companies34,772,308.4634,525,223.9834,740,223.98Other investments1,465,398.731,455,327.471,470,235.70Current assets2,149,358.25226,856.22235,315.25Deferred assets4,470,732.937,919,834.769,765,268.22Unadjusted debits19,931,985.1420,809,870.8221,837,048.48Total assets122,752,315.93125,238,460.29128,487,585.72Debit balance in profit and loss (excess of liabilities plus capital stock over assets)110,29,176.3812,994,013.3714,644,498.42To balance133,781,492.31138,232,473.66143,132,084.14LIABILITIESCapital stock40,000,000.0040,000,000.0040,000,000.00Long term debt77,628,855.2876,711,936.7776,858,990.99Interest unpaid8,953,000.0011,901,400.0014,849,800.00Other current liabilities925,177.218,647.4126,127.10Deferred liabilities53,029.193,034,667.533,383,848.36Unadjusted credits6,221,430.636,575,821.958,013,317.69Total liabilities133,781,492.31138,232,473.66143,132,084.142959 30. The item "Investments in affiliated companies" represented investments in the stocks, bonds, and notes of and advances made to the following affiliated companies: Oregon Electric Railway Co. Oregon Trunk Railway Co. Pacific & Eastern Railway Co. United Railways Co. Great Northern Pacific Steamship Co.31. During the years in question the capital stock plus the liabilities of these affiliated companies exceeded their assets by the following amounts: Dec. 31, 1917Dec. 31, 1918Dec. 31, 1919Oregon Electric Ry. Co$845,947.48$1,330,585.29$1,714,020.87Oregon Trunk Ry. Co2,037,124.452,392,060.102,741,831.70Pac. & Eastern Ry. Co811,916.12938,163.891,037,709.04United Railways Co2,206,080.572,515,997.282,826,583.02Great Northern Pacific S.S. Co663,916.76707,873.15726,246.46Total6,564,985.387,884,679.719,046,391.09237 The outstanding capital stock of the above-named companies on December 31, 1917, 1918, and 1919 was as follows: Oregon Electric Railway Co$2,530,000Oregon Trunk Railway Co10,000,000Pacific & Eastern Railway Co500,000United Railways Co3,000,0002960 The capital stock of the Great Northern Pacific Steamship Co. at the close of 1917 was $4,578,800, and at the close of 1918 and 1919 $325,000. During the year 1919 the Pacific & Eastern Railway Co. passed into the hands of a receiver and was liquidated with a loss to the Spokane, Portland & Seattle Railway Co. of $1,704,066.29. During the same year the Great Northern Pacific Steamship Co. was liquidated with a loss to the Spokane, Portland & Seattle Railway Co. of $760,228.25. 32. The respondent held that the interest due the petitioner from the Spokane, Portland & Seattle Railway Co. for the years 1917, 1918, and 1919 constituted taxable income for those years and in the determination of the proposed deficiency for those years added the following amounts to the income of the petitioner: 1917$1,572,100.0719181,519,784.6819191,518,227.1133. During 1921 substantial payments having been received from the Spokane, Portland & Seattle Railway Co. as a result of its settlement with the United States, the petitioner accrued in 1921 all of this interest for prior years, but in the year 1923 made a reversal entry by reason of a ruling of the Interstate2961 Commerce Commission that its regulations did not justify the accrual. The net effect of these entries is that interest from this debtor has not appeared in the petitioner's income statements except when and as collected. Interest due from Glacier Park Hotel Co.34. During all of the year 1917 the entire capital stock of the Glacier Park Hotel Co. of the par value of $1,500,000 was owned by the Washington & Great Northern Townsite Co. During the same 238 period the entire capital stock of the latter company was owned by the petitioner. 35. Prior to December 31, 1917, the petitioner made loans and advances to the Glacier Park Hotel Co. both for construction purposes and to meet operating deficits. 36. These loans and advances bore interest and during the year 1917 such interest amounted to $29,558.61. 37. No part of this interest has ever been earned or paid. The payment of such interest was not assured by past experience, guaranty, anticipated provision, or otherwise. 38. In compliance with the rule of the Interstate Commerce Commission referred to in finding No. 27, the petitioner did not accrue in its income account interest due from the Glacier2962 Park Hotel Co. for the year 1917 for the reason that the same was not paid and payment was not reasonably assured by past experience, guaranty, anticipated provision, or otherwise. It made entries upon its books, however, debiting a deferred asset account and crediting a deferred liability account for the amount of the interest, in order that it might have a record of the amount. 39. The Glacier Park Hotel Co. owns and operates the hotels located in Glacier National Park. It began operation in 1913. On December 31, 1917, its assets and liabilities, in condensed form, were as follows: ASSETSProperty account$1,944,111.74Current assets11,003.11Material accounts32,640.14Total assets1,987.754.99Debit balance in profit and loss (excess of liabilities over assets)832,334.32To balance2,820,089.31LIABILITIESCapital stock1,500,000.00Working liabilities586,476.74Interest due Great Northern Ry72,461.81Depreciation accrued347,220.90Deferred liabilities313,929.86Total liabilities2,820,089.3140. The respondent held that the interest due the petitioner from the Glacier Park Hotel Co. for the year 1917 constituted taxable2963 income for that year and in its determination of the proposed deficiency for that year added the sum of $29,558.61 to the income of the petitioner. 239 Interest due from South Butte Mining Co.41. During all the year 1917 the entire capital stock of the South Butte Mining Co. of the par value of $50,000 was owned by the petitioner. 42. Prior to December 31, 1917, the petitioner made advances to the South Butte Mining Co. to the amount of $74,704.59. 43. These advances bore interest and during the year 1917 such interest amounted to $4,504.12. 44. Of this amount the sum of $3,518.94 was not earned by the South Butte Mining Co. and has never been paid. The payment of such interest was not assured by past experience, guaranty, anticipated provision, or otherwise. 45. In compliance with the rule of the Interstate Commerce Commission referred to in finding 27, the petitioner did not accrue in its income account interest due from the South Butte Mining Co. in the amount of $3,518.94, for the reason that the same was not paid, payment was not assured by past experience, guaranty, anticipated provision, or otherwise, and there was no possibility of receiving2964 it. It made entries upon its books, however, debiting a deferred asset account and crediting a deferred liability account for the amount of the interest, in order that it might have a record of the amount. 46. On December 31, 1917, the assets and liabilities of the South Butte Mining Co. were as follows: ASSETSProperty accounts$102,027.18Investment in Reno Copper & Silver Mining Co. and South Butte Development Co25,945.27Current assets153.84Deferred assets332.23Total assets128,458.52Debit balance in profit and loss (excess of liabilities over assets)1,903.32To balance130,361.84LIABILITIESCapital stock$50,000.00Advances due Great Northern Ry74,704.59Current liabilities1,153.13Unpaid interest4,504.12Total liabilities130,361.8447. The respondent held that the interest due the petitioner from the South Butte Mining Co. for the year 1917, in the amount of $3,518.94, constituted taxable income for that year and in the determination of the proposed deficiency for that year added the sum of $3,518.94 to the income of the petitioner. 240 Interest due from the Washington & Great Northern Townsite Co.2965 48. During all of the year 1917 the entire capital stock of the Washington & Great Northern Townsite Co. of the par value of $50,000 was owned by the petitioner. 49. Prior to January 1, 1917, the petitioner had loaned the Washington & Great Northern Townsite Co. the sum of $1,500,000, evidenced by a note for $1,095,000 dated May 16, 1914, and one for $405,000 dated November 24, 1914. 50. These notes read as follows: $1,095,000.00 MAY 16, 1914 On demand after date, Washington & Great Northern Townsite Company promises to pay to the order of Great Northern Railway CompanyOne million and ninety-five thousand and … no/100 Dollars at the General Offices of Great Northern Railway Company, St. Paul, Minnesota, with interest at the rate of 6% per annum from the date hereof. Attest: L. E. KATZENBACH SecretaryWASHINGTON & GREAT NORTHERN TOWNSITE CO. BY RALPH BUDD, President.$405,000.00 NOVEMBER 24, 1914 On demand after date, washington & Great Northern Townsite Company promises to pay to the order of Great Northern Railway CompanyFour hundred and five thousand and … No/100 Dollars at the General Officer of Great Northern Railway Company, 2966 St. Paul, Minnesota, with interest thereon at the rate of 6% per annum until paid. Value received. Attest: L. E. KATZENBACH Secretary.WASHINGTON & GREAT NORTHERN TOWNSITE CO. BY JAMES T. MAHER, Vice-President.51. During the year 1917 the interest on these notes amounted to $90,000. No part of this interest has ever been paid. During the year 1917 the operations of the Townsite Company resulted in a loss of $22,061.20, exclusive of this interest. Up to December 31, 1917, the operations of the Townsite Company had resulted in a loss of $1,273.25 exclusive of interest. 52. In the year 1917 the townsite Company accrued the interest on these bonds amounting to $90,000 and also accrued interest to the amount of $14,085.58 on unpaid interest on these notes. The accrual of interest on unpaid interest was reversed in 1922, leaving only the interest on the notes. 241 53. In compliance with the rule of the Interestate Commerce Commission referred to in finding No. 27, the petitioner did not accrue in its income account interest due from the Washingto & Great Northern Townsite Co. for the year 1917 for the reason that the same was not paid and payment2967 was not reasonably assured by past experience, guaranty, anticipated provision, or otherwise. It made entries upon its books, however, debiting a deferred asset account and crediting a deferred liability account for the amount of the interest, in order that it might have a record of the amount. 54. On December 31, 1917, the assets and liabilities of the Washington & Great Northern Townsite Co., in condensed form, were as follows: ASSETSProperty account$278,730.43Investment in affiliated companies1,500,000.00Current assets34,675.62Deferred accounts23,237.61Total assets1,836,643.66Debit balance in Profit and Loss (excess of liabilities over assets)165,635.34To balance2,002,279.00LIABILITIESCapital stock$50,000.00Notes and advances due Great Northern Ry1,571,122.74Interest accrued338,845.17Other current liabilities42,311.09Total liabilities2,002,279.0055. The respondent held that the interest due the petitioner from the Washington & Great Northern Townsite Co. for the year 1917, in the amount of $90,000, and also interest on unpaid installments of interest in the amount of $14,085.58, constituted taxable2968 income of the petitioner for that year, and in the determination of the proposed deficiency for that year added the sum of $104,085.58 to the income of the petitioner. Depreciation on equipment of petitioner.56. During the years 1917, 1918, and 1919 the petitioner scrapped or otherwise disposed of certain units of equipment which cost $1,739,783.60. 57. The fair market value of such equipment as of March 1, 1913, was $735,030.82. 242 58. The depreciation sustained by such equipment between March 1, 1913, and date of sale or other disposition was $111,443.62, as follows: 1917$32,583.85191843,748.65191935,111.12111,443.6259. In computing the loss sustained from the sale or other disposition of such equipment the petitioner used as the basis the fair market value of such equipment as of March 1, 1913, less the depreciation sustained after that date. 60. The respondent made no change in the computation of the loss sustained from the sale or other disposition of such equipment. Depreciation on boats of Glacier Park Hotel Co.61. The Glacier Park Hotel Co. is a corporation organized under the laws of the State of2969 Minnesota. During the year 1919 all its capital stock was owned by the petitioners, and the petitioner filed a consolidated income-tax return for that year on behalf of itself and the Glacier Park Hotel Co. and paid the taxes assessed upon the said return. 62. In the fall of 1913 the Glacier Park Hotel Co. acquired 28 row boats at a cost of $1,702.97. In September, 1919, these row boats were destroyed and there was no salvage. 63. The depreciation actually sustained on these row boats between the date of acquisition and the date of retirement was $540.75. 64. In its income-tax return for the year 1918 the Glacier Park Hotel Co. computed the loss sustained on these row boats by deducting from the cost thereof depreciation sustained between date of acquisition and date of retirement and entered in its return a deductible loss of $1,162.22. Depreciation on property of Cottonwood Coal Co.65. The Cottonwood Coal Co. is a corporation organized under the laws of the State of Minnesota. During the years 1918 and 1919 all of its capital stock was owned by the petitioner, and the petitioner filed consolidated income-tax returns for those years on behalf of itself and2970 the Cottonwood Coal Co. and paid the taxes assessed upon the said returns. 66. During the year 1914 the Cottonwood Coal Co. acquired a cement and sand house at a cost of $499.83. In December, 1918, these facilities were destroyed. No salvage was recovered. The amount of depreciation actually sustained on said cement and sand house 243 between date of acquisition and date of retirement was $74,97. In its income-tax return for the year 1918 the Cottonwood Coal Co. computed the loss by deducting from the original cost the depreciation accrued subsequent to date of acquisition, namely, $74.97. 67. During the year 1914 the Cottonwood Co. also acquired a boiler house and some fire hose at a cost of $518.74. These were destroyed during October and December, 1919, and no salvage was recovered. In its income-tax return for the year 1918 the Cottonwood Company computed its loss from the destruction of these facilities by deducting from the cost thereof the depreciation sustained subsequent to date of acquisition, namely, $160.71. Depreciation on facilities of Somers Lumber Co.68. The Somers Lumber Co. is a corporation organized under the laws of the State of2971 Minnesota. During the years 1918 and 1919 all of its capital stock was owned by the petitioner, and the petitioner filed consolidated income-tax returns for those years on behalf of itself and the Somers Lumber Co. and paid the taxes assessed upon said returns. 69. Subsequent to March 1, 1913, the Somers Lumber Co. acquired certain facilities at a cost of $1,330.30. These facilities were destroyed during the year 1918 and no salvage was recovered. Between the date of acquisition and date of retirement the depreciation actually sustained on such facilities was $173.70. 70. In its income-tax return for the year 1918 the Somers Lumber Co. computed its loss from such destruction by deducting from the cost of such facilities the depreciation that accrued subsequent to acquisition, namely, $173.70. 71. Prior to March 1, 1913, the Somers Lumber Co. acquired certain facilities at a cost of $15,317.89. Between the date of acquisition and March 1, 1913, the depreciation actually sustained on such facilities amounted to $5,203.69. The fair market value of such facilities on March 1, 1913, was $10,114.20. 72. Subsequent to March 1, 1913, the Somers Lumber Co. acquired certain2972 facilities at a cost of $115,325.70. These facilities, together with those referred to in finding No. 71, were destroyed in the year 1919, the salvage recovered amounting to $58,859.23. 73. The depreciation actually sustained on such facilities subsequent to date of acquisition, together with the depreciation subsequent to March 1, 1913, on facilities referred to in finding No. 72 amounted to $56,357.31. 74. In its income-tax return for the year 1919 the Somers Lumber Co. computed its loss from such facilities by deducting from the cost or March 1, 1913, value the depreciation that accrued subsequent to the basic date, namely, $56,357.31. 244 Loss on stock of Spokane & Inland Empire Railroad Co.75. Between May 5, 1906, and November 4, 1909, the petitioner acquired 34,652 1/2 shares of common stock of the Spokane & Inland Empire Railroad Co. (referred to as the Inland Company) at a cost of $1,863,415, or an average of $53.77 per share; also $10,833 1/2 shares of preferred rights of the same company at a cost of $975,015, or an average of $90 per share. The par value of each class of stock was $100 per share. 76. In the year 1909 the Northern Pacific2973 Railway Co., through its subsidiary, the Northwestern Improvement Co., acquired an equal amount of such common stock and preferred rights at an average cost of $54.24 per share for the common stock and $97.80 per share for the preferred rights. 77. The Spokane & Inland Empire Railroad Co. owned and operated an electric railroad 212 miles long with lines running from Spokane, Wash., to Couer d'Alene, Idaho, with branches to Hayden Lake and Liberty Lake and a main line to Colfax, Wash., and a branch line to Moscow, Idaho. It owned a street car line in Spokane, and had a water power and power plant which furnished the electricity for the railroad and also for sale commercially. 78. The total amount of capital stock outstanding was 100,000 shares of common stock and 64,091 shares of preferred rights. The preferred rights had no voting power. The combined holdings of the petitioner and the northern Pacific Railway Co. constituted 69.30 per cent of the total voting stock. 79. At the time the stock was purchased the Inland Company was quite prosperous and had a very good passenger business. Its lines reached into wheat and timber country and it was believed that they would2974 furnish considerable traffic for the main lines of the petitioner and of the Northern Pacific. At Spokane it connected with the Oregon-Washington Railroad & Navigation Co. and the Spokane International Railway, a Canadian Pacific connection. A little later the Chicago, Milwaukee & St. Paul Railway Co. also built into Spokane. The business originating on the Inland Company could also move out of Spokane over these lines in competition with the petitioner and the Northern Pacific. 80. By means of the control exercised through the ownership of stock, the petitioner and the Northern Pacific diverted to themselves a large amount of traffic that might otherwise have been moved over competing lines. Prior to the World War the Inland Company was a valuable feeder to the parent companies, but the changed conditions brought about by the war reduced its value. 81. The net earnings of the Spokane & Inland Empire Railroad Co. for the six years ended June 30, 1912, were as follows: Year ended June 30 - Net earningsDeficit1907$253,950.95190895,553.711909145,497.80191024,892.331911$131,701.11191270,167.76519,894.79201,868.87245 2975 The average net earnings for the above period were $53,004.32. During the year ended June 30, 1907, a dividend of $91,940 was declared and paid from income. During the next fiscal year a dividend of $114,065 was declared and paid from surplus. There were no dividends declared or paid thereafter. On March 1, 1913, the books of the company showed assets to the amount of $26,133,840.24, and liabilities, exclusive of stock, of $9,508,285.13, leaving a surplus for stock of $16,625,555.11, which would indicate a book value for the stock of $101.32 per share. The surplus of the company at March 1, 1913, according to its balance sheet, was $216,455.11 This balance sheet contains no reserve for depreciation, but indicates depreciable assets in the form of equipment alone in the amount of $1,886,760.72. At December 31, 1918, there was a deficit of $2,525,354.38. 82. The balance sheet at June 30, 1913, showed as follows: ASSETSCost of road$17,782,056.39Cost of equipment1,827,111.98General expenditures467,595.10Stocks owned96,285.00Property rights and franchise5,087,899.47Cash and current assets393,247.76Advances to proprietary affiliated and controlled companies129,294.27Sinking and other special funds23,484.86Unextinguished discount on capital stock311,737.00Deferred debit items4,967.04Total26,123,678.87LIABILITIESCapital stock preferred$6,409,100.00Capital stock common10,000,000.00Funded debt4,806,500.000Current liabilities121,035.43Unfunded debt4,170,073.14Taxes accrued279,742.89Interest on funded debt accrued38,311.81Miscellaneous interest accrued101,491.92Deferred credit items9,772.87Reserves14,584.60Surplus173,066.21Total26,123,678.872976 246 There is no evidence that the asset account "Property rights and franchises," in the amount of $5,087,899.47, represents any outlay on the part of the company. 83. On September 21, 1911, the Public Service Commission of the State of Washington, pursuant to law, and after due hearing and the taking of testimony, found that the cost to reproduce that portion of the property of the Inland Company used and necessary for railroad purposes on January 1, 1911, was $17,575,899, in addition to which it owned considerable real estate in the City of Spokane not used or necessary for railroad purposes; that the property was substantially constructed and reasonably well maintained and the average age of the entire plant was four years. 84. During the time that the Inland Company was controlled by the petitioner and the Northern Pacific Railway Co. those companies made advances to it of $5,168,931.95 for the purpose of enabling it to meet its interest payments and other obligations. 85. The stock of the Inland Company was not listed on the New York Stock Exchange or any other well recognized exchange. During the months of February and March, 1913, no sales of the stock2977 of the Inland Company were reported. During both months and bid price of the common stock was $10 per share and the asked price $20 per share, and the bid price of the preferred rights was $30 per share and the asked price $40 per share. 86. During the year 1918 the stock of the Inland Company held by the petitioner became worthless and was written off on the books of the petitioner a total loss. 87. The fair market value as of March 1, 1913, of the common stock of the Inland Company was $30 per share. The fair market value as of March 1, 1913, of the preferred rights was $60 per share. Petitioner's deductible loss on this transaction was $1,689,585. 88. The respondent computed the petitioner's loss on this stock on the basis of the value as of March 1, 1913, of $10 per share for common stock and $30 per share for preferred rights and in the determination of the proposed deficiency added $2,166,900 to petitioner's income for the year 1918. The petitioner computed its loss on the basis of the cost of the stock at time of purchase and claimed a deduction of $2,838,430. Profit or loss on sale of various small parcels of real estate.89. During the year 1918 the2978 petitioner sold several parcels of real estate. The cost, the March 1, 1913, value, and the selling price of the several parcels were as follows: DescriptionCostValue, Mar. 1, 1913Selling price39.14 acres Helena, Mont$5,000.00$2,500.00$1,174.202 lots Sioux City, Iowa803.724,000.004,000.007.6 acres Pennock, MinnNot shown.610.80610.802 2/3 acre Pelican Rapids, Mich51.00125.00125.003.05 acres Yukon, Wash161.13250.00250.00247 The respondent determined profits upon the sale of these parcels of property of $1,173.20, $799.07, $610.80, $74.00, and $88.87, respectively. Contributions towards the construction of spur tracks, etc.90. During the years 1918 and 1919 certain individuals and corporations made contributions to the petitioner toward the cost of constructing spur tracks or farm crossings desired by the contributors. In some instances instead of contributing cash they furnished the labor or material used in the construction of such spur tracks or farm crossings. The amount of such contributions, including the estimated value of the labor and material furnished by such persons or corporations2979 was $28,116.04 in 1918 and $19,128.98 in 1919. 91. The spur tracks and farm crossings, for which such contributions were made, were constructed under contracts which provided that the title to the property constructed would remain in the petitioner, although a part or all of its cost would be paid by the person applying for the same. 92. The "classification of investment in road and equipment," prescribed by the Interstate Commerce Commission, provided as follows: 2. ITEMS TO BE CHARGED - To these accounts [accounts for Investment in Road and Equipment] shall be charged the cost of original road, original equipment, road extensions, additions and betterments; also the estimated values at time of acquisition of right of way and other road and equipment property donated to the carrier * * * COSTS shall be actual money costs to the carrier where a portion of the funds expended by the carrier has been obtained through donations by states, municipalities, individuals, or others, as deductions on account of such donations shall be made in stating the costs. * * * 93. The "classification of income, profit and loss and general balance sheet accounts," prescribed by the Interstate2980 Commerce Commission, effective July 1, 1914, contained the following rules: 606. Donations - This account shall include amounts creditable to surplus of cash or its equivalent in estimated money value at the time of acquisition of lands or other properties donated by individuals or companies for the construction 248 or acquisition of property. It shall include donations made by individuals and companies in connection with the construction of new lines for the purpose of compensating the carrier for loss anticipated during the early period of operations. Any advances made by individuals or companies with absolute or conditional provisions or partial or complete reimbursement shall not be considered a donation prior to the fulfillment of all conditions, and then only to the extent to which the liability for reimbursement is nullified or negatived. Prior to such determination the amount received shall be credited to balance sheet account No. 778 "other unadjusted credits." Note: Donations made by States, municipalities and other public corporations as their contributions toward the construction or acquisition of property, shall be included in balance sheet account No. 2981 754, grants in aid of construction. 606. Surplus Appropriated for Investment in Physical Property. This account shall include amounts definitely appropriated from surplus, to be applied for the construction or acquisition of new lines and extensions of additions to and betterments of property, the cost of which is includible in balance sheet No. 705, "Miscellaneous Physical Property," and also the amount of donations in aid of construction, made by individuals and companies, not subject to distribution as dividends. 94. In compliance with the foregoing rule of the Interstate Commerce Commission, the petitioner charged to its investment account the entire cost of spur tracks or farm crossings built at the request of individuals or corporations where the title to such spur tracks and farm crossings remained in the petitioner. Included in such cost was the estimated value of labor and material furnished by such individuals and corporations. The amount contributed by such individuals and corporations, including the estimated value of labor and material furnished by them, was credited to the account under "Profit and Loss" styled "606. Donations," and at the same time an entry2982 was made transferring the amount so credited to "Donations" from "Profit and Loss" to "Appropriated Surplus." 95. The individuals or corporations that contributed to the construction of such spur tracks or farm crossings paid the same lawful tariff rates for shipments of freight as did other shippers who had not contributed toward the cost of constructing spur tracks or farm crossings. 96. The respondent included the amounts contributed by such individuals and corporations, as well as the estimated amount of labor and material furnished by such individuals and corporations toward the construction of such spur tracks and farm crossings, in computing the taxable income of the petitioner and in the determination of the proposed deficiency added to the income of petitioner for the years 1918 and 1919 the sums of $28,116.04 and $19,128.98, respectively. Compensation due petitioner under Federal Control Act.97. On December 30, 1918, a contract was entered into between William G. McAdoo, Director General of Railroads, acting on behalf of the United States and the President, and the petitioner, the Duluth 249 Terminal Railway Co., Minneapolis Western Railway Co., 2983 Minneapolis Belt Line Co., Great Northern Terminal Railway Co., Great Northern Equipment Co., Duluth & Superior Bridge Co., Watertown & Sioux Falls Railway Co., Montana Eastern Railway Co., and the Great Falls & Teton County Railway Co. Section 8(a) of that agreement read - SEC. 8(a) The annual compensation guaranteed to the Companies under Section 1 of the Federal Control Act shall be the sum of twenty-eight million, seven hundred seventy-one thousand, three hundred sixty dollars and seventy-eight cents ($28,771,360.78) during each year and pro rata for each fractional part of a year of Federal control, subject, however, to any increase or decrease in the standard return hereafter made by the Commission as provided in paragraph (d) of the preamble of this agreement. Compensation paid by the Director General under this agreement, including that provided for in paragraph (d) of this section, or arising from any other source, shall be paid to the Company (taxpayer); and the Company, after retaining such part thereof as it may be entitled to retain, shall distribute the remainder to the parties entitled thereto. 98. The amount of annual compensation to which the petitioner2984 and its affiliated corporations, with which it filed consolidated returns for 1918 and 1919, was entitled under this agreement, as shown by certificates of the Interstate Commerce Commission to the President, was as follows: Great Northern Railway Co$28,666,681.07Duluth & Superior Bridge Co33,048.48Duluth Terminal Railway Co23,830.40Watertown & Sioux Falls Railway Co51,339.50Minneapolis Western Railway Co. (Def.)3,538.67Total28,771,360.7899. The petitioner and its affiliated corporations accrued as income and reported for taxation in its income-tax returns for each of the years 1918 and 1919 the sum of $28,771,360.78 due from the Director General under said agreement. 100. From time to time during the period of Federal control the Director General made advances to the petitioner on account of such compensation. At the time of final settlement a balance of approximately $15,000,000 remained unpaid on account of such compensation. 101. On April 22, 1921, an agreement was entered into between the Director General of Railroads and the companies named in the agreement of December 30, 1918, providing for final settlement of all accounts2985 between the Director General and those companies. Under this agreement the Director General agreed to pay to the petitioner in final settlement the sum of $6,500,000, subject to further adjustment upon the issuance by the Commission of its final certificate as to the "standard return" of the companies. Neither at the time of 250 entering into said agreement nor prior or subsequent thereto was any agreement reached as to the application of the payment of $6,500,000, or any part thereof, to any item or any statement or statements of claim made by either the Great Northern Railway Co. or the Director General. 102. On January 5, 1922, the Interstate Commerce Commission issued its final certificate restating the standard return of the Great Northern Railway Co. and fixing its annual compensation at $28,613,045.30. The evidence does not show the annual compensation finally fixed for the Great Northern Railway Co. and its affiliated subsidiaries, but the amount alleged by the respondent is $28,680,866.93. 103. On January 25, 1922, the Interstate Commerce Commission issued the following instructions to railroad companies whose property had been under Federal control: 2986 INTERSTATE COMMERCE COMMISSION Washington. At a session of the INTERSTATE COMMERCE COMMISSION, Division 4, held at its office in Washington, D.C., on the 25th day of January, A.D. 1922. The Commission having under consideration the procedure to be observed by carriers whose systems of transportation were under Federal control, in accounting for the ammounts receivable from or payable to the Director General of Railroads in final settlement for the use and operation of their property during Federal control: It is ORDERED, That the following accounting procedure to be observed by such carriers: (1) All ledger accounts with the United States Railroad Administration covering items adjusted in such final settlement shall be considered as liquidated and shall be closed. (2) Items on which the amount of settlement may be mutually agreed upon between the Director General and the carrier whether or not preciously recorded in the accounts, shall be recorded in the accounts in accordance with the effective accounting regulations on basis of settlement agreed upon. (3) Any difference between amounts adjusted in accordance with the foregoing and the amount collected or paid by2987 the carrier in such final settlement shall be cleared to profit and loss account 607, "Miscellaneous credits," or 621 "Miscellaneous debits," as may be appropriate, provided that the use of profit and loss in clearing balances shall not operate to relieve carriers of the observance of classification rules applying to additions to and retirement of physical property and the maintenance of adequate depreciation reserves for equipment. By the Commission - Division 4. GEORGE B. McGINTY, Secretary.104. Complying with these instructions, the petitioner accounted for the $6,500,000 received from the Director General by Crediting the same to its profit and loss account in the year 1921, after first closing off to that account all accounts with the Director General as 251 shown by its books, including the account covering "unpaid compensation." 105. The respondent computed the taxable income of the petitioner for the years 1918 and 1919 on the basis of the final certificate made by the Interstate Commerce Commission under date of January 5, 1922, and in the determination of the proposed deficiency reduced the taxable income for each of those years in the sum of $90,493.85. 2988 Interest due from Director General under Federal control agreement.106. The contract between the Director General and the petitioner dated December 30, 1918, covering operations during Federal control contained the following provision: SEC. 4(a) * * Balances of the above accounts shall be struck quarterly on the last days of March, June, September and December of each year, and the cash balance found on such adjustments to be due either party shall be then payable and, if not paid, shall bear interest at the rate of 6 per cent per annum, unless the parties shall agree upon a different rate. * * * 107. No quarterly balances were struck between the Director General and the petitioner and the only settlement of accounts made between the parties was the final settlement evidenced by agreement dated April 22, 1921. 108. In its accounts for the year 1919 the petitioner accrued as income the sum of $1,570,199.75, representing the estimated amount of interest due the petitioner from the Director General under the contract of December 30, 1918, and reported the same for taxation as taxable income for the year 1919. 109. As stated before, no agreement was reached between2989 the petitioner and the Director General as to any particular item or items contained in any statement of claim made by either the petitioner or the Director General, or as to the application of the payment of $6,500,000 to any such item or items. 110. Complying with instructions from the Interstate Commerce Commission, petitioner accounted for the $6,500,000 received from the Director General by crediting that sum to its profit and loss account for the year 1921 after first closing off to that account all accounts with the Director General, including the account representing interest due from the Director General. 111. The respondent computed the amount of interest due the petitioner from the Director General for the year 1918 at $693,005.39 and for the year 1919 at $351,764.86, these computations being based upon the allocation made by the Director General of the lump-sum settlement of $6,500,000, and in the determination of the proposed deficiency the respondent added $693,005.39 to the taxable income of the petitioner for the year 1918 and reduced the taxable income for the year 1919 in the sum of $1,218,434.89. 252 Interest due from the Farmers Grain & Shipping2990 Co.112. The Brandon, Devils Lake Southern Railway Co. is a corporation organized under the laws of the State of North Dakota. At all times during the years 1918 and 1919 its entire capital stock was owned by the petitioner, and the petitioner filed consolidated income-tax returns for itself and the Brandon Company for the years 1918 and 1919 and paid the tax assessed upon such consolidated returns. 113. At all times during the years 1918 and 1919 the Brandon Company owned 60.51 per cent of the capital stock of the Farmers Grain & Shipping Co., a corporation organized under the laws of the State of North Dakota (referred to as the Farmers Company). 114. The Farmers Company owned and operated a line of railroad about 52 miles in legth, extending from Devils Lake to Rock Lake, and it operated a line owned by the Brandon Company about 13.05 miles in length, extending from Rock Lake to Hansboro, N. Dak. 115. The Farmers Company was organized by the farmers located in the region north of Devils Lake, North Dakota, for the purpose of giving these farmers transportation. Its line intersects that of the petitioner at Devils Lake, N. Dak. 116. During the years 1918 and2991 1919 the line of the Farmers Company was operated as a branch line of the petitioner as a part of its Dakota Division, under the jurisdiction of the superintendent of that division. With the exception of its president, the officers of the Farmers Company are the same as those of the petitioner. 117. During the years 1918 and 1919 the Brandon Company owned all of the outstanding bonds of the Farmers Company, amounting to $438,000 par value. 118. The interest due the Brandon Company on such bonds amounted to $21,900 for each of the years 1918 and 1919. 119. No part of the interest due on these bonds was paid during the years 1918 and 1919. 120. For a great many years prior to 1918 the Farmers Company had neither earned nor paid the interest on these bonds. 121. In compliance with the rule of the Interstate Commerce Commission referred to in finding No. 31, the Brandon Company did not accrue in its income accounts interest due from the Farmers Company for the years 1918 and 1919, for the reason that the same was not paid and payment was not reasonably assured by past experience, guaranty, anticipated provision, or otherwise. The income-tax returns of the Brandon2992 Company were made in accordance with its books. 253 122. On December 31, 1918, and 1919 the assets and liabilities of the Farmers Company, in condensed form, were as follows: Dec. 31,1918Dec. 31, 1919ASSETSInvestment in road and equipment$653,981.98$652,910.91Other investments1,056.521,056.52Current assets867.201,993.58Deferred assets41,016.5544,044.70Unadjusted debit5,555.3011,116.27Total assets702,477.55711,121.98Debit balance in profit and loss (excess of liabilities over assets)198,187.01224,287.25To balance900,664.56935,409.23LIABILITIESCapital stock200,000.00200,000.00Funded debt unmatured438,000.00438,000.00Unpaid interest due Brandon Company183,650.00205,550.00Other current liabilities36,453.5449,350.25Deferred liabilities11,802.1512,971.48Unadjusted credits30,758.8729,537.50Total liabilities900,664.56935,409.23123. The interest due the Brandon, Devils Lake & Southern Railway Co. from the Farmers Grain & Shipping Co. for the years 1918 and 1919 was not collectible when it became due. 124. The fact that this interest was uncollectible was ascertained2993 by and known to the petitioner during the years 1918 and 1919. 125. The respondent held that the interest due the Brandon, Devils Lake & Southern Railway Co. from the Farmers Grain & Shipping Co. for the years 1918 and 1919 constituted taxable income for those years and in the determination of the deficiency for those years the respondent added the sum of $21,900 to each of the years 1918 and 1919. Alleged sale of steamship by the Northern Steamship Co.126. The Northern Steamship Co. is a corporation organized under the laws of the State of Wisconsin, and during all of the years 1918 and 1919 its entire capital stock was owned by the petitioner and the petitioner filed consolidated income-tax returns on behalf of itself and the Northern Steamship Co. for the years 1918 and 1919 and paid the taxes assessed upon such consolidated returns. 127. On November 27, 1918, the Northern Steamship Co. entered into what was purported to be an agreement with the Davie Shipbuilding & Repairing Co., Ltd., referred to as the Davie Company, for the sale of the Northern Steamship Co.'s steamship Northland for $600,000. This agreement read as follows: MEMORANDUM OF AGREEMENT, 2994 entered into this 27th day of November, 1918, between the NORTHERN STEAMSHIP COMPANY, owner of the steamer NORTHLAND, hereinafter called the Owner, and the DAVIE SHIPBUILDING AND REPAIRING COMPANY, LTD., of Levis, Canada, hereinafter called the Repairer. 254 I. The Owner agrees to turn over the Northland to the Repairer immediately, as and where she now lies at the port of Buffalo, with all apparel and appurtenances now on board, together with spare propeller blades, furniture, blankets, linen, and all other furnishings and supplies originally on board the Northland and now on storage, it being understood, however, that the owner is not required to replace any supplies or equipment which have been consumed or have passed out of its possession. II. The Repairer agrees, at his own expense, to do all work and furnish all materials necessary to make over said steamer, the work done on the vessel to be of such nature as to insure that when the repairs are completed she will be a mechantable vessel, whether cargo or passenger, free and clear of all liens whatsoever. III. The Owner represents that it has obtained the consent of the United States Shipping Board to the sale2995 and transfer of said steamer to the Repairer, and agrees to execute at once a bill of sale for the transfer of the title in said steamer, free and clear of all liens whatever, to the Davie Shipbuilding and Repairing Company, Ltd., which bill of sale, together with the evidence of such consent of said Shipping Board, shall be deposited in escrow with Haight, Sandford & Smith, and shall be delivered to the Repairer upon payment to said Haight, Sandford & Smith of Six Hundred Thousand Dollars ($600,000), it being agreed that said sum shall be paid by the Repairer as soon as it is in funds from the sale of said steamer, but, in any event, whether the steamer is sold or not, said sum shall be paid not later than August 1, 1919. IV. The Repairer agrees to pay all expenses incident to ownership which may accrue after possession is given by the owner, and to keep the steamer insured against all marine and fire risks from the date upon which it obtains possession of the steamer, said insurance being in the sum of Six hundred thousand dollars ($600,000), payable to the Owner or Repairer as interest may appear, steamer to be valued in said policies at Six hundred thousand dollars ($600,000) 2996 and policies to be approved and effected by Parsons & Eggert. V. The Repairer shall have the right to sell such materials and equipment covered by this contract as he may deem advisable, which materials and equipment if sold shall be sold by the Repairer, at the best prices obtainable and satisfactory to Edgerton Parsons. The proceeds of such sales shall be deposited with Haight, Sandford & Smith, to be applied, in so far as they are sufficient, to the payment of the cost of repairs. Repair bills which are to be paid out of the said proceeds of salvage sales shall be approved by the surveyor representing the Classification Society in charge of the work, and, as so approved, may be paid by Haight, Sandford & Smith without further proof that they are correct. VI. If by August 1, 1919, the sum of Six hundred thousand dollars ($600,000) has not been paid by the Repairer, the Owner without prejudice to any other right, shall have the right to take possession of the steamer and sell her at public auction (after giving the Repairer at least ten days' written notice of the time and place fixed for such auction), and hold the Repairer for any deficit which may result from the said2997 sale, the Repairer to be charged not only with the purchase price of Six hundred thousand Dollars ($600,000) but also with all costs, expenses and fees incident to the sale and all liens and charges, if any, arising after the date of this contract, to which the steamer may be subject; or the Owner shall account to the Repairer for any sum which may be obtained above Six hundred thousand dollars ($600,000), after paying the above mentioned costs, expenses, etc. It is understood and agreed, however, that if the completion of the work to be done by the Repairer is delayed, or prevented by 255 the act of God, restraint of Princes, Rulers, or Peoples, strikes, fire, or any other like or different cause over which the Repairer has no control, then the date of payment shall be extended beyond August 1, 1919, for the like period that the work is so delayed. The Repairers shall give the owner immediate notice on the happening of any of the above causes for which he will claim delay. NORTHERN STEAMSHIP COMPANY, By RALPH BUDD DAVIE SHIPBUILDING AND REPAIRING COMPANY, LTD. By C. A. BARNARD, President.Addendum to Memorandum of Agreement between Northern Steamship Company2998 and Davie Shipbuilding and Repairing Company, Ltd., executed November 27th, 1918. If the consent of the Shipping Board to the sale and transfer of the Northland should be revoked while the bill of sale is held in escrow, the Repairer shall have the right to require the owner to sell and transfer her to any American or other buyer approved by the Shipping Board whom the Repairer may nominate, and the Repairer shall receive the total sum realized by such sale above Six hundred thousand dollars ($600,000). If, however, it shall prove impossible, within thirty (30) days after the completion of the work or the extended period hereinafter provided for, to find an American or other buyer approved by the Shipping Board who will pay a sum sufficient to cover the cost of making over said steamer plus the Six hundred thousand dollars ($600,000) to be paid the Owner, then the Owner shall pay the Repairer the cost of the work done and cost of materials furnished, together with insurance premiums and incidental expenses, and shall assume any unpaid bills for labor and material on account of repairs, and shall be entitled to take the steamer over for its own use. The cost of labor and materials2999 shall be based upon current market rates, approved by Henry Black or other surveyor in his office, the intent of the parties being that, in the event of the revocation of the consent of the Shipping Board and the taking over of the steamer by the Owner, the Repairer shall be put in the same position as if the work upon the steamer had been undertaken in the first instance as a regular repair job, on a day's work basis, and the Repairer shall have interest at the rate of six per cent per annum upon any unpaid balance, said interest being figured from the end of each month upon the amount due at that time. In the event that an American or other buyer approved by the Shipping Board cannot be found within the thirty (30) days mentioned in this paragraph, the Repairer may have an extension of that period by thirty (30) days more, upon waiving its right to interest upon the unpaid balance of the cost of the work, during the period of such extension. In computing the cost of the work done and the materials furnished, the Owner shall be entitled to credit for all salvage. The Repairer agrees to give the Owner at the end of each calendar month during repairs a statement of the work done3000 and the percentage which the work done bears to the total repairs. The completion of the work referred to in this addendum shall be interpreted to mean the date when the Classification Society shall deem the vessel to be in a fit condition for classification. The Repairer agrees to apply for classification for this vessel at the earliest date when it is possible to apply for the classification and to use due diligence in obtaining the classification after the application therefor. NORTHERN STEAMSHIP COMPANY, By RALPH BUDD DAVIE SHIPBUILDING AND REPAIRING COMPANY, LTD. By C. A. BARNARD, President.256 128. In accordance with the provisions of this purported agreement a bill of sale covering the steamship was deposited in escrow pending the payment of the purchase price. 129. Payments on the purchase price were received from C. A. Barnard, as follows: August 2, 1919, $100,000; August 21, 1919, $50,000; October 16, 1919, $50,000 - total $200,000. The steamship was delivered to one Captain Green who took possession and gave a receipt in the name of the Davie Company. 130. Thereafter the Davie Company repudiated the agreement on the ground that said Barnard3001 was without authority to execute the same. 131. Thereafter, on January 6, 1920, the Northern Steamship Co., the Davie Shipbuilding & Repairing Co., and C. A. Barnard, individually, entered into an agreement reading as follows: MEMORANDUM OF AGREEMENT, entered into this 6th day of January, 1920, by and between the NORTHERN STEAMSHIP COMPANY, owner of the steamer Northland, (hereinafter called the Steamship Company), a corporation organized and existing under the laws of the State of Wisconsin, party of the first part, the DAVIE SHIPBUILDING & REPAIRING COMPANY, LIMITED, (hereinafter called the Davie Company), a corporation organized and existing under the laws of the Dominion of Canada, party of the second part, and CHARLES A. BARNARD, individually, of Montreal, Canada, party of the third part: WHEREAS, on the 27th day of November, 1918, a contract was entered into by the Steamship Company for the sale of the steamer Northland to the Davie Company, which contract was signed "Davie Shipbuilding & Repairing Company, Ltd., by C. A. Barnard, President"; and WHEREAS, after the execution of said agreement, one Captain Green took possession of the steamer Northland and gave a receipt3002 therefor in the name of the Davie Company; and WHEREAS, the Davie Company claims that Charles A. Barnard had no authority to enter into said agreement on its behalf and that said Captain Green had no authority to accept possession on its behalf, and disclaims all liability under said contract and any interest in or under or by virtue thereof; and WHEREAS the repudiation of said contract by the Davie Company was not disclosed to the steamship Company by the Davie Company nor by said Barnard, and was not, in fact, known to the Steamship Company; and WHEREAS said Barnard personally made certain payments to the Steamship Company on account of the purchase price, said payments aggregating Two hundred thousand dollars ($200,000), which payments the Steamship Company at the time understood were in fact made on behalf of the Davie Company, whereas both the Davie Company and Barnard now claim that these payments were made on account of Barnard personally; and WHEREAS the steamer Northland has been cut in two, for the purpose of taking her from Buffalo to Quebec, and the forward part of the steamer is now at Sorel and the after part is at Coteau, in the Soulange Canal; and WHEREAS3003 all of the parties of this agreement desire to accomplish an adjustment of the differences which have arisen as the result of the making of said contract and the repudiation thereof by the Davie Company. 257 NOW, THEREFORE, THIS AGREEMENT WITNESSETH: 1. The Davie Company hereby specifically disclaims any interest in or under or by virtue of the contract of November 27th, 1918, a copy of which is annexed hereto, marked Schedule A and made a part of this agreement. The Davie Company further represents that a resolution has been duly passed by its board of directors, a certified copy of which is annexed hereto and marked Schedule B. II. Charles A. Barnard hereby (1) Agrees to and does hereby renounce any claim against the Steamship Company and/or against the steamer Northland and/or any interest in said steamer which he personally might have under said contract and/or by reason of the payments which he personally has made on account of the purchase price or otherwise, and hereby releases the Steamship Company from any and all claims arising in any way from said contract or from said payments or in any other way connected with the steamer Northland; (2) Represents3004 (which representation has been acted upon by the Steamship Company and has induced the making of this contract) that the Northland, at the time of the execution of this agreement, is free from any liens in connection with anything that has happened since the 27th day of November, 1918, and in particular that no lien or claim against said steamer exists in favor of the Montreal Transportation Company and/or the Cowls Shipyards, and, in proof of said representation said Barnard has, prior to the delivery of this contract, submitted receipted bills and other documents showing payment for certain work and materials furnished by the Cowls Shipyards, and showing also payment to the Montreal Transportation Company for towage services rendered the Northland, and hereby warrants that said bills cover all work and materials furnished by said Cowls Shipyards and all towage services rendered by the Montreal Transportation Company, and that there is nothing due or to become due to either of the two concerns above mentioned or to any other individual or corporation which now is or hereafter can become a lien upon said steamer. (3) Agrees to assume and arrange for the payment of Twenty-eight thousand3005 four hundred sixty-one 02/100 dollars ($28,461.02) now due March & McLennan (Marine) for premiums on insurance policies issued to cover the Northland since November 27th, 1918, which premiums have been paid by Marsh & McLennan (Marine) to the underwriters to maintain the insurance on said vessel, and said Barnard hereby sells to the Steamship Company all pig iron now on board both halves of said vessel, at the actual cost thereof, and hereby directs the Steamship Company to pay the same to Marsh & McLennan (Marine) on account of the amount due to them for insurance premiums as aforesaid; and, to secure the payment of the balance thereof, said Barnard agrees, simultaneously with the execution and delivery of this agreement, to deliver to Andrew Haydon, of 19 Elgin Street, Ottawa, a mortgage running to said Andrew Haydon for the amount of said unpaid balance, said mortgage to cover a parcel of about one hundred and eighty (180) acres of land situated on the east end of the island of Montreal (which land said Barnard represents belongs to him individually, free and clear except only for a purchase money mortgage amounting to Twenty Thousand Dollars), said mortgage to become due in six3006 (6) months from date and to draw six per cent (6%) interest until paid; (4) Agrees that all articles which have been removed from the steamer Northland since November 27th, 1918, shall be returned to the Steamship Company, and, in particular, that all articles taken from said steamer and now stored at Levis or Quebec shall be delivered to a responsible warehouse 258 in Quebec, to be designated by the Steamship Company, and that a warehouse receipt shall be taken therefor in the name of the Steamship Company and delivered to Andrew Haydon, above referred to, within ten (10) days after the execution of this contract. (5) Agrees that all insurance policies now outstanding, covering the steamer Northland, may be altered so as to make loss, if any, payable solely to the Steamship Company. III. In consideration of the above, the Steamship Company agrees, upon the execution of this contract, to retake possession of the steamer Northland and to purchase the aforesaid pig iron and to release and acquit the Davie Company and Charles A. Barnard individually of and from all claims and demands rising from or in any way connected with the contract of November 27th, 1918, and/or3007 arising from any action or thing done by said Barnard in connection with said steamer. IV. The bill of sale and all other papers now held in escrow by Haight, Sandford & Smith shall be returned to the Steamship Company. IN WITNESS WHEREOF, two counterparts of this contract have been executed by the Steamship Company, said execution having been duly authorized by its board of directors as per certified copies of the resolution of the board thereto attached, and three counterparts have been executed by the Davie Company and Charles A. Barnard, said execution thereof by the Davie Company having been duly authorized by the board of directors of the Davie Company as per certified copies of the resolution of its board of directors thereto attached; execution and delivery of this contract to be fully effected by exchange of said counterparts. 132. The Northern Steamship Company did not accrue any profit from this transaction during the year 1918, but accrued in 1919 the sum of $21,735.71, being one-third of the estimated profit from the sale. 133. The respondent determined that the Steamship Northland was sold in the year 1918 at a profit of $65,207.13 and in the determination3008 of the deficiency for the years 1918 and 1919 added the sum of $65,207.13 to the income of the petitioner for the year 1918 and deducted the sum of $21,735.71 from its income for the year 1919. Taxes due from Director General.134. At all times during the years 1918 and 1919 the railroads of the petitioner and the Duluth Terminal Railway Co., the railroad and bridge of the Duluth & Superior Bridge Co., and the railroad of the Watertown & Sioux Falls Railway Co. were in the possession and control of the President under the Federal Control Act. 135. On December 30, 1918, the companies enumerated above executed the agreement with the Director General of Railroads, referred to in finding No. 97. Said agreement provided: 6(a) * * All taxes commonly called war taxes which have been or may be assessed against the Companies under the act of Congress entitled "An act to provide revenue to defray war expenses, and for other purposes" approved October 3, 1917, or under any act in addition thereto or in amendment thereof * * * shall be paid by the Companies. 259 6(c) The Director General shall either pay out of revenues derived from railway operation during the period3009 of Federal Control or shall save the Companies harmless from all taxes lawfully assessed under Federal or any other governmental authority for any part of said period on the property under such control, or on the right to operate as a carrier, or on the revenues derived from operation, and all other taxes which under the accounting rules of the Commission in force December 31, 1917, are properly chargeable to "railway tax accruals," except the taxes and assessments for which provision is made in paragraph (a) of this section. The Director General shall pay or save the companies harmless from the expense of all suits respecting the classes of taxes payable by him under this agreement. 136. In determining additional taxes due from the petitioner the respondent computed taxes for the year 1918 at the rate of 12 per cent, and for the year 1919 at the rate of 10 per cent. Depreciation of Allouez Bay Docks.137. During the years 1918 and 1919 the petitioner was the owner of certain dock property at Allouez Bay, Wis., consisting of docks Nos. 1, 2, 3, and 4, with office buildings, power house and miscellaneous structures and machinery appurtenant thereto. 138. The reasonable3010 allowance for the depreciation, exhaustion, wear and tear of said dock property amounted to $231,126.36 for the year 1918 and $230,449.50 for the year 1919. 139. Section 5 of the Federal control agreement dated December 30, 1918, provided that the Director General should pay to the petitioner the amount requisite to make good the depreciation that accrued during Federal control on property taken over by the Director General. 140. During the period of Federal control the petitioner did not charge any depreciation on such ore docks to its operating expense accounts in its income-tax returns for those years or claim any deduction for depreciation, exhaustion, wear or tear thereon, but instead charged to the Director General the sum of $231,126.36, representing depreciation that accrued during the year 1918, and $230,449.50, representing depreciation that accrued during the year 1919. 141. On April 22, 1921, the petitioner entered into an agreement with the Director General known as the final settlement agreement, under which the Director General agreed to pay the petitioner the sum of $6,500,000 in settlement of all accounts between the petitioner and the Director General. 3011 142. By the method of accounting prescribed by the Interstate Commerce Commission the petitioner applied this sum in payment of all its accounts against the Director General, including said depreciation for the year 1918, in the amount of $231,126.36, and said depreciation for the year 1919, in the amount of $230,449.50. 260 143. The books of the Director General show that out of the sum of $6,500,000 the sum of $42,439.95 was applied in payment of said depreciation for the year 1918 and the sum of $41,763.09 in payment of depreciation for the year 1919 instead of the amounts charged to the Director General by the petitioner. Assessment paid to Association of Railway Executives.144. The Association of Railway Executives is a voluntary association maintained by the railway companies. On October 16, 1919, the Chairman of the Association of Railway Executives issued a circular letter, a copy of which was received by the petitioner, announcing an assessment to be levied for the purpose of providing funds for carrying out the purposes of the Association. One-half of the assessment was to become due November 1, 1919, one-quarter on February 1, 1920, and one-quarter3012 on May 1, 1920. This circular letter announced that the proposed assessment was made up of the following items: 1. Advertising and publicity in connection with pending legislation and the return of the roads to private operation$1,000,0002. Bureau of Railway Economics (1920)90,0003. Railway Corporate Engineers Association (1920)10,0004. Railroad Corporate Accounting Conference (1920)10,0005. President's Conference Committee on Federal Valuation (1920)200,0006. Association of Railway Executives for general and legal expenses (1920)290,000Total1,600,000145. On November 15, 1919, petitioner paid to the Association $28,776.91, being one-half of the total assessment levied against the petitioner. OPINION. SMITH: The points in issue will be discussed in the order of the findings of fact. 1. Transportation for Investment-Cr. - In its original income-tax return for 1917 the petitioner claimed a deduction from gross income for ordinary and necessary expenses of $59,403,357.05. It filed an amended return for that year in which it increased the deduction for expenses by the amount of $6,307.30, representing the refunds made under3013 the Minnesota rate case decision, making the amount claimed $59,409,664.35. Included in this amount was $422,677.80 which stood upon its books as a credit to the account "Transportation for Investment-Cr." It now claims that the correct amount of its deduction for expenses is $59,367,864.90 or $41,799.45 less than the amount claimed upon its original return, said $41,799.46 representing 261 in its opinion the correct credit to "Transportation for Investment-Cr." The petitioner's books of account for the year 1917 were kept in accordance with the uniform system of accounts prescribed by the Interstate Commerce Commission. Under the provisions of such system of accounts railroad companies are permitted to charge to construction cost a reasonable allowance for the cost of transporting men and materials for construction projects over their own lines in transportation service trains. The Interstate Commerce Commission does not fix the amount which may thus be charged to construction but merely places a maximum limit thereon. Such maximum limit is one per cent per man mile for employees and six mills per ton mile for materials. In keeping its books of account for 1917 the3014 petitioner made the maximum charge permitted by the Interstate Commerce Commission and in effect capitalized $422,677.80 as the cost of transporting men and materials engaged in construction work on its revenue trains. It here contends that at the time the charge was made the petitioner had not made an exact determination of cost of such charge and that such cost should have been computed at $41,799.45 instead of at $422,677.80 and that the respondent erred in disallowing the deduction from gross income of the difference between these two amounts, or $380,878.35. The petitioner's general manager, a man with 32 years' experience in petitioner's operating department, testified that men are transported to construction work on the ordinary passenger trains; that no extra trains are run or extra cars put on to carry them; that no extra service is performed for them; that during the year 1917 the men so transported were equal to 3,220,609 men transported one mile; that they averaged approximately 1 man to every 4 passenger trains and constituted approximately .48 of 1 per cent of the total passengers carried on such trains; that at all times many more passengers could have been carried3015 on such trains without increasing the number of trains or cars run. The witness testified that in his opinion the operating expenses of the petitioner would not have been reduced if these men had not been carried on these passenger trains. He also testified that company material, including construction material, was transported in such a way as not to require the use of additional trains; that a great deal of it was transported by local way-freights and branch-line trains which usually ran with light tonnage; that the company controlled movement of construction material so as to move it on trains that did not have full tonnage; that construction material for a given job was accumulated from time to time at a station near the job until a sufficient quantity had been received to justify putting on a work train by which the material was transported to the place where it 262 was to be used; that the entire cost of the work train was then charged to the job. He also testified that the prevailing tonnage on petitioner's line of railroad was east-bound and that empty cars had to be used west-bound at all times of the year to supply sufficient cars for east-bound traffic; that in3016 the case of construction material moved west-bound the only extra service performed was the haul of the material itself as the cars would otherwise be moving light; that no extra service was performed in the handling of construction material; that the material was usually loaded by the firm from which it was bought, or, if loaded by the petitioner's employees, the work was done by store department men whose time was not charged to operating expenses; that the material was also unloaded by store department employees; that during the year 1917 construction material equivalent to 65,076,446 tons moved one mile was transported in the ordinary commercial trains of the petitioner; that this material was carried in small amounts at various times during the year; that it averaged 5 1/2 tons per train and constituted .67 of 1 per cent of the total tonnage of freight carried by the petitioner during the year. He stated that it was his opinion that if such construction material had not been transported by the petitioner during the year 1917 the cost of maintenance of way or maintenance of equipment would not have been reduced, except in the case of repairs to freight cars. In connection with3017 repairs to freight cars he stated that it was his opinion that 60 per cent of such repairs varied with the volume of traffic and 40 per cent was due to weather conditions and natural deterioration; also that if such construction material had not been moved, traffic expenses, the cost of operating dining cars, hotels, stock yards, etc., and the general expenses of the company such as salaries of its general officers, accounting department expense, etc., would not be changed; that the only items of expense classified as transportation expenses which would be affected would be fuel for yard locomotives and fuel for train locomotives. Upon the basis of the testimony given by petitioner's general manager, a cost analyst, with twelve years' experience in railroad work, testified that the operating expenses of the petitioner for the year 1917 had been increased not more than $41,799.45 by the transportation of employes engaged in and construction material used in additions and improvements in transportation service trains. The method of the computation is detailed and no useful purpose would be served by setting it forth here, except that is should be noted that in the determination of3018 the revised estimate only freight-car repairs, fuel for yard locomotives, water for yard locomotives; fuel for train locomotives and water for train locomotives and train power produced have been taken into consideration. 263 The classification accounts prescribed by the Interstate Commerce Commission permit the petitioner to charge to capital "a fair allowance representing the expense to the carrier of such transportation in transportation service trains over the carrier's own line." The petitioner's operating expenses claimed as a deduction from gross income were $422,677.80 in excess of the amount shown as its operating expenses in returns made to the Interstate Commerce Commission. The petitioner now admits that $41,799.45 of the $422,677.80 was properly disallowed as a deduction from gross income by the respondent. We think that the evidence does not show that any part of the $422,677.80 was a proper deduction from gross income. That amount was the estimate made by the petitioner of the portion of its operating expenses which should be charged to capital when it made up its accounts for 1917. Apparently in the making of that estimate other cost factors were taken3019 into consideration in addition to those used in computing the revised estimate of $41,799.45. The latter figure has been computed upon the basis of the additional cost to the petitioner of transporting men and materials engaged in and used in construction work, but the account "Transportation for Investment - Cr." does not apparently have reference entirely to the additional cost to the petitioner of transporting men and materials so engaged. In our opinion, a part of the wear and tear of the train equipment of the rails, ties, etc., may be properly capitalized when men and materials for construction work are transported in transportation service trains. The evidence adduced does not convince us that the real cost to the petitioner of this transportation is the amount of $41,799.45. The disallowance of the deduction of $422,677.80 is therefore approved. 2. Federal fines paid by petitioner for 1917 and Federal fines paid by Great Northern Express Co., an affiliated company, for 1918. - This issue relates to the deductibility from gross income of amounts paid as fines or penalties for violation of certain Federal regulatory statutes. The petitioner claims the deduction3020 of these amounts as ordinary and necessary expenses. The respondent has disallowed the deduction of these amounts, The amounts claimed as deductions for the year 1917 are as follows: Violation of Safety Appliance Acts$3,388.17Violation Hours of Service Act517.63Violation of 28-Hour Live Stock Act536.22Violation of customs regulations145.004,587.02The amount of the disallowance for the year 1918 is $14, which represents one-half of a penalty paid by the Great Northern Express Co., an affiliated corporation, for a violation of a customs regulation 264 by the Adams Express Co. The Great Northern Express Co. contributed one-half of the penalty because of the difficulty of ascertaining which company was at fault. The Safety Appliance Acts consist of an act passed March 2, 1893, with various amendments, making it unlawful for a railway company to operate cars or locomotives with certain specified defects over its line. (27 Stat. 531; 29 Stat. 85; 32 Stat. 943; 36 Stat. 298; 36 Stat. 1397.) The provisions of the Acts with respect to the beginning of the time of enforcement after the enactment are liberal. The Hours of Service Act was3021 an act passed March 4, 1907, and amended May 4, 1916, making it unlawful for a railroad company to employ telegraph operators, enginemen, trainmen or switchmen more than a given number of hours without rest. (34 Stat. 1415; 39 Stat. 61.) The Act contains the liberal proviso that it does not apply: * * In any case of casualty or unavoidable accident or the act of God; nor where the delay was the result of causes not known to the carrier or its office or agent in charge of such employee at the time the said employee left a terminal which could not have been foreseen. The 28-Hour Live Stock Act (34 Stat. 607) was an act passed June 29, 1906, making it unlawful for railway companies to confine live stock in cars more than 28 hours without unloading them for feed and rest, unless the shipper gave his written consent, in which case they could be confined for 36 hours without being given an opportunity to obtain feed and rest. The act contains a proviso that the penalty or fines shall not be imposed if the carrier is prevented by storm or other accident or unavoidable causes which could not be anticipated or avoided by the exercise of due diligence and foresight. We think that3022 all the operating expenses of a railroad company must ordinarily be regarded as "ordinary and necessary expenses" and deductible from gross income. We note, however, that the Interstate Commerce Commission has not classified fines of the character of those paid by the petitioner as operating expenses. They are required to be recorded in account No. 621, "Miscellaneous Debits." It is provided that this account "shall include amounts, not provided for elsewhere, chargeable to Profit and Loss from other accounts, amounts written off in consequence of adjustment, and payments not properly chargeable to the income accounts. * * Among items which shall be charged to this account are * * * Penalties and fines for violation of the Act to Regulate Commerce, or other Federal laws, but not specifically provided for elsewhere." Payments of the fines above indicated do not constitute operating expenses under the classification of accounts of the Interstate Commerce Commission. We are of the opinion that they do not constitute 265 ordinary and necessary expenses deductible from gross income in income-tax returns. Cf. 3023 Sarah Backer et al., Executors,1 B.T.A. 214">1 B.T.A. 214; Norvin R. Lindheim,2 B.T.A. 229">2 B.T.A. 229; John Stephens,2 B.T.A. 724">2 B.T.A. 724; Columbus Bread Co.,4 B.T.A. 1126">4 B.T.A. 1126. 3. Interest due from Spokane, Portland & Seattle Railway Co.; Glacier Park Hotel Co.; South Butte Mining Co.; and Washington & Great Northern Townsite Co. - This issue involves for 1917 the question of whether or not the petitioner shall be taxed on interest accruing to it upon debts owed to it by the Spokane, Portland and Seattle Railway Co., the Glacier Park Hotel Company, the South Butte Mining Co., and the Washington and Great Northern Townsite Co. in the respective amounts of $1,572,100.07, $29,558.61, $3,518.97, and $104,085.58, and for the years 1918 and 1919 the question of whether it shall take up as income in its income-tax returns interest accruing to it on debts of the Spokane, Portland & Seattle Railway Co. in the respective amounts of $1,519,784.68 and $1,518,227.11. All of these debtor corporations were nonaffiliated subsidiaries of the petitioner for the years involved. The petitioner did not include in its accrued income the interest in question because3024 it was not shown upon its books of account as accrued income. The petitioner's books of account are kept in accordance with the requirements of the Interstate Commerce Commission. The "classification of income, profit and loss, and general balance sheet accounts of steam railroads" prescribed by that Commission in accordance with section 20 of the Act to Regulate Commerce, effective July 1, 1914, and in effect during the years 1917, 1918, and 1919, contains to the following provision: Income from funded securities. - * * Interest accrued shall not be credited prior to actual collection unless its payment is reasonably assured by past experience, guaranty, anticipated provision or otherwise. The petitioner did not, however, wish to lose sight in its bookkeeping records of the fact of the accrual of the interest upon the obligations of the above named companies and therefore recorded in a balance sheet account, designated "Other Deferred Assets," the interest which accrued yearly upon these obligations and counterbalanced such entry by a corresponding entry on the liability side of its balance sheet designated "Other Deferred Liabilities." During the tax years involved the3025 petitioner did not record the interest in its income accounts because it was of the opinion that there was no likelihood of its ever collecting the interest. George R. Martin, the petitioner's vice president, and in 1917 its comptroller, testified that during the years 1917, 1918, and 1919 he was familiar with the financial condition of the Spokane, Portland & Seattle Railway Co.; that he received from that company weekly and monthly income accounts and 266 balance sheets, and went to Portland once or twice to examine their books for the purpose of keeping in touch with their financial requirements. He knew how far behind the Spokane, Portland & Seattle Railway Co. was in its payments. The books of the other debtor companies were kept by the petitioner's comptroller who was also comptroller for these companies. He knew better than anybody else their actual financial condition and possibilities of future collection of the interest accruing. In connection with the interest due from the South Butte Mining Co. the comptroller stated in answer to the question as to why such interest was not accrued as income, "Because there seemed no possibility of collecting it. The company3026 had no income and no operations." It was also testified by officers of the petitioner that there seemed no likelihood that the Spokane, Portland & Seattle Railway Co. would ever pay interest upon its bonds. It was continually operating at a deficit. In the opinion of one of the witnesses the coupons which matured during the taxable years were worth nothing at all. The same condition obtained with respect to the other subsidiaries. The officers of the petitioner in good faith believed that the interest never could be collected. No part of the interest which accrued during the taxable years on any of the companies has ever been paid except a portion of that which accrued on the bonds and other interest-bearing obligations of the Spokane, Portland & Seattle Railway Co. In 1921 this company received a large payment from the United States and a part thereof was used to liquidate certain notes which that company had given to the petitioner in payment of interest which accrued prior to 1917. Based upon conditions existing in 1921, the petitioner accrued upon its books as income interest which had theretofore accrued upon the obligations of the Spokane, Portland & Seattle Railway Co. 3027 This treatment was, however, vetoed by the Interstate Commerce Commission and the entry was reversed in 1923 with the result that the interest which accrues upon the obligations of the Spokane, Portland & Seattle Railway Co. is recorded in the income accounts of the petitioner only when collections are actually made. In justification of his action in holding that the interest which accrued upon the obligations of these subsidiaries was income of the petitioner for the years 1917, 1918, and 1919, as above indicated, the respondent points out that the balance sheets of the debtor corporations for the years involved show assets in excess of liabilities exclusive of capital liabilities; that therefore they have a net worth from which it might have been possible for the petitioner to recover the interest which accrued upon the obligations even though such recoveries would have been at the expense of the petitioner's investment in the capital stock of the corporations. He also argues that 267 the petitioner keeps its books of account upon the accrual basis; that the requirement of the Interstate Commerce Commission is for the purpose of its proper administration of the affairs3028 of railroads and in effect combines the cash system of accounting with the accrual system; that such practice is not permissible for the purposes of determining income for taxation, and in support of this proposition relies upon Consolidated Asphalt Co.,1 B.T.A. 79">1 B.T.A. 79; Clarence Schock,1 B.T.A. 528">1 B.T.A. 528; Henry Reubel, Executor,1 B.T.A. 676">1 B.T.A. 676. It is the theory of the respondent that the petitioner is required under the income-tax law to report as income the amount of interest which accrued upon interest-bearing obligations held by it for the years 1917, 1918, and 1919, regardless of the requirements of the Interstate Commerce Commission, and that if it ascertained in those years that the interest was not collectible and charged it off from its gross income, the same can be claimed as a deduction from gross income in income-tax returns. We are satisfied from a careful study of the balance sheets and income accounts of the debtor corporations involved in this issue that the interest owed to the petitioner by these corporations could not have been collected by legal process during the taxable years if at all, without impairment of the principal3029 investment of the petitioner in such companies. The petitioner, with the Northern Pacific Railway Co., owned the capital stock of the Spokane, Portland & Seattle Railway Co. The petitioner and its associated company might conceivably have had a receiver appointed for the Spokane, Portland & Seattle Railway Co. and might possibly have collected principal and interest upon the bonds held by it. But this would have been at the sacrifice of petitioner's and its associate's investment in the stock of these companies. There clearly would have been no income to the petitioner corporation from such proceeding. Section 13(d) of the Revenue Act of 1916 provides: A corporation * * keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned. Section 212(b) of the Revenue Act of 1918 provides: The net income shall be computed * * * in accordance3030 with the method of accounting regularly employed in keeping the books of such taxpayer; * * or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * * The petitioner kept its accounts upon the basis of the system of accounts prescribed by the Interstate Commerce Commission. It 268 could not have done otherwise. The question before us is whether the accounts of the petitioner so kept reflect the true income of the petitioner. We have carefully considered the decisions of the Board above referred to which the respondent relies upon as requiring the petitioner, keeping its books as it does upon an accrual basis under the regulations of the Interstate Commerce Commission, to include in income the interest upon all obligations of the debtor corporations here involved. In Consolidated Asphalt Co., supra, we said: It would be an obvious distortion to return only the gross income actually received and deduct therefrom both the amounts paid out and the payments anticipated. 3031 In Henry Reubel, Executor, supra, it was said: In this appeal the taxpayer followed one of the two alternative bases provided by statute for keeping accounts and making returns of income. He claimed a deduction which can only be justified under the other alternative basis. In our opinion, to allow such a deduction would result in a distortion of the result of the income of the taxpayer for the year in question and would lead to the inevitable conclusion that Congress, instead of providing for two alternative bases for reporting income, each complete in itself, provided for alternative bases with respect to the reporting of items of income and the taking of items of deductions. Such a holding would be inconsistent with the specific language of Congress in sections 200 and 212 and wholly at variance with the obvious intent of Congress that income should be reported in such a manner upon an annual accounting basis as to reflect the truth. The statute does not lay down two alternative bases for keeping accounts and making returns of income. It simply provides that a corporation keeping accounts upon any basis other than that of actual receipts and disbursements3032 may, subject to regulations, make its returns upon the basis upon which its books are kept "unless such other basis does not clearly reflect its income." We are not therefore primarily concerned with whether the classification of accounts of steam railroads laid down by the Interstate Commerce Commission is an accrual system of accounting or some other system. The only question before us is whether the system reflects the income of the petitioner. As indicated by the income-taxing statutes, corporations keeping books of account may make their returns upon the basis of actual receipts and disbursements or upon some other basis which truly reflects income. There are two methods of accounting in general use, (1) the cash basis commonly used by individuals and small concerns, and (2) the so-called "accrual basis." Both methods have for their object the same purpose, which is the recording of the financial transactions of a business and the summarizing of the results so as to show the effect of these transactions upon the business. 269 The principal difference between them is the period of time to which a given transaction is allocated. Under either method the taxpayer3033 must have before him some definitely ascertained item of income to record before it can be reported and if a given transaction does not correspond to the definition of income then there is no income to record whether the taxpayer keeps its books on a cash or an accrual basis. Where books are kept on the accrual basis there is no requirement that there shall be accrued as income that which may never be received. The position of the respondent in this case carried to its logical conclusion would require a taxpayer keeping its books of account upon the accrual basis to accrue as income interest on bonds held as an investment which it did not collect and which in all probability it never would collect. If the theory of the respondent is correct an insolvent corporation keeping its books of account upon the accrual basis might merely by the purchase of bonds of insolvent corporations upon which interest was neither being earned or pair, easily show a large income. In our opinion the requirement of the Interstate Commerce Commission that interest accrued on funded securities shall not be credited to income accounts prior to actual collection "unless its payment is reasonably assured3034 by past experience, guaranty, anticipated provision or otherwise," is entirely consistent with a system of accounting which is designed to reflect any company's true income. If the petitioner had kept its accounts in the manner suggested by the respondent it would have reported to the public each year that it had earned income in excess of one million and a half dollars which, as a matter of fact, it had not received and which in all probability it would never receive. Such a system of accounting would not have reflected the petitioner's true income but would have given to its stockholders and the public a false idea of its income. The respondent does not contend that the petitioner actually had earnings during the taxable years of the interest that accrued upon the interest-bearing obligations of its subsidiaries herein considered. It does contend, however, that it should have accrued the interest upon its books of account and unless it can show that the interest could not be collected by legal process and that the amounts accrued upon its books had been charged off as bad debts, the petitioner is liable to income tax in respect of such interest. Manifestly, the petitioner3035 can not keep its books of account in the manner suggested by the respondent. It is prohibited by the rulings of the Interstate Commerce Commission to set up as income the accrued interest. Therefore it could not have charged the amounts off. 270 We are of the opinion that the interest upon the interest-bearing obligations of the debtor corporations above enumerated which was not collected during the tax years involved was not taxable income. 4. Depreciation on equipment of petitioner scrapped or sold; boats of Glacier Park Hotel Co. destroyed; property of Cottonwood Coal Co. destroyed; and facilities of Somers Lumber Co. destroyed or sold. - Various items involved in this issue do not present for the determination of the Board any question of fact since all of the facts involved are agreed upon by the parties. The only question presented is whether in determining the deduction on account of loss sustained by destruction, sale or scrapping of assets, the March 1, 1913, value or cost subsequent to that date should be reduced by depreciation sustained up to the date of destruction, sale, or scrapping, which depreciation was charged off the petitioner's books of account3036 and presumably claimed as a deduction from gross income in income-tax returns. The principle involved in this question has heretofore been decided by the Board adversely to the contentions of the petitioner in Even Realty Co.,1 B.T.A. 355">1 B.T.A. 355. The principle has also been decided adversely to the petitioner in the recent decision of the United States Supreme Court in United States v. Ludey,274 U.S. 295">274 U.S. 295. 5. Loss on stock of Spokane & Inland Empire Railroad Co.. - This issue is merely one of fact, namely, the value at March 1, 1913, of stock, both preferred and common, of the Spokane & Inland Empire Railroad Co. which became worthless in the hands of the petitioner in 1918. The petitioner wrote off as a loss for that year the entire cost of the stock of the above-named company which it had acquired from 1906 to 1909. The respondent conceded that the stock was worthless in 1918 but did not allow the loss claimed. He allowed a loss based on a March 1, 1913, value of $10 per share for the common stock and $30 per share for the preferred stock. These amounts were the prices which were bid for the stocks as shown by market quotations on or3037 about March 1, 1913. The asked prices, as shown by such quotations, were $20 for the common stock and $40 for the preferred. There were no sales of either class so far as the record shows at or about the basic date. The Spokane & Inland Empire Railroad Co. occupied a unique position with respect to the railroad operations of the petitioner. It was an electric road 212 miles long. It extended into the Coeur d' Alene territory of Idaho, and to certain points in the State of Washington. The road tapped rich wheat and lumbering sections. At the time the stock was acquired it was believed that the road would act as a valuable feeder to the petitioner and to the Northern Pacific Railway Co., which also purchased heavily of the stock. The passenger traffic on the road was heavy for a number of years. The control of the road to a large extent meant the control of traffic 271 originating in the territory. The petitioner, together with the Northern Pacific Railroad Co., had a controlling interest in the voting stock of the company. We have no doubt that this factor should be taken into account in determining the fair market value as of March 1, 1913. 3038 Phillips v. United States, 12 Fed.(2d) 598. The petitioner contends that the fair market price or value of its shares of common stock in the Spokane & Inland Empire Railroad Co. on March 1, 1913, was $30 per share for the common stock and $90 per share for the preferred stock. In support of its contention it placed on the stand at the hearing an investment banker who testified that in his opinion the fair market value of the common stock on March 1, 1913, was $30 per share and of the preferred stock $60 per share. Taking into consideration all of the evidence of record we are of the opinion that these values represent the fair market values on March 1, 1913, of the stock held by the petitioner. We therefore determine the fair market value of the petitioner's shares on the basic date and the loss sustained in 1918 to be $1,689.585. 6. Profit or loss on sales of various parcels of land. - The sole question involved in this issue is one of fact, namely, the cost and March 1, 1913, value of five parcels of property sold during the year 1918. The respondent has determined an aggregate profit of $2,745.94 from the sale of these parcels, based upon the March 1, 1913, value, 3039 whereas the petitioner contends that no taxable profit was realized on the sale of any parcel and that a deductible loss of $1,325.80 was sustained on the sale of 39.14 acres near Helena, Mont. The evidence satisfies us that no taxable profit was sustained upon the sale of any parcel and that an actual loss, as contended for by the petitioner, was sustained upon the sale of the tract of land near Helena. The petitioner is, therefore, entitled to the deduction of a loss of $1,325.80 on these sales. 7. Contributions towards the construction of spur tracks, etc. - The question involved in this issue grows out of the acquisition by the petitioner, without cost to it, of facilities such as spur tracks and farm crossings on its right of way constructed at the cost of patrons of the railroad. It was the practice of this carrier, where an industry located along its tracks desired transportation facilities from its plant, to construct the necessary spur track, take title to so much thereof as lay on its right of way, and require the industry to pay the cost of construction. This item is accounted for under the Interstate Commerce Commission's rule entitled "Account No. 606. Donations. 3040 " Where the facility was constructed by the industry the cost of construction to the industry was taken upon the petitioner's books either at the exact cost to the industry, or at the estimated cost thereof. The 272 amount of the contributions, including the estimated value of the labor and material furnished by the industry or persons performing the labor, was $28,116.04 in 1918, and $19,128.98 in 1919. The petitioner did not return these amounts as income in its income-tax returns upon the theory that they did not constitute taxable income within the meaning of the Sixteenth Amendment and the income-tax laws. The respondent has amended the petitioner's returns for these years by including in the gross income the above amounts. It is the contention of the respondent that all of the tests of income are met in the receipt of these amounts. He argues that the carrier is to furnish service at a point away from the main line and that the industry is to pay the cost of the property to which the carrier gets title; that the consideration given by the road is its service at the point of the spur track; that this is obviously a charge imposed upon the industry over and above3041 tariff rates; that the petitioner's assets are increased by the cost or value of the facility and on such investment the petitioner is entitled to earn a fair return; furthermore, that rights are reserved in the contract to move freight of other industries over such spurs from points beyond the first industry's property into the lines of the carrier. On behalf of the petitioner, it is argued that the amounts received were not derived from the employment of labor, from capital, or from both combined, and that they do not constitute income as that word has been defined in numerous decisions of the Supreme Court. Eisner v. Macomber,252 U.S. 189">252 U.S. 189; Merchants' Loan & Trust Co. v. Smietanka,255 U.S. 509">255 U.S. 509; United States v. Phellis,257 U.S. 156">257 U.S. 156; Edwards v. Cuba Railroad Co.,268 U.S. 628">268 U.S. 628; Bowers v. Kerbaugh-Empire Co.,271 U.S. 170">271 U.S. 170. The facts in this case are strikingly similar to those which obtained in the Appeal of Liberty Light & Power Co.,4 B.T.A. 155">4 B.T.A. 155. In that case, the petitioner had entered into four contracts with certain individuals for the construction of3042 transmission lines in territory in which the power company had assumed no franchise obligations. The contracts provided that the title to the lines should be in the power company, but that the individuals should contribute a certain part of the cost of construction. The accounting rules prescribed by the Indiana Public Utilities Commission provided that in such cases the entire cost of construction should be charged to the proper capital account and the amount contributed by the individuals should be credited to an account styled "Donations in Aid of Construction." Relying upon the Cuba Railroad Co. decision above cited, we held that such contributions did not constitute taxable income to the power company. There is nothing to distinguish that case from the one under consideration. We there extensively reviewed the authorities upon this subject. In accordance 273 with the rule laid down in that case, we are of the opinion that the petitioner is not liable to income tax in respect of the contributions received in aid of construction during the years 1918 and 1919. 8. Compensation due petitioner under the Federal Control Act. - The standard return, or annual3043 compensation based upon the annual average earnings for the "test period," agreed to in the contract of this petitioner and its subsidiaries with the Director General, was $28,774,899.45. By the terms of the contract this was not a final figure, but was subject to correction by increase or decrease as the Commission might determine under the provisions of the preamble of the agreement. This provides for a correction of the tentative standard return to accord with what the Commission might certify after the accounts and reports of the company, used by the Commission in arriving at the standard return, may have been brought into conformity with the accounting rules of the Commission. When the Commission finally certified the standard return it was changed to $28,684,405.60, or $90,493.85 less than that contained in the contract and reported in the returns of the petitioner. This issue is fully controlled by the principle adopted by the Board in its decision in Appeal of Illinois Terminal Co.,5 B.T.A. 15">5 B.T.A. 15. All of the facts necessary to a determination of the correct standard return were in existence and capable of ascertainment within the year 1918 and before the3044 year 1919. Under such circumstances the corrected figure is the proper amount to be accrued. United States v. Anderson,269 U.S. 422">269 U.S. 422. 9. Interest due from Director General under Federal control agreement. - Section 4(a) of the contract of the petitioner with the Director General provided that balances of certain accounts therein and previously mentioned in the contract should be struck quarterly and that such balances should bear interest at a specified rate. The balances in question were not in fact struck. The petitioner accrued nothing on its books in the year 1918 on account of interest on such balances. It, however, accrued in 1919 interest due it by the Director General in the amount of $1,570,199.75. The respondent determined that the interest on such quarterly balances accruable in the year 1918 was $693,005.39 and in the year 1919 was $351,764.86. The petitioner desires to return its income from this source in accordance with its books and to adjust any differences in the year in which it made final settlement with the Director General. An examination of the contract indicates that all of the facts necessary for a determination of the3045 quarterly balances were in existence and known or capable of being known at the end of each quarter. There is no evidence to indicate that these balances depended upon any contingencies or any basic facts to come into existence in later years. We are of the opinion that this issue is controlled 274 the same as the preceding one by the decision of the Board in Illinois Terminal Co., supra.The action of the respondent upon this point is sustained. 10. Interest due from the Farmers Grain & Shipping Co. - The petitioner claims affiliation with the Farmers Grain & Shipping Co. If this contention is granted, the action of the respondent by adding to the petitioner's gross income for 1918 and 1919 any amount for interest due it from its subsidiary must be reversed. The petitioner owned 100 per cent of the capital stock of the Brandon, Devils Lake & Southern Railway, which in turn owned 60.51 per cent of the stock of the Farmers Grain & Shipping Co. The properties of the Brandon and Farmers companies were operated as a unit and as a part of the system of the petitioner. There is no evidence that the minority of 39.49 per cent of the Farmers Grain3046 & Shipping Co. stock was either owned or controlled by the petitioner, its subsidiaries, its stockholders, or its subsidiary's stockholders. The evidence does not warrant a conclusion that substantially all of the stock of this company was owned directly or controlled through closely affiliated interests, or by a nominee or nominees of the petitioner. We must, therefore, hold that the petitioner was not affiliated with the Farmers Grain & Shipping Co. during either of the years 1918 or 1919. See Adaskin-Tilley Furniture Co. v. Commissioner,6 B.T.A. 316">6 B.T.A. 316. This makes it necessary to determine whether the petitioner derived any income from the accrual of interest upon the obligations of the Farmers Grain & Shipping Co. The situation here is substantially the same as that considered in the third issue of this proceeding. Under the regulations of the Interstate Commerce Commission the petitioner could not take into income the interest which accrued upon these obligations for the reason that the interest was not paid during the taxable years and the payment was not "reasonably assured by past experience, guaranty, anticipated provision or otherwise." The company3047 was not earning any interest upon its obligations and had not been for many years. The petitioner derived no income from the interest accruable upon bonds of this company during the taxable years and the addition to the reported income of the petitioner of any amount for interest upon these obligations was in error. 11. Alleged sale of steamship by Northern Steamship Co. - The contention of the petitioner upon this issue is that there was no sale of the steamship Northland by the Northern Steamship Co., an affiliated subsidiary of the petitioner, in 1918; that if it be held, however, that there was a sale in the year 1918 the gain therefrom should be computed upon the installment-sale method and that the only income from the transaction was the $200,000 received from Barnard in 1919. The contention of the respondent upon this point is that one of the 275 subsidiaries of the petitioner entered into a contract in 1918 for the sale of the steamship Northland at a price of $600,000; that if the purchase price had been paid in cash at the date of sale the profit which would have been realized would have amounted to $65,207.13; that the contract of sale was valid; 3048 that payments were not to be made in installments and that the profit which actually accrued to it in 1918 was $65,207.13. The Northern Steamship Co. received no down payments on account of the sale of the steamer Northland in 1918. It admits that it received $200,000 in 1919 and confesses that it is liable to income tax in respect of the amount received in 1919. In our opinion this is the only amount of income received by the petitioner from this transaction, and we think, in the circumstances, it was properly allocated by the petitioner to the year 1919. 12. Taxes due from Director General. - The issue here raised is whether the petitioner is liable to tax upon its net income at the rates of 12 per cent and 10 per cent for the years 1918 and 1919, respectively, or at the rates of 10 per cent and 8 per cent for those years, respectively. This issue is controlled by the decision of the Board in New York, Ontario & Western Railway Co.,1 B.T.A. 1172">1 B.T.A. 1172. In accordance therewith, it is held that the proper rates applicable are 10 per cent for 1918 and 8 per cent for 1919. 13. Depreciation on Ore Docks. - The petitioner submits that if the Board3049 holds that its accounts relating to Federal control operations in 1918 and 1919 should be restated to correspond with the books of the Director General, then its income for the years 1918 and 1919, respectively, should be reduced in the sum of $188,686.41, representing depreciation actually sustained and charged to the Director General, but which the Director General's books show was not assumed or paid by him. That the depreciation claimed to have been sustained by the petitioner upon its dock property at Allouez Bay, Wis., was actually sustained as claimed is admitted by the respondent's answer. In accordance therewith, the claim of the petitioner with respect to additional depreciation for the years 1918 and 1919 is allowed. 14. Assessment paid to Association of Railway Executives. - There was in existence during the year 1919 an association known as the "Association of Railway Executives." On October 16, 1919, the president of that association mailed the president of the petitioner a letter announcing plans for the assessment of $1,600,000 for the support of the association. Included in the letter was a committee report relating to the proposed expenditure by the association3050 of $1,000,000 for the purpose of a publicity campaign to bring pressure to bear upon Congress through the medium of public opinion to enact 276 legislation favorable to the railroads in connection with the return of the roads to private control and in connection with other legislation affecting the roads. On November 1, 1919, the president of the association mailed a letter to the petitioner containing a statement that its quota of the entire assessment of $1,600,000 was $57,553.83, of which one-half, or $28,776.91, was due and payable immediately, and that the remaining one-half would be due and payable in two installments during the year 1920. The respondent contends that ten-sixteenths of the amount paid in 1919 should be disallowed as a deduction from gross income on the ground that to this extent the payment to the association was not an ordinary and necessary business expense. The evidence before the Board does not show how or for what purpose the money collected by the Association of Railway Executives was expended nor to what account or accounts the payment made by the petitioner in 1919 was charged on its books. The record is also silent as to whether the petitioner3051 deducted this payment from its gross income in making its income-tax return for 1919. This issue injected into the proceeding by the respondent is, for lack of proof on his part, decided in favor of the petitioner. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.STERNHAGEN dissents in part.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623389/	William A. Scheuber and Hildegard Scheuber v. Commissioner.Scheuber v. CommissionerDocket No. 79638.United States Tax CourtT.C. Memo 1961-43; 1961 Tax Ct. Memo LEXIS 306; 20 T.C.M. (CCH) 235; T.C.M. (RIA) 61043; February 21, 1961306 Petitioner, Hildegard Scheuber, purchased numerous parcels and interests in parcels of improved and unimproved real estate, and title thereto was taken in her name. She sold 82 parcels of unimproved and improved parcels during the years 1949 through 1957. During 1955, 1956, and 1957, the years in which the deficiencies here involved were assessed, she realized gains on the sale of 31 unimproved parcels, a 98-acre tract, and 5 rental properties, all of which were sold during these years except 3 which were sold on an installment basis in 1949 and 1953. She gave full authority to real estate agents, co-owners, or her husband (a licensed real estate broker) to sell the property for her at prices to be fixed by them. She herself was not active in procuring such sales. Her agents advertised and sold the respective properties, exercising practices common to the real estate business. The 31 undeveloped parcels were held to be sold whenever a satisfactory profit could be realized. Most of the parcels were held less than 18 months. The 98-acre tract was purchased for the development of a motel, but was sold when difficulties with the sewer and water departments frustrated the plans therefor. 307 Held: That all of the unimproved parcels sold, except for the 98-acre tract, were held primarily for sale to customers in the ordinary course of business. Held, further: That the 98-acre tract and the 5 rental properties were not held primarily for sale to customers in the ordinary course of business, but were held primarily for investment purposes. E. C. Pommerening, Esq., 231 W. Wisconsin Ave., Milwaukee, Wis., and Glen E. Pommerening, Esq., for the petitioners. William J. Wise, Esq., and James T. Wilkes, Esq., for the respondent. FISHERMemorandum Findings of Fact and Opinion FISHER, Judge: Respondent determined deficiencies in income tax against the petitioners as follows: YearDeficiency1955$10,132.3819561,843.68195711,453.08Respondent, by an amendment to his answer, claimed that petitioners are liable for a further deficiency for 1956 because of an unreported gain on the sale of real estate in the amount of $1,139.71. The additional gain was admitted by petitioner; the question of whether it is taxable as long-term capital gain or ordinary income remains in dispute. The parties also stipulated the amount of long-term308 capital loss on the sale of securities and allowable automobile expense. The primary issue presented is whether or not certain improved and unimproved parcels sold in the years 1949, 1953, 1955, 1956, and 1957 were, in the years in which said sales were made, held primarily for sale to customers in the ordinary course of business. A subsidiary issue relating to self-employment taxes for the years 1955, 1956, and 1957 is dependent upon our determination of the primary issue referred to above. Findings of Fact Certain facts have been stipulated and these are incorporated herein by reference. Petitioners, William A. Scheuber and Hildegard Scheuber, husband and wife, filed timely joint Federal income tax returns for the taxable years 1955, 1956, and 1957 with the district director of internal revenue, Milwaukee, Wisconsin. On the returns for these years, Hildegard reported gains from the sale of 33 parcels of real estate sold during these years and gains realized during these years on three installment sales consummated in the years 1949 and 1953. The following gains were reported as long-term capital gains on the sale of real property on petitioners' return for 1955 Schedule ANumber ofTrans-DescriptionactionsProfit13 parcels, Fairy Chasm13$10,309.682 lots, Crestwood14,949.482 lots, Capitol Intersection15,602.714 lots, Capitol Crest211,381.461 parcel, Sub. #771791.851 lot, Marnitz11,249.16 a1335 N. Prospect1715.27 aTotal$34,999.61309 The following gains (except one which was unreported) were reported as long-term capital gains on the sale of real property on petitioners' return for 1956. Schedule BNumber ofTrans-DescriptionactionsProfit2 acres, Bayside1$ 551.931 lot, New Butler1242.8922 acres, Mequon23,849.911 parcel, Quentura1486.29Farm, Saukville2874.302 lots, Grantosa1612.00 a1335 N. Prospect1699.56 a98-acre tract12,470.00 a1 lot, Capitol Crest11,139.71 bTotal$10,926.59The following gains were reported as long-term capital gains on the sale of real property in petitioners' return for 1957. Schedule CNumber ofTrans-DescriptionactionsProfitFarm, Saukville1$ 2,295.701 lot, Milwaukee11,069.274 lots, Capitol Intersection113,817.232 acres & house (part of farm)1251.07 a2 lots, Grantosa1432.00 a1335 N. Prospect12,827.50 a98-acre tract19,880.00 aTotal$30,572.77310 Three sales were made during 1955 of property held less than six months for a total profit of $1,522.49. This amount was reported as short-term capital gain of Hildegard. Respondent disallowed long-term capital gain treatment on all gains from the sale of the above properties including the unreported sale and claims that they were held primarily for sale to customers in the ordinary course of business. Petitioners claim that all of the properties were owned by Hildegard as investments; that she was completely passive throughout the transactions involved; that she was not engaged in a trade or business; and that there are "special circumstances" surrounding many of the sales which support the view that the properties were held as investments. William Scheuber has been a licensed real estate broker since 1920 and has engaged in the real estate and insurance business during the years 1949 through 1957. He employed two real estate salesmen who were licensed under him. Hildegard Scheuber has never been a licensed real estate broker and did not actively engage personally in the buying and selling of real estate. During the311 years 1949 through 1957, William reported the following income from real estate commissions. YearCommissions1949$1,808.7519503,054.3519512,332.881952145.001953212.501954689.581955640.1719561,518.5619571,726.98In 1954, Hildegard entered into a joint venture to purchase 20 parcels of real estate in the Fairy Chasm area with Harry A. Worth and Edwin Kern who were at that time co-owners of the Shorewood Realty and Finance Company (hereinafter referred to as the company). Worth was president of the company. Although Williams personally entered into the purchase agreement, all of the parcels were deeded to Hildegard. Her actual undivided interest was one-half, and that of Worth and Kern was one-fourth each. Worth and Kern paid Hildegard for one-half of the down payment made for the purchase of the lots. Soon afterward additional parcels were purchased (through Worth acting as president of the company) by Hildegard either alone or jointly with Worth. At the time of the purchase of all of the afore-mentioned parcels, there was an agreement between the interested parties that Worth would have full authority and sole discretion to determine312 when the parcels would be sold and at what price. Upon the sale of each parcel, Hildegard would execute a deed to the property. The company would deduct its fees and expenses, and pay the balance to Hildegard, Worth, and Kern according to their respective interests. Numerous settlement statements of the company for the years 1954 through 1956, concerning the Fairy Chasm property, were introduced into evidence. All such statements name Hildegard the owner of the property and the recipient of a portion of the profits. All of the property purchased by Hildegard had previously been subdivided and no improvements were made after the purchase. The company, however, was instrumental in having Fairy Chasm annexed to a suburb of Milwaukee in 1954 or 1955. In disposing of all of these properties, Worth, acting as president of the company, followed the policy of holding the property only as long as it was necessary to realize a substantial profit, and pursued the same methods and policies as is customary in the real estate business. Many of the parcels were sold within approximately two years, most of them being sold within the first year. A model home financed by the company in the313 area was used by Worth as a temporary office from which he conducted sales of the Fairy Chasm lots. Signs were also placed on many of the parcels sold by the company for Hildegard and her co-owners. Nineteen of these parcels were sold by the company in 1955 and 1956 and are now in issue. Thirteen are Fairy Chasm properties sold in 1955 (see Schedule A) which were owned jointly or solely by Hildegard. Four others, the first four sold in 1956 (see Schedule B) were owned jointly with Worth, and two parcels sold in 1955 were solely owned by Hildegard but adjoined lots owned by Worth in Crestwood and Subdivision #77, (see Schedule A). Eight other parcels, in addition to those referred to above, were sold by William personally and are in issue. Three parcels in the Capital Drive area were sold after being repeatedly advertised by William after being informed that the zoning in the area was to be changed from business to residential. Two other parcels in the Capital Drive area and parcels on 50th Street, in Grantosa, and in Marnitz, were also sold. Of these five parcels, one was advertised and the others were sold to persons who contacted William, knowing him to deal in real estate in314 these areas. William advertised frequently in a local newspaper in connection with his real estate business and many ads, while not referring to particular parcels in issue, referred to the same areas. Another parcel in issue, a 98-acre tract, was purchased by Hildegard in a joint venture with a local attorney for the purpose of erecting a terminal and motel. The tract was sold two and one-half years later in one transaction through the attorney after difficulties in obtaining water and sewage permits frustrated their plans. Another parcel in Quentura was sold by a real estate agency which received a commission therefor. During the years in question, Hildegard owned numerous improved rental properties, most of which were farms. In 1956 and 1957, four of the farms, held for approximately one and one-half years and rented mainly at a loss, were sold by Worth through the company which was paid a commission on the sale. An improved parcel on Prospect Avenue was sold by William to a person answering a "For Rent" sign who sought to purchase the property on an installment basis. Hildegard consulted with her husband in regard to the advisability of selling and buying except in those315 instances in which the authority and discretion to sell was given to Worth. The sales activity of property owned by Hildegard was as follows: YearBoughtSold1949761950127195135195245195336195432191955112119569195714As of the end of 1957 Hildegard continued to own 18 parcels of land. The record does not disclose the year in which they were purchased and consequently they are not included in the "bought" column, supra. None of the parcels in question were improved or subdivided, and they were sold in the same condition as they were when purchased. The duration of real estate held by Hildegard over the years 1949 through 1957 is as follows: under6 months 20under12 months 22under18 months 14under24 months 6under30 months 3under36 months 9over36 months 8Opinion The primary issue presented is whether or not profits realized from the sale of certain improved and unimproved parcels during the years in question are to be taxed as ordinary income or as long-term capital gains. Respondent contends that such parcels were, in the years and at the time of sale, held316 primarily for sale to customers in the ordinary course of business within the meaning of section 1221(1) of the Code of 1954. Petitioners contend that all of the parcels in issue were held as investments and the gains should be accorded capital gain treatment under the same section. The problem of whether real estate, improved or unimproved, is held primarily for sale to customers in the ordinary course of business has been considered by the courts on numerous occasions. In many instances, criteria have been mentioned in the various opinions which may have weight in resolving the issue in a particular case. Among these have been the purpose or reason for the acquisition of the property; the number, frequency and volume of sales; the extent to which the owner or his agent engaged in sales activities, by developing, improving, and advertising the property; and whether the taxpayer continued to purchase more properties during the period as part of a basic plan of buying and selling real estate. Criteria which may be significant in some settings, however, are of little, if any, aid in others. No single factor is necessarily controlling. Inasmuch as each case must be decided on its317 own facts, no useful purpose would be served by discussing the various fact situations presented by the cases relied on by the parties. See (C.A. 6, 1957), affirming a Memorandum Opinion of this Court. Respondent contends on brief that the property in question was really owned by William and placed in his wife's name as nominee and respondent urges, therefore, that the property should be treated as being a part of William's stock in trade in his own real estate business. We disagree with this contention on the basis of the evidence in the record, but we see no occasion for a labored discussion of the point since we hold, infra, that the properties in question (with certain exceptions which we find, infra, to have been investments) were held by Hildegard primarily for sale to customers in the ordinary course of business. Petitioners allege generally that all of the parcels, the sales of which are in issue, were investments. There are a few which they maintain are surrounded by "special circumstances" which indicate that they were investments. Nevertheless, their main argument is that Hildegard was passive throughout all of the318 transactions herein involved, and this factor alone prevents any conclusion that she was engaged in the real estate business during the years in question. While "passivity" is a factor to be considered in determining whether property is held as an investment, we cannot agree with petitioners' argument that it is controlling. A socalled "passive" owner can engage in the real estate business and act through agents and may also be a partner or joint adventurer in a real estate business. The actions of his agent or co-owner are directly attributable to him whether or not they are supervised. The mere use of an agent to sell a parcel of land will not of itself establish that the owner is in the real estate business. Examination will be made into all relevant criteria attributing the actions of the agent to the owner. If and when the agent's actions on behalf of the owner are sufficiently substantial to become the conduct of a real estate business, the owner will be held to be engaged in such business. See , affd. (C.A. 6, 1960); , affd. 319 (C.A. 6, 1957); ; (C.A. 5, 1944), affirming a Memorandum Opinion of this Court; (C.A. 9, 1936), affirming . The case of (C.A. 5, 1947), relied on by petitioner is clearly distinguishable. There the court found that the taxpayer was liquidating an unprofitable investment which he had held for many years. Also, all of the property was sold to one developer who developed the property and resold it at his own expense. The developer was an independent contractor rather than an agent, so his actions could not be attributed to the owner. The question, thus stripped of petitioner's main contention, is: Was Hildegard engaged in the real estate business during the years in question through her agents and jointadventurers? From 1949 through 1957, Hildegard was engaged in two facets of real estate transactions. She bought and sold, individually or jointly with others, both developed and undeveloped land. She also held real estate for rental purposes and purchased320 a 98-acre tract for development purposes. Under these circumstances, it is possible that she may have been both a dealer and an investor in real estate, a dual role which we have previously recognized. See ; . Accordingly, in deciding the ultimate issue in the instant case, we must determine as to each transaction whether the disposition was of property held primarily for sale in the ordinary course of business, or of property held as an investment. During the taxable years, Hildegard disposed of some of her rental properties as well as some vacant and unimproved pieces of real estate. We turn first to a discussion of the latter. Hildegard sold 13 Fairy Chasm lots and 6 miscellaneous lots through the company. There were also 8 parcels sold by William and two sold by other parties. From the beginning Worth, through the company, pursued an active course of conduct in selling property which Hildegard owned entirely or in which she owned an interest. The sales were solicited and many parcels were advertised. Most of them were sold within two years. Clearly, the owners did not intend321 to maintain the parcels for long-term holding. The sales were frequent and continuous. Petitioners failed to introduce evidence as to the reason for purchasing or holding the parcels other than the bare statement that they were investments. The parcels were not placed with the company after deciding to sell them, but were left with the company from the beginning for the company to sell whenever a satisfactory profit could be realized. This is clearly a path pursued by one engaging in the real estate business. Of the eight parcels sold by William, three of these, in the Capitol area, were sold after being repeatedly advertised. William asserts that he advertised and sold them because he was informed about a change in zoning in the area. Although the reasons for purchasing and selling property may sometimes have significance, the crucial question is the reason for holding the property. There is no evidence that these parcels were purchased or held for any reason different from the others - to sell whenever a satisfactory profit could be realized. A parcel may be purchased with the intention of holding it as an investment but later held for sale in the ordinary course of business. 322 Also, a parcel may be held for sale in the ordinary course of business even though sold prematurely for some reason. In both situations, the reason for holding the parcel is determinative and in both situations the property will be deemed to have been sold in the normal course of business. See , affd. (C.A. 10, 1952); . Of the five other parcels sold by William only one was advertised, while the others were sold to persons inquiring about parcels, knowing William to be engaged in selling real estate in the area. Petitioners contend that since most of these sales were unsolicited, they cannot be held to have been sold in the ordinary course of business. While it is true that William may not have publicly advertised some of the parcels, such advertising was not necessary. He had been engaged in various phases of the general real estate business for many years and he knew and was known to potential customers. Advertising is merely a means of attracting customers, and where an active market exists and potential customers are known and buyers seek out the owner, the323 employment of conventional methods of advertising may not be essential. See , affd. (C.A. 7, 1960). William was known in the area as a real estate broker and advertised many properties he held for sale. When approached by a potential customer he had complete authority to sell his wife's property. There is no suggestion in the record that he was unwilling to sell any of her property and there is every indication that he did sell whenever he received a satisfactory offer. This is the usual course of the dealer rather than the investor, and petitioner has failed to prove that these parcels were held for investment purposes. We conclude, accordingly, that these parcels were held primarily for sale in the ordinary course of business. One parcel in Quentura was sold by an outside real estate broker for a commission. Here again, we have no evidence to support the view that it was held as an investment, and petitioner has failed to meet the burden of proving that it was held for any reason different from the others which we have decided were held primarily for sale in the ordinary course of business. The 98-acre324 tract, held for about two and one-half years, was sold in one piece without being subdivided or improved. Both William and Hildegard's co-owner testified that this tract was purchased to erect a motel and terminal and the plans were abandoned after encountering building difficulties with respect to sewerage and water. This testimony was uncontroverted. The tract was not the type of land which was usually held by Hildegard. It was also sold for her by one who was not otherwise engaged in the sale of her properties. We are convinced that this tract was acquired and held at the time of sale, not for sale as part of the real estate business, but as an investment. The gain thereon is therefore entitled to capital gains treatment. See . With the exception of the 98-acre tract, all of the unimproved parcels sold by Hildegard's agents over the years 1949 through 1957, including those in issue discussed above, were not sold in sporadic, occasional, or isolated transactions. During the years 1949 through 1957, a total of 82 sales was transacted. These sales were not made to dispose of long-term investments. The majority of the parcels sold325 over these years were held for less than 18 months. As of the end of 1957, Hildegard continued to own 18 parcels of land. Petitioners also strongly contend that the absence of improvements or subdivision precludes a finding that the parcels in question were sold as part of a business. While it is true that such action on the part of an owner is a factor to be considered, it is unimportant here, where the parcels had been subdivided prior to purchase and the taxpayer is found to be in the business of selling unimproved lots. The parcels in question, except for the 98-acre tract, were acquired as part of a plan to buy and hold to sell whenever a satisfactory profit could be realized. Hildegard or her agent or joint adventurers may not have aggressively promoted some of the properties or improved them. Nevertheless, the frequency, volume of sales, relatively short duration held, the continuing purchase of more parcels, and the activity of her agents convince us that Hildegard was a dealer in undeveloped land throughout this period. As stated above, a dealer in real estate may hold certain parcels for investment, and the sale thereof may be treated differently for tax purposes. In326 the instant case, however, we are satisfied that all of the undeveloped properties here in issue, other than the 98-acre tract, were held primarily for sale in the ordinary course of business whenever a satisfactory profit could be realized. The five rental properties (the four farms, and the Prospect Avenue parcel) were sold after either being rented mainly at a loss or after an attempt to rent had failed. There is sufficient evidence in the record to conclude that these parcels were held as incomeproducing investments and not for sale with the other lots in the ordinary course of business. The gains realized on these sales are to be accorded capital gains treatment. See ; On the basis of our view on the principal issues as expressed supra, self-employment taxes will be recomputed for 1955, 1956, and 1957; the deficiency for 1956 arising from the stipulation to amend the amount of gains realized on the sale of real estate will be adjusted; and the long-term capital loss on the sale of securities will be given effect all under the Rule 50 computation. Decision will be entered under Rule 50. 327 Footnotesa. Profit realized during year on installment sale.↩a. Profit realized during year on installment sale. ↩b. Unreported gain included pursuant to stipulation.↩a. Profit realized during year on installment sale.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623391/	JOHN M. AND GERALDINE G. CANNON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCannon v. CommissionerDocket No. 6680-77.United States Tax CourtT.C. Memo 1980-224; 1980 Tax Ct. Memo LEXIS 361; 40 T.C.M. (CCH) 541; T.C.M. (RIA) 80224; June 26, 1980, Filed; As Amended July 29, 1980 361 John M. Cannon, for petitioners. William E. Bogner, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: 1Tax YearDeficiency1973$ 1,767.9519743,593.0019753,369.00The issues for decision are: (1) Whether Geraldine G. Cannon's educational expenses are deductible under section 162; (2) Whether certain automobile expenses are deductible and whether petitioners are entitled to an investment tax credit with respect to the purchase of the automobile; (3) Whether a club entrance fee is deductible; (4) Whether petitioners are entitled to a casualty loss deduction, and if so, in what amount; (5) Whether the expenses incurred in maintaining an office in petitioners' home are deductible as ordinary and necessary business expenses. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and the attached exhibits are incorporated herein by this reference. John M. and Geraldine M. Cannon (hereinafter referred to as petitioners or John362 or Geraldine) filed joint Federal income tax returns for the years 1973 through 1975. At the time of the commencement of this suit, petitioners were residents of Northbrook, Illinois. In his notice of deficiency, the respondent disallowed the following deductins which were claimed by the petitioners: ItemTax Year197319741975Automobile expenses$1,850$5,833$5,621Educational expenses2,3824,6602,126Home Office expenses576629Casualty Loss879The respondent also disallowed an investment tax credit of $139 for 1974 and increased petitioners' 1973 income by $500 to reflect additional partnership income. Geraldine is a registered nurse who completed a 3-year nursing school program at St. Francis Hospital, Evanston, Illinois in 1955, at which time she received a registered nurse certificate. Geraldine then worked full-time as a registered nurse at the University of Chicago clinics until September 1956. From September 1956 until October 1957, she worked full-time as a registered nurse for the United States Air Force. During October of 1957 she quit her job in order to begin raising a family. Between October 1957 and July of 1975 Geraldine was never employed full-time as a registered professional 363 nurse and did not engage in the practice of nursing with the following exceptions: (1) During the summer of 1970, she was employed part-time as a nurse in a doctor's office, and (2) for approximately 1 month during the spring of 1972 she provided private duty nursing care, without pay, for her hospitalized father. Geraldine was licensed as a registered nurse by the State of New Jersey for the year ending December 31, 1971, and was licensed as a registered professional nurse by the State of Illinois for an undisclosed period ending May 1, 1974. Geraldine enrolled at Trinity College as a full-time student in September of 1972. She graduated in May of 1975 with a bachelor of arts degree, having majored in biology. On her application to Trinity College, she stated that she was planning to prepare for a vocation in medicine and that the factor which influenced her the most to attend Trinity College was the desire for a biology degree in connection with her medical studies. In furtherance of this objective, she applied to 10 medical schools for admission during October of 1974. 2364 Since July of 1975, Geraldine has worked full-time as a registered professional nurse. He training and the certification received in 1955 qualified petitioner for the job she held from July 1975 to June 1976 at Highland Park Hospital, Highland Park, Illinois. Petitioners' Federal income tax returns for 1973 and 1974 disclose Geraldine's occupation to be that of a housewife and student. Petitioners deducted automobile expenses on their Federal income tax returns as follows: $1,850 in 1973, $5,833 in 1974 and $5,621 in 1975. These deductions were claimed as incidents of Geraldine's attendance at Trinity College. Although the 1973 return states no percentage of business use, the 1974 and 1975 returns claim a business usage for the automobile of 83-1/3 percent and 75 percent, respectively. Petitioners also claimed an investment tax credit with respect to the automobile on their 1974 Federal income tax return. During 365 1973, John was a law partner in the firm of Chadwell, Kayser, Ruggles, McGee and Hastings of Chicago, Illinois. During 1973, the firm paid a $500 entrance fee for John to join the University Club of Chicago, a private club. The entrance fee is a one-time expenditure which entitles the payor to membership in the club as long as he continues to pay the club's annual dues. The club's by-laws provide that termination of membership by death, resignation, expulsion or otherwise shall release all of the member's right, title and interest in the property and assets of the club. Following an audit of John's law firm, the respondent disallowed the partnership's deduction of this $500 entrance fee. The partnership agreed to its disallowance. The respondent has alleged in his notice of deficiency that petitioners should have reported this amount as additional partnership income on their 1973 Federal income tax return. Petitioners' automobile was involved in an accident during September of 1975. The total cost of repairs shown on receipts furnished by the petitioner was $1,724.05. Of this amount, petitioners' insurance company paid $1,474.05, the difference being the deductible amount of $250 366 which petitioners actually paid. Petitioners also paid $1,166.90 for the use of rental cars. Petitioners' 1975 Federal income tax return showed a loss before insurance reimbursement of $2,500 and insurance reimbursement of $1,521. After subtracting the $100 for the limitation contained in section 165(c)(3), petitioners claimed a casualty loss deduction of $879. In connection with the Emergency Wage/Price Stabilization Program, John, an attorney, established an office in his home. While petitioner's law firm did not require him to maintain such an office in his home, it did recommend that he do so in connection with the Stabilization Program. Subsequent to that program, John used the office primarily to avoid travel to and from his office in downtown Chicago on days when he visited clients close to his home. The office was also useful for evening and weekend work. John's law firm provided him an office at the firm which he could use any day or night. In fact, John only used his home office an average of 1 day a week. The office was located in a former bedroom on the second floor of his home. It contained normal office furnishings. The office was used for no purpose other 367 than John's business. OPINION Issue 1 Educational ExpensesThis issue involves the determination of whether Geraldine's educational expenses are deductible. Geraldine was a full-time student at a 4-year college commencing in September of 1972 and ending in May of 1975, at which time she was awarded a bachelor of arts degree with a major in biology. Geraldine's background prior to entering college was that of a registered nurse, having completed a 3-year nursing school program in 1955. She worked full-time as a registered nurse from 1955 until 1957, at which time she began raising a family. Except for two part-time nursing jobs (one of which was without pay for a family member) Geraldine did not work again until following her graduation in 1975. Geraldine's application to college indicated a desire to seek admission to medical school. During her final year of college, she in fact applied to 10 medical schools. She later sued two of those schools for discriminatory admissions policies, in a further effort to gain entrance. Since her graduation from college, Geraldine has worked full-time as a registered nurse. The threshold issue is whether or not these expenses were incurred 368 in carrying on a trade or business. Section 162(a) allows as a deduction "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * ". Section 1.162-5(a), Income Tax Regs., provides for the deduction of certain educational expenses as ordinary and necessary trade or business expenses. Thus in order to prevail, petitioner must show that she is engaged in a trade or business. Whether a taxpayer is engaged in a trade or business is a question of fact. Corbett v. Commissioner,55 T.C. 884">55 T.C. 884, 887 (1971). Generally, in order for an expenditure to be deductible as a business expense, the expenditure must relate to activities which constitute the present carrying on of an existing business. Corbett v. Commissioner,supra at 887. This is not to say that only students who work in a related capacity while attending school are entitled to the deduction. One may qualify for the deduction so long as he can show that he was engaged in some trade or business prior to starting his education and intends to return to that trade or business. Reisinger v. Commissioner,71 T.C. 568">71 T.C. 568, 572 (1979). It is undisputed that the taxpayer entered 369 the business of nursing subsequent to graduation. However, taxpayer has failed to show the existence of a trade or business prior to entering college. Geraldine stopped working as a nurse in 1957 in order to raise a family. During the 15 years thereafter she was employed only twice; and then only for short periods in a part-time capacity. Petitioners rely heavily on Furner v. Commissioner,393 F.2d 292">393 F.2d 292 (7th Cir. 1968), revg. 47 T.C. 165">47 T.C. 165 (1966). That case is clearly distinguishable from the present case in that Furner was only out of work for 4 months prior to beginning her studies; and she only resigned her job initially because she could not obtain a leave of absence. In other words, she terminated her employment for the purpose of completing her studies. Petitioner here left nursing 15 years prior to enrollment in the pre-medical school program for the purpose of raising a family. Petitioner certainly did not cease practicing her profession as a nurse in order to return to school. In Reisinger v. Commissioner,supra, the taxpayer left her nursing position in 1969 and merely stopped working until 1974 when she enrolled at Johns Hopkins. The Court noted that a temporary cessation 370 of employment does not always indicate termination of a trade or business, and then went on to hold that she was not entitled to any deduction since she was not engaged in the trade or business of nursing. In the present case, petitioner's abandonment is for a much longer period of time and there is no evidence of an attempt to secure anything more than part-time employment during those intervening years. "Mere membership in good standing in a profession does not constitute carrying on a trade or business." Reisinger,supra, at 572. Petitioners appear to realize this and in effect argue that full-time study without any concurrent employment amounts to carrying on a trade or business. It is difficult to understand how petitioners can consider college studies to be a trade or business, much less to equate such with practicing as a registered nurse. That Geraldine did not consider herself to be a nurse during 1973 and 1974 is demonstrated by the fact that she listed her occupation on her Federal income tax returns for those years to be that of a student and housewife. Petitioners also appear to find hope for their cause in section 183. 3372 373 This provision restricts the deduction of expenses 371 connected with activities not engaged in for profit. Section 183(d) creates a presumption 4374 at an activity is engaged in for profit if the gross income derived from the activity for 2 or more of the taxable years in the period of 5 consecutive taxable years exceeds the deductions attributable to such activity. Even assuming arguendo that section 183 has any bearing on this case, the record before us reveals no basis on which this Court could apply the presumption. But section 183 is really of no relevance for, in any event, a finding that an activity was engaged in for a profit merely allows the taxpayer to avoid the restrictions of section 183. Section 183 does not independently authorize a deduction for expenses related to activities engaged in for profit. Issue 2 Automobile Expenses and Investment Tax CreditPetitioners claimed a deduction for certain automobile expenses. The only evidence of the actual use of this vehicle is John's testimony that it was used approximately 20 percent for his business related travel and the balance by his wife for travel in connection with her educational courses. We have found that Geraldine was not engaged in a trade or business at the time she was attending college. We further find that she was not engaged in any income-producing activities at that time. Therefore, any automobile expenses she may have incurred in attending school are not deductible under sections 162 or 212. They are purely personal expenses and as such not deductible under section 262. As to the 20 percent John claimed to have used the vehicle in his own business, petitioner has the burden of proving to what extent his automobile expenses were incurred for business or 375 personal purposes. Michaels v. Commissioner,53 T.C. 269">53 T.C. 269, 275 (1969); see section 1.162-17(d), Income Tax Regs. Petitioner has presented no substantiation for his business use of the vehicle. Thus no portion of the automobile expenses may be deducted. The petitioners also claimed an investment tax credit in 1974 due to the purchase of an automobile. Section 38 allows a credit against income taxes for certain depreciable property. Section 48(a) defines "section 38 property" to include only property with respect to which depreciation (or amortization) is allowable. Section 167(a) allows a depreciation deduction only for property used in the trade or business or held for the production of income. Since petitioner has failed to show that the automobile was utilized for either purpose, it is not "section 38 property" and no investment tax credit is allowable. Issue 3 Entrance FeePetitioners do not dispute respondent's designation of the $500 entrance fee as additional partnership income. Rather they claim entitlement to an offsetting deduction of $500 for the entrance fee as a business expense. The entrance fee is assessed but once. Its benefits last so long as petitioner remains 376 a member of the club. It thus has an indefinite useful life lasting beyond the taxable year of payment. Mercantile National Bank at Dallas v. Commissioner,30 T.C. 84">30 T.C. 84, 95 (1958), affd. on another issue, 276 F.2d 58">276 F.2d 58 (5th Cir. 1960). Petitioners argue that the entrance fee is merely an initial charge to offset the expenses of processing his application and acceptance. They feel that no goodwill or capital asset is acquired since the annual dues are as much a precondition for the following year's dues as is the entrance fee. It is true that the entrance fee, once paid, is nonrecurring in that petitioner cannot be called upon to pay it again; nor is it any longer possible for his membership to be terminated for failure to pay it. Yet the simple fact that an expenditure is made in a single payment does not automatically cause classification as a currently deductible expense. Indeed, the usefulness of the payment here in question may outlast the year of payment merely because to the extent it exceeds the actual costs of initial processing petitioner is not called upon to pay it again. Petitioners have introduced no evidence that the fee covers solely the actual costs incurred due to 377 his application in the taxable year of payment. In Grace National Bank of New York v. Commissioner,15 T.C. 563">15 T.C. 563 (1950); affd. per curiam, 189 F.2d 966">189 F.2d 966 (2d Cir. 1951), the taxpayer's admission fee covered a membership in an association which could not be sold or transferred and no part of the admission fee was returnable to the member. Since we feel that through the entrance fee John has acquired a benefit lasting for the duration of his membership without regard to the lack of any benefit upon termination, we hold as we have in Grace,supra, at 565, that the entrance fee is a capital expenditure rather than an ordinary and necessary business expense. Issue 4 Casualty Loss DeductionPetitioners' automobile was wrecked in September of 1975. Repairs were made and petitioners were reimbursed by their insurance company except to the extent of a $250 deductible. Petitioners also paid $1,166.90 to secure the use of a rental car. Section 165(a)5 generally allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(c) limits the deduction of such losses; but section 165(c)(3) allows to individuals a deduction for losses 378 of property not connected with a trade or business where the loss is due to a casualty (subject to the $100 limitation). The regulations 6 state that the amount allowable as a deduction for the loss shall be the lesser of the fair market value of the property immediately before the casualty reduced by the fair market value of the property immediately after the casualty or the adjusted basis of the property prescribed by section 1.1011-1, Income Tax Regs. , for determining a loss. The regulations provide two alternative methods for determining this valuation. The first method 379 requires a competent appraisal of the fair market value. 7 The record here reveals no evidence of such competent appraisal other than petitioners' testimony as to a range of values which information he acquired from the dealer who repaired the car, his own insurance company, and from a personal examination of the blue book listing for the car. No testimony or documentation was received from any of these sources. We believe that the requirement of a competent appraisal was not met with regard to this car. The regulations provide an alternative method of valuation based on the cost of repairs. The taxpayer, must show that: (a) the repairs are necessary to restore the property to its condition immediately before the casualty, (b) the amount spent for such repairs is not excessive, (c) the repairs do not care for more than the damage suffered, and (d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property before the casualty. [Sec. 1.165-7(a)(2)(ii), Income Tax Regs.] There has been no showing by petitioners as to any of these points.No evidence has been put forth as to the condition of 380 the vehicle prior to the accident. Petitioner himself failed to testify as to this critical factor. Since petitioners have failed to establish a valuation for the amount of their loss, no deduction is allowable under section 165. Issue 5 Home Office ExpenseJohn used a portion of his home for an office approximately 1 day per week in order to avoid travel time when visiting clients located closer to his home than his office. His law firm did not require him to do so. The law firm did provide John with an office at the firm that he could use at any time. We hold that John's home office expenses were nondeductible personal expenditures under section 262. 8 The expenses were incurred for his personal convenience and not as a requirement of his employer. To the contrary, John's employer provided him with an office which was always at his disposal. Petitioners urge that his home office was useful and appropriate in that it eliminated unnecessary and unproductive travel time. Many expenses, such as the cost 381 of commuting which petitioner was trying to avoid, are useful and possibly even necessary to one's employment, but they are not deductible under section 162(a) as they are personal expenses. Joel A.Sharon,66 T.C. 515">66 T.C. 515, 524 (1976); affd.per curiam, 591 F.2d 1273">591 F.2d 1273 (9th Cir. 1978). Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, and in effect during the years in issue.↩2. Geraldine brought suit against two of the universities alleging that she had been denied admission due to policies which discriminated against her on the basis of her age and her sex. The United States Supreme Court has held that the petitioner has a right to maintain a private cause of action against the universities. Cannon v. University of Chicago,441 U.S. 677">441 U.S. 677↩ (1979).3. SEC. 183. ACTIVITIES NOT ENGAGED IN FOR PROFIT. (a) GENERAL RULE.--In the case of an activity engaged in by an individual * * * is such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section. (b) DEDUCTIONS ALLOWABLE.--In the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed-- * * * (c) ACTIVITY NOT ENGAGED IN FOR PROFIT DEFINED.--For purposes of this section, the term "activity not engaged in for profit" means 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. (d) PRESUMPTION.--If the gross income derived from an activity for 2 or more of the taxable years in the period of 5 consecutive taxable years which ends with the taxable year exceeds the deductions attributable to such activity (determined without regard to whether or not such activity is engaged in for profit), then, unless the Secretary establishes to the contrary, such activity shall be presumed for purposes of this chapter for such taxable year to be an activity engaged in for profit. * * * (e) SPECIAL RULE.-- (1) IN GENERAL.--A determination as to whether the presumption provided by subsection (d) applies with respect to any activity shall, if the taxpayer so elects, not be made before the close of the fourth taxable year (sixth taxable year, in the case of an activity described in the last sentence of such subsection) following the taxable year in which the taxpayer first engages in the activity. * * * (2) INITIAL PERIOD.--If the taxpayer makes an election under paragraph (1), the presumption provided by subsection (d) shall apply to each taxable year in the 5-taxable year * * * period beginning with the taxable year in which the taxpayer first engages in the activity, if the gross income derived from the activity for 2 or more of the taxable years in such period exceeds the deductions attributable to the activity (determined without regard to whether or not the activity is engaged in for profit). (3) ELECTION.--An election under paragraph (1) shall be made at such time and manner, and subject to such terms and conditions, as the Secretary may prescribe. ↩4. Geraldine has filed with the respondent a request to make an election under sec. 183(e)(1), I.R.C. 1954, for the tax years here under consideration. Insofar as the record reveals, the respondent has not yet acted on her request. This election merely postpones the determination of whether the presumption provided by sec. 183(d), I.R.C. 1954, applies until after the end of the fourth taxable year following the taxable year in which the taxpayer engages in the activity. In view of the fact that the presumption cannot help the taxpayer in this case as we find that Geraldine was not engaged in a trade or business under sec. 162(a), I.R.C. 1954↩, without regard to any profit motive or lack thereof, it is of no consequence whether the election is available to Geraldine.5. 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 not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. A loss described in this paragraph shall be allowed only to the extent that the amount of loss * * exceeds $100. * * *↩6. Sec. 1.165-7(b)(1), Income Tax Regs.↩7. Sec. 1.165-7(a)(2)(i), Income Tax Regs.↩8. We point out that that tax years involved here, 1974 and 1975, predate the passage of sec. 280A which deals with expenses in connection with the business use of one's home.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623392/	WILLOUGHBY CAMERA STORES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Willoughby Camera Stores, Inc. v. CommissionerDocket No. 100707.United States Board of Tax Appeals44 B.T.A. 520; 1941 BTA LEXIS 1319; May 16, 1941, Promulgated 1319 Where petitioner set up a reserve for bonus payments to employees before the legal liability for their payment existed, the amounts so set up are not thereupon deductible. James H. Douglas, Esq., and Menahem Stim, C.P.A., for the petitioner. Conway N. Kitchen, Esq., and Allen T. Akin, Esq., for the respondent. LEECH520 Respondent has determined deficiencies in income tax of $7,917.92 and $9,624.26 for the calendar years 1935 and 1936 and a deficiency in excess profits tax of $278.34 for the latter year. The issues presented 521 are upon the correctness of the action of the respondent in disallowing deductions of $57,584.83 and $95,169.66 taken by petitioner upon its returns for 1935 and 1936, respectively, which represented in each instance an amount set up on petitioner's books at the close of the taxable year as a "Reserve for Bonus" to be paid employees in the following year. FINDINGS OF FACT. Petitioner is a New York corporation, with its principal office in New York City, and was incorporated in the year 1927 as a successor corporation and continuation of a business known as Charles G. Willoughby, Inc., which had1320 been in existence for many years. Petitioner, for the taxable years here involved and for many years prior thereto, kept its books and filed its tax returns upon the accrual basis. On December 31, 1934, the petitioner credited an account upon its books termed "Reserve for Bonus" in the amount of $47,584.83, and charged its profit and loss account with this amount. The amount so credited was paid to employees at various times during the year 1935 pursuant to resolutions adopted at various times during that year by petitioner's board of directors. As each payment was made in 1935 out of the total amount of $47,584.83, a debit entry was made in a ledger account of petitioner termed "Bonus as Extra Compensation." The offsetting debit entry in the account "Reserve for Bonus" in the amount of $47,584.83 was made on December 31, 1935. During the year 1935 the petitioner paid to its employees as extra compensation a total amount of $65,840.25, which included the amount of $47,584.83 which had been credited to the bonus reserve at the end of 1934. The balance of $18,255.42 which was paid out in 1935 was charged to the petitioner's profit and loss account in that year. On December 31, 1935, the1321 petitioner credited its "Reserve for Bonus" account with $57,584.83 and charged the sum of $57,584.83 to its profit and loss account. In his notice of deficiency for that year the respondent disallowed the deduction of $57,584.83 from the petitioner's 1935 income on the ground that no legal liability was incurred in 1935 for the payment of this amount. This amount of $57,584.83 was paid to employees at various times during the year 1936 pursuant to resolutions of petitioner's board of directors adopted at various times during the year 1936. During the year 1936 the petitioner paid to its employees as extra compensation the total amount of $97,221.50, which included the $57,584.83 that had been credited to the bonus reserve at the end 522 of 1935. The balance of $39,636.17 which was paid out in 1936 was charged to the petitioner's profit and loss account in that year. On December 31, 1936, the petitioner credited its "Reserve for Bonus" account with $95,169.66 and charged this sum to its profit and loss account. In his notice of deficiency the respondent disallowed as deduction from petitioner's 1936 income the sum of $37,584.83 on the ground that no legal liability1322 was incurred in 1936 for the payment of this amount. The $37,584.83 represented the difference between the $95,169.66 credited on December 31, 1936, to the "Reserve for Bonus" and $57,584.83 which was the credit balance in the reserve account at the beginning of 1936, which amount was paid out in 1936 and for which no deduction from the petitioner's 1935 income was allowed by the respondent. The amount of $95,169.66 was paid out at various times during the year 1937 pursuant to resolutions of the petitioner's board of directors adopted at various times during that year. As each payment was made in 1935 and 1936 the "Bonus as Extra Compensation" account was debited by the amount paid with a credit to cash. At the end of each of the taxable years the bonus reserve was debited with the total amount by which it had been credited. The petitioner kept a cash book in which entries were made from time to time showing the dates and amounts of extra compensation paid by it to individual employees but when the aforesaid amounts of $57,584.83 and $95,169.66 were credited to the bonus reserve at the end of 1935 and 1936 as hereinbefore detailed, no specific amount thereof was credited1323 to or set aside for any individual employee. Petitioner in its dealings with its employees termed the latter "coworkers." When employing personnel petitioner ordinarily advised the individuals that it was the plan of the company to permit its employees to share in the earnings of the company and that its custom was to pay to employees bonuses from the earnings of the company in addition to the salary. OPINION. LEECH: The deduction of amounts which petitioner actually paid to its employees as bonuses or extra compensation during each of the years 1935 and 1936, is not in issue. However, petitioner contends that since it is on an accrual basis the right to deduct the two contested additions to the reserve for bonuses matured when those additions were made and not when actually paid to employees. Respondent concedes the existence of the premise, but disagrees with the conclusion. He argues that the additions to bonus reserves 523 were not legally accruable as deductions in the years in which the additions were set up and deductions therefor are claimed and did not become so in either instance until the following year which was the year in which payment to the employees1324 was actually made. The issue is resolved by a determination as to whether at the close of each year, the amounts set aside and credited to the bonus reserve then constituted, in each instance, a legal liability in the amount so credited. If, by the setting aside of these amounts petitioner incurred no legal liability to make payment of those sums it is clear, we think, that these amounts were the estimated sums which the corporation deemed necessary to meet such payment of bonuses in the following year as its board of directors would then, by voluntary action, authorize. It would then follow that these additions to the reserve would not constitute proper deductions for the year in which set up, since, in neither instance, had the liability at that time matured. As was said in : * * * An item accrues when all events have occurred necessary to fix the liabilities of the parties concerned therewith and to determine the amount of such liabilities. * * * The record reveals that petitioner for many years had maintained a custom of paying bonuses from earnings to its employees and that1325 these employees were told that they might expect such payments. There is, however, no indication that the contract of employment of these employees obligated the petitioner to make bonus payments nor is it indicated that there was any fixed method of computing the actual payment made to any employee. It is testified that the bonuses paid were in accordance with length of service, but whether they were based upon the salary received is not disclosed nor is it indicated that any liability was assumed or admitted by petitioner to make a bonus payment to an employee unless the latter was in the service at the time the payment was actually authorized by petitioner's board of directors and made. In fact, the action taken by petitioner's directors in paying the bonuses in the year following that in which the reserve was set aside and deducted as an accrued liability, indicates that it was not a liability enforceable against petitioner by its employees at the close of the year in which set up. If it represented a liability it would be due and payable to the employees upon the expiration of the year. It seems inconsistent with this condition that petitioner should pay the amounts of these1326 accruals in specific bonus allowances throughout the course of the following year upon successive resolutions adopted by its board of directors specifically authorizing the payments. *524 It is our conclusion that the amount determined at the close of each of the taxable years here involved and set aside in the reserve for bonus did not in either instance then constitute a legal liability of the petitioner to its employees. It follows that these amounts were not subject to deduction in either of those years and that respondent's action in allowing the deduction in the following year in which payment was made and in disallowing the deduction in the year in which the reserve was credited was proper. ; certiorari denied, ; . Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623393/	Thomas J. Barkett and Martha L. Barkett, Petitioners, v. Commissioner of Internal Revenue, RespondentBarkett v. CommissionerDocket No. 60877United States Tax Court31 T.C. 1126; 1959 U.S. Tax Ct. LEXIS 224; March 10, 1959, Filed 224 Decision will be entered under Rule 50. Held, that petitioners are not entitled to deduct membership assessments paid to the Atlanta Retail Liquor Association for the taxable year 1950, since they have failed to meet the burden of proving that no substantial part of the activities of said association was carrying on propaganda, or otherwise attempting, to influence legislation. L. Eugene McNatt, Esq., for the petitioners.James R. Harper, Jr., Esq., for the respondent. Fisher, Judge. FISHER1126 Respondent determined a deficiency in income tax of petitioners for the taxable year 1950 in the amount of $ 1,037.96.The sole contested issue is whether or not petitioners are entitled to deduct membership assessments paid in 1950 to the Atlanta Retail Liquor Association, the focal point being whether petitioners225 have met the burden of proving that no substantial part of the activities of said association was carrying on propaganda, or otherwise attempting, to influence legislation.FINDINGS OF FACT.Petitioners are individuals residing in Atlanta, Georgia. Petitioners filed their income tax return for the year 1950 with the collector of internal revenue for the district of Georgia, Atlanta, Georgia.1127 Petitioner Thomas J. Barkett operated, in 1950, one retail liquor business as a partnership and another retail liquor business as a proprietorship.Thomas J. Barkett paid to the Atlanta Retail Liquor Association an assessment of 20 cents for each case of liquor delivered to his stores. The assessments of 20 cents per case were included in the invoices accompanying incoming cases of whiskey and were paid by Barkett along with payment for the whiskey received. Petitioners included the 20 cents per case assessment as a part of the cost of goods sold in preparing their individual and partnership income tax returns for 1950. The amount of assessments so deducted on petitioners' income tax return amounted to $ 1,584.19 in 1950.Petitioner was one of approximately 175 members of the Atlanta226 Retail Liquor Association, all of whom were located in Fulton County and Atlanta, Georgia.The Atlanta Retail Liquor Association employed only two persons in 1950. The executive committee and board of directors also worked for the association, and, together with said employees, performed all of the functions of the association.The charter of the Atlanta Retail Liquor Association provides, in part, as follows:3. Said corporation shall be a non-profit corporation and shall have no capital stock.4. Said corporation shall have for its objects and purposes the following:(a) To effect a thorough organization of the retail liquor dealers in the City of Atlanta, Georgia, and its trade area;(b) To promote the welfare of the liquor industry, and to co-operate with wholesalers and manufacturers for that purpose;(c) To improve the condition of retail liquor dealers, individually and collectively, and their service to the public;(d) To encourage fraternal spirit and resist encroachment on their rights;(e) To secure uniform and united action in the common interests;(f) To provide a medium for the exchange of ideas for the purpose of developing better methods of management and of increasing227 efficiency and industrial betterment for the benefit of all retail liquor dealers.(g) To co-operate with civic organizations and others for the purpose of promoting and improving the public relations of the liquor industry.(h) To help promote understanding between all Government authorities and the liquor industry, and to co-operate with all law enforcement agencies in controlling and preventing any violations of any law or regulation by any retail liquor dealer.(i) To encourage the highest ethical standards in the operation of retail liquor stores;(j) And other purposes of like nature.5. Said corporation shall not engage in any business of a kind ordinarily carried on for profit.6. Said corporation shall raise funds from dues and/or contributions from its members in such amounts and at such times as the Board of Directors shall determine.1128 7. No part of the net income of said corporation shall inure to the benefit of any member; and upon dissolution, or expiration of the charter of said corporation, if said charter should lapse without a revival thereof, any excess of assets over liabilities shall not be distributed to its members, but shall be distributed to a charitable228 organization or organizations located in the City of Atlanta, Georgia, to be selected by the Board of Directors of said corporation.8. Said corporation shall have all of the powers and enjoy all of the privileges enumerated in Chapter 22-18 of the Code of Georgia not inconsistent with the objects and purposes of its existence.The activities of the association included the following: To unite the retail liquor dealers in the area; to police the industry; to paint the industry in a favorable light before the public; to render services to prevent the passing of bad checks to members of the association; to encourage obedience among the members to Federal, State, and local laws; to police violations of the minimum markup law; and to send out shoppers to check on rumors of violations.A purpose of petitioner Thomas J. Barkett in joining the association was to benefit himself and his business because of the ultimate effect of the association's activities in preventing practices in the industry which would tend to have an adverse effect on his profits.OPINION.Respondent determined that the membership assessments in question were not deductible as contributions under section 23(o) or as229 trade or business expenses under section 23(a), both of the Code of 1939. 1230 Respondent's determination is prima facie correct, and the burden of proof of error in such determination rested with petitioners. . We have no doubt that petitioners were fully aware of the real issue in the case in relation to 1129 such burden. No motion was made looking toward a further and better statement of respondent's case under the provisions of this Court's Rule 17(c)(1). At the trial, respondent's counsel stated, inter alia:In short, then, the real question here, was a substantial part of the funds of this Atlanta Retail Association used for carrying on propaganda, influence legislation, or for any of the purposes which are specifically listed in Section 23(o), again restated in the Regulation? We state now that that is the premise of the case * Petitioners' counsel made no claim of surprise, and made no effort to produce or request for an opportunity to produce evidence bearing on the issue as presented by respondent's counsel, which was within the purview of the disallowance in the statutory notice. Instead, petitioners' counsel sought to avoid the issue of whether any substantial231 part of the association's activities consisted of carrying on propaganda, or otherwise attempting, to influence legislation (which would not have been inconsistent with the stated objects and purposes set forth in the charter of the association) by stating on behalf of petitioners that they were not contending for a deduction under section 23(o), but that they were contending for a section 23(a) deduction as ordinary and necessary business expense paid to a business league. This, in itself, was an implied recognition of the issue.In this posture of the case, petitioners having produced no evidence supporting the view that no substantial part of the association's activities consisted of carrying on propaganda, or otherwise attempting, to influence legislation, a disposition of the issue in favor of respondent is required by the principles announced by the Supreme Court in Cammarano v.United States (and F. Strauss & Son, Inc. v. Commissioner), (both cases dealt with in one opinion filed Feb. 24, 1959). See also, more specifically, , in which we said, in part (p. 59):The law232 is well settled. In , the Supreme Court, in a case involving donations made by a corporation, gave its approval to the substance of the regulations here involved when it sanctioned the then applicable provision of Regulations 74 containing precisely the same language presently included in Regulations 111, sections 29.23(o)-1 and 29.23(q)-1. The application of such principles to limit the deductibility of donations of individuals under section 23(o) by Regulations 111, section 29.23 (o)-1, is equally valid. ;; . We have also held that the principles embodied in such regulations were applicable as well under section 23(a). (Issue 2), reversed on another issue (C.A. 9, 1954) . See also ,233 affirming a Memorandum Opinion of this Court.Decision will be entered under Rule 50. 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. * * ** * * (o) Charitable and Other Contributions. -- In the case of an individual, contributions or gifts payment of which is made within the taxable year to or for the use of: * * (2) A corporation, trust, or community chest, fund, or foundation, created or organized in the United States or in any possession thereof or under the law of the United States or of any State or Territory or of any possession of the United States, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation; * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623394/	L. Lee Stanton and Helen La Fetra Stanton, Petitioners, v. Commissioner of Internal Revenue, RespondentStanton v. CommissionerDocket No. 68914United States Tax Court34 T.C. 1; 1960 U.S. Tax Ct. LEXIS 178; April 7, 1960, Filed 178 Decision will be entered under Rule 50. 1. Interest or Capital Gain -- Profit on Sale of Non-interest-Bearing Notes. -- Commissioner did not err in holding that a profit on the sale of non-interest-bearing notes is taxable as interest and was not a part of sales proceeds of the notes for income tax purposes. F. Rodney Paine, 23 T.C. 391">23 T.C. 391, followed.2. Interest -- Sec. 23(b). -- Interest on genuine indebtedness incurred to buy short-term obligations non-interest-bearing or with interest at a lower rate than that being paid on the indebtedness is deductible under section 23(b) regardless of whether the taxpayer anticipated that the transactions would be beneficial before taxes or whether he anticipated that they would be beneficial only after taxes. Hugh Satterlee, Esq., and Rollin Browne, Esq.,179 for the petitioners.Emil Sebetic, Esq., for the respondent. Murdock, Judge. Opper, J., dissenting. Harron, J., agrees with this dissent. Bruce, J., dissenting. Harron, J., agrees with this dissent. Pierce, J., dissenting. Harron, J., agrees with this dissent. MURDOCK 1 The Commissioner determined income tax deficiencies against the petitioners of $ 117,054.16 for 1952 and $ 232,678.86 for 1953. The principal issues for decision are whether the Commissioner erred in disallowing deductions for each year for interest paid on indebtedness and whether interest income was received when non-interest-bearing notes were sold. Alternative errors were alleged.FINDINGS OF FACT.The petitioners, husband and wife, filed their income tax returns for 1952 and 1953 with the director for the second district of New York. They kept their books and filed their returns on a calendar year cash basis.Lee has been a member of the New York Stock Exchange for 36 years and is a partner in the brokerage firm of Carlisle & Jacquelin. He reported "Adjusted Gross Income" of $ 254,507.79 for 1952 and of $ 376,281.30 for 1953. His income, at least since 1950, has180 been subject to very high tax rates. He took this into account in making his personal investments and sought transactions which would give him the greatest net income after taxes. One such type investment was the purchase of large amounts of short-term Government notes or commercial paper at a substantial discount, financing the purchase 2 through ordinary bank loans secured by the purchased notes and selling them at a profit before maturity but after holding them 6 months. The excess of the amount realized over cost would be reported as a long-term capital gain and the interest on the borrowed funds would be claimed as a deduction. The net interest received on the obligations would be taxable as ordinary income. The excess of the interest paid on the borrowed funds over the interest, if any, on the obligations would thus be offset in whole or in part by capital gain and in any event there would be a tax benefit because the interest deduction would wipe out high-rate taxable income and the capital gain would be taxed at only 25 per cent.Lee purchased $ 9 million principal amount of non-interest-bearing financial notes of Commercial Investment Trust, Inc., at market from181 Saloman Bros. & Hutzler as shown in the following table:Purchase-datePrincipalPrice paidMaturityamountDec. 11, 1952$ 2,000,000$ 1,974,750.00July 1, 1953Dec. 11, 19523,000,0002,962,312.50June 30, 1953Dec. 11, 19521,000,000987,312.50July 2, 1953Dec. 16, 19523,000,0002,964,562.50June 23, 19538,888,937.50Lee borrowed money from three New York banks and gave his own 3 per cent promissory notes in the full amounts as security for the loans. Three per cent was the current rate on such loans. The following table shows the dates of the loans and personal notes, the amounts of each, the maturity, and the lender:DateAmountMaturityLenderDec. 11, 1952$ 1,974,750.00June 25, 1953Hanover BankDec. 11, 19522,962,300.00June 25, 1953Hanover BankDec. 11, 1952987,312.50July 2, 1953Marine MidlandDec. 16, 19522,964,562.50June 23, 1953Guaranty Trust8,888,925.00The C.I.T. notes which Lee purchased were delivered to the banks for Lee's account against payment by the banks for his account of the purchase prices of those notes. The loans were secured solely by the C.I.T. notes and Lee's personal notes.Lee182 anticipated that the interest he would have to pay on the loans would exceed the gain he would have on the notes but he would have a net gain after taxes from the transaction.Lee paid $ 144,032.37 interest on his four notes to maturity in December 1952, as required by the lenders, and claimed that amount on his 1952 return as a deduction for interest paid. The Commissioner, in determining the deficiency for 1952, disallowed that deduction 3 and merely stated that it was not deductible under section 23 of the Internal Revenue Code of 1939.Lee sold the $ 9 million of C.I.T. notes at market before their maturity, as shown in the following table:Sale datePrincipalSale priceamountJune 26, 1953$ 2,000,000$ 1,999,097.22June 26, 19533,000,0002,998,916.67June 26, 19531,000,000999,458.33June 19, 19533,000,0002,998,916.678,996,388.89Each lending bank received from the purchaser the sales price of the C.I.T. notes held by it, applied part of it to pay off Lee's notes held by the bank, and paid the balance to Lee. Lee paid the Hanover bank in June 1953 additional interest of $ 411.42 on his promissory notes for the 1 day past maturity which183 they were held by that bank, and in that same month he received $ 493.66 from Marine Midland Trust and $ 988.19 from Guaranty Trust, representing refunds or rebates of interest to maturity which he had prepaid on his promissory notes held by those banks for the period from the date of payment of the principal of those notes to the date of maturity of each. The additional interest paid was claimed as a deduction and the refunds reported as income on the petitioners' 1953 return. The Commissioner made no adjustment with respect to those amounts.The excess of the amount received from the sale over the cost of the C.I.T. notes, was reported on the petitioners' income tax return for 1953 as a long-term capital gain. The Commissioner, in determining the deficiency for 1953, added to the reported income $ 107,805.94, with the explanation that it was interest income from the C.I.T. notes and was not includible in the sales proceeds of the notes. He eliminated $ 107,801.73 from long-term gain and showed the transaction to have resulted in a net long-term capital loss of $ 4.21.Lee purchased at market $ 5 million principal amount of United States Treasury notes bearing interest at 1 1/2184 per cent, maturing on March 15, 1955, and having accrued interest thereon at the date of purchase, as shown in the following table:DatePurchased fromPrincipalCostAccruedpurchasedamountinterestJune 24, 1953C. J. Devine & Co$ 800,000$ 788,000.00$ 3,456.52June 24, 1953C. J. Devine & Co600,000590,812.502,592.39June 29, 1953First Wisconsin NationalBank 2,400,0002,361,000.0010,467.38June 24, 1953C. F. Childs & Co500,000492,343.752,078.80June 25, 1953Salomon Bros. & Hutzler500,000492,812.502,160.33July 1, 1953Garvin, Bantel & Co200,000197,000.00888.595,000,0004,921.968.7521,644.014 Lee borrowed $ 5 million from four banks and gave his own 3 1/2 per cent promissory notes in like amounts as security for the loans. The loans were to become due on March 15, 1955. Three and one-half per cent was the current rate on such loans. The following table shows the lender, the dates of the loans and notes, and the amounts of each:LenderDateAmountMercantile National Bank of ChicagoJune 26, 1953$ 800,000Lakeview Trust & Savings Bank of ChicagoJune 29, 1953600,000First Wisconsin National Bank of MilwaukeeJune 30, 19532,400,000June 25, 1953500,000First National Bank of BaltimoreJune 29, 1953500,000July 2, 1953200,000185 Lee expected that his profit on the sale of the notes would exceed the excess of the interest on his borrowings up to the date of sale over the net interest on the Treasury notes to that same date by a substantial amount.The Treasury notes which Lee purchased were delivered to the banks for Lee's account against the payment by the banks for his account of the purchase price of those notes. The $ 56,387.50 excess of the loans over the cost of the Treasury notes was remitted by the banks to Lee. Lee, at the time of giving his promissory notes, paid interest thereon in the total amount of $ 151,830.77. Coupons on the Treasury notes came due on September 15, 1953. The banks retained the proceeds of those coupons.Lee sold the $ 5 million of Treasury notes at market to Wm. E. Pollock & Co., Inc., as shown in the following table:Sale datePrincipalSale priceAccrued interestamountFeb. 3, 1954$ 800,000$ 802,250.00$ 4,707.18Feb. 3, 1954600,000601,687.503,530.39June 25, 19542,400,0002,413,875.0010,271.74Feb. 3, 1954500,000Feb. 3, 1954500,0001,203,375.007,060.77Feb. 3, 1954200,0005,021,187.5025,570.08Lee's promissory notes186 were paid off from the proceeds of the sales at the time of the sales. Lee paid to each of the lending banks in 1954 as additional interest on his promissory notes the accrued interest which he received upon the sale of his Treasury notes, and he also paid in 1954 to the First Wisconsin National Bank $ 13,500 as additional interest on his promissory note held by that bank.Lee was charged interest of $ 189,330.77 on his promissory notes during 1953 against which was applied $ 15,855.99, the net interest received by the banks on the Treasury notes so that the net interest 5 charged against Lee, paid by him and claimed as a deduction on his return, all for 1953, was $ 173,474.78.Lee was charged interest of $ 57,070.08 on his promissory notes during 1954 against which was applied $ 43,570.08 interest received by the banks on the Treasury notes in that year, resulting in net interest of $ 13,500 charged against Lee in 1954 and paid by him in that year and claimed as a deduction on his return for that year.The excess of the amount realized from the sale of the Treasury notes over their cost, both amounts exclusive of accrued interest, was reported as a long-term capital gain on187 the petitioners' 1954 return.The Commissioner, in determining the deficiency for 1953, added $ 15,855.99 to the reported income with the explanation that it was interest income from the 1 1/2 per cent Treasury notes and disallowed the deduction of $ 173,474.78 taken for interest paid, merely stating that it was not deductible under the provisions of section 23 of the Internal Revenue Code of 1939.Lee expected at the time he entered into the Treasury notes transactions that the lending banks would terminate the loans when he chose to sell the Treasury notes and refund to him all unearned interest which they had received on those loans. He had no agreement either with the New York banks which had loaned to him almost $ 9 million in December 1952 or with the out-of-town banks which loaned him $ 5 million in the middle of 1953, but the two New York banks had refunded the unearned interest at the time the notes were sold and Lee thought that the out-of-town banks would follow the same practice. However, the out-of-town banks refused to cancel the loans and refund the unearned interest when Lee sought to sell the Treasury notes. He delayed the sales until he negotiated with the banks. 188 He reached compromise agreements with three of them and sold the notes held by them on February 3, 1954. Negotiations with the Milwaukee bank continued, and it was not until June 25, 1954, that they were concluded and the notes sold.The difference between the quoted bid and offered prices of the Treasury notes at all times material hereto was generally 2/32 but occasionally it was only 1/32. The quoted bid price declined from 98 24/32 on March 16, 1953, to 97 31/32 on June 1, 1953. It gradually rose to 98 14/32 on June 22, 1953, was 98 12/32 on June 29, 1953, and rose for the first time above par, to 100 1/32 on January 18, 1954. It was 100 9/32 on February 1, 1954, and thereafter generally rose, reaching a high of 100 20/32 on May 3, 1954, after which it fluctuated between 100 19/32 and 100 17/32 until about August 1954, when it started to decline and reached 100 4/32 on December 20, 1954, after which it gradually declined to par in February 1955 and remained there until the maturity date.6 Lee would have had a long-term capital gain of $ 92,093.75 if he had been able to sell all of his $ 5 million United States Treasury notes on February 3, 1954. The excess of the 189 3 1/2 per cent interest on his loans up to that time over the net interest which he would have received on the Treasury notes up to that date would have been $ 60,910.47. His capital gain would thus have exceeded net interest by $ 31,183.28. The action of the banks in refusing to terminate Lee's loans on February 3, 1954, required him to pay to those banks $ 125,999.69 in excess of the amount which he otherwise would have had to pay. He could find no use for the borrowed money after the sale of the Treasury notes and had none in mind when he borrowed the money.All stipulated facts are incorporated herein by this reference.OPINION.Lee sold the C.I.T. notes in 1953 and reported for that year on that transaction a long-term capital gain. The Commissioner, in determining the deficiency for that year, taxed the gain as interest instead of allowing it to be included in the sales proceeds of the notes for tax purposes. He eliminated the gain as a long-term capital gain. The Commissioner's action is supported by the decision of this Court in F. Rodney Paine, 23 T.C. 391">23 T.C. 391. Cf. Charles T. Fisher, 19 T.C. 384">19 T.C. 384, affd. 209 F. 2d 513,190 certiorari denied 347 U.S. 1014">347 U.S. 1014, and Arnfeld v. United States, 163 F. Supp. 865">163 F. Supp. 865. The Paine case was reversed by the Court of Appeals for the Eighth Circuit, one Judge dissenting, see 236 F. 2d 398, but the grounds on which it was reversed are not present in this case.The petitioners argue that our decision in George Peck Caulkins, 1 T.C. 656">1 T.C. 656, affd. 144 F. 2d 482, is in direct conflict with our decision in the Paine case, but this Court in the Paine case explained how the two are distinguishable. The grounds given there for distinguishing the Paine and Caulkins cases would likewise apply to distinguish the present case from the Caulkins case. Cf. Commissioner v. Morgan, 272 F. 2d 936, reversing 30 T.C. 881">30 T.C. 881. The Commissioner's determination on this issue has not been shown to have been in error.The only other issue that need be decided is whether the Commissioner erred in disallowing deductions for 1952 and 1953 for interest paid in those years on indebtedness. 191 Section 23(b) of the Internal Revenue Code, applicable to all years involved herein, provides that in computing net income there shall be allowed as a deduction --All interest paid * * * within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally 7 subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this chapter.No contention is made or could be made that the exception quoted above applies here, nor does section 24(a)(6) apply. Those are the only exceptions to the general rule allowing the deduction of "all interest paid * * on indebtedness." Congress having enacted the only exceptions it desired to make, the maxim of interpretation, "Inclusio unius est exclusio alterius" applies, e.g., Congress intended no other exception or limitation on the deductibility of interest on indebtedness. All interest paid within the taxable year on genuine indebtedness of any other kind thus entitles a cash basis taxpayer to a deduction of the amount of interest paid. The Commissioner192 here concedes, as he must, "the reality and validity of the series of transactions." Thus the payments of principal and interest were enforcible. Cf. W. S. Gilman, 18 B.T.A. 1277">18 B.T.A. 1277, affd. 53 F. 2d 47; William Park, 38 B.T.A. 1118">38 B.T.A. 1118, affd. 113 F. 2d 352. Congress has indicated that this deduction is not dependent in any other way upon the purpose or motive of the borrower, or the use made of the borrowed funds. Lee borrowed the money here involved for a purpose not prohibited by any provision of the Code and is entitled to the deductions claimed.$ 56,387.50 of the borrowed money was not used to buy the Treasury notes. Actually, Lee did not use the rest of it for any evil, immoral, or illegal purpose, if that makes any difference. Congress has included no requirement in the Code that the borrowed money be used in connection with a transaction entered into for profit or that it cannot be borrowed for personal or non-business purposes or used in a transaction involving tax benefits, cf. Commissioner v. Park, 113 F. 2d 352, and the Tax 193 Court has no authority to write or read such requirements into the law.The legislative history of section 23(b) shows that Congress has repeatedly considered and ultimately rejected limitations somewhat comparable to the one now urged by the Commissioner. The House, for example, proposed to restrict the interest deduction in the 1924 Act to interest paid or incurred in carrying on a trade or business and other interest which, when added to nonbusiness losses, exceeded tax-exempt interest received. The Senate struck this out and inserted a limitation on indebtedness incurred or continued for the purpose of evading the payment of taxes when the purchaser carried tax-exempt securities other than certain United States obligations. But the reference to "indebtedness incurred or continued for the purpose of evading the payment of taxes" was stricken out in conference. The House proposed another limitation for the 1926 Act, but again the Senate refused and the House concurred. The 1932 Act broadened the restriction to deny deduction for interest 8 on indebtedness incurred or continued in connection with the purchasing or carrying of an annuity. The House proposed to broaden the194 restriction in the 1934 Act, but the Senate refused and also struck out all reference to annuities. The House at the same time proposed in section 24(a)(5) to disallow any deduction allocable to any class of income wholly exempt from tax, but the Senate amended to preclude the application of this provision to the deduction for interest and the House accepted the amendment. See also Revenue Act 1921, section 206(a)(3) and (4), and Revenue Act 1924, section 208(a)(3), (5), and (6), which imposed certain restrictions afterwards dropped from the law and never reenacted. Cf. sec. 24(a)(5) and (6) of the 1939 Code.The Internal Revenue Code imposed heavy taxes upon Lee and he sought a legal way within the provisions of the Code to make a profit for himself after taxes, the only kind of profit which can do any taxpayer any good. His Treasury note transactions would have been profitable before taxes, if events had happened as he anticipated they would at the time of entering into the transactions. He had reasons, which seemed sufficient to him at the time, to believe that the out-of-town banks would allow him to terminate his loans with the return to him by the banks of the unearned 195 interest at any time he chose to sell the Treasury notes and pay off his bank loans, as the New York banks had done. A deduction for the actual interest which he paid over the term of the loans could not have been denied to him, if that had happened. The taxability of the excess of the amount realized from the sale of the Treasury notes in 1954 over their cost is not an issue in this case, but it was a transaction entered into for profit, and which resulted in a profit, if that is material here. What reason is there for penalizing Lee and deviating from the plain words of the Internal Revenue Code merely because the unexpected action of the banks wiped out Lee's real gain by requiring him to pay about $ 126,000 of additional interest?All of Lee's borrowings involved herein were genuine and resulted in real indebtedness within the meaning of section 23(b). There was no collusion. The lenders actually advanced the money borrowed for Lee's use. The money was used in the outright purchase of securities at market. The securities became the property of Lee. They were held as security by the lenders of the money. Lee had all the benefits and risks of ownership. All dealings were196 "at arm's length." Once he entered into the transactions he was required to do all that he did do, and no step which he took was lacking in substance or legal effect. He was strictly within the law at all times, and the interest deductions which he took for 1952 and 1953 were in exact accordance with the express provisions of section 23(b). The 9 Commissioner concedes all of this. How then does the Commissioner attempt to justify his disregard of the plain provisions of the Internal Revenue Code whereby he taxes interest received and capital gains on the transactions but denies deductions for all interest paid? He says:This Court has already approved determinations of respondent comparable to the one at issue herein. Cf. Eli D. Goodstein (1958) 30 T.C. [1178], No. 124, aff'd (CA 1, 1959) F. 2d , 3 A.F.T.R. 2d 1500; Abraham M. Sonnabend, T.C. Memo. 1958-178, aff'd per curiam (CA 1, 1959) F. 2d , 3 A.F.T.R.2d (RIA) 1505">3 A.F.T.R. 2d 1505; John Fox, T.C. Memo. 1958-205; Matthew M. Becker, T.C. Memo 1959-19">T.C. Memo 1959-19; George G. Lynch (1959) 31 T.C. [990], No. 98197 (On appeal); Leslie Julian (1959) 31 T.C. [998], No. 99 (On appeal); Egbert J. Miles (1959) 31 T.C. [1001], No. 100 (On appeal); See also W. Stuart Emmons (1958) 31 T.C. [26], No. 4 (On appeal). Respondent submits that the principles applied in the above decisions are controlling and dispositive of the case at bar.* * * In the light of the foregoing discussion, respondent submits that as a matter of substantial commercial reality, Stanton did not purchase any CIT Notes and Treasury Notes, incur any indebtedness, pay any interest, or sell any CIT Notes and Treasury Notes, which were significant or recognizable for tax purposes. George G. Lynch, supra; Egbert J. Miles, supra; W. Stuart Emmons, supra.The facts in each of the cited cases distinguish it from the present case. The Emmons case bears no resemblance to the facts here. The leading case cited is Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affd. 267 F. 2d 127, but important differences rob it of all effect as an authority here. The alleged Goodstein198 transactions were collusive shams throughout arranged by Eli Livingstone. 1 The Treasury notes were "purchased" and "sold" practically as one transaction in which no real money passed on behalf of the taxpayer. The alleged lender corporation had no money to lend. No Treasury notes were held as security or otherwise by that corporation. Goodstein was not the owner of any Treasury notes during the time the "loan" was supposed to be in effect. He was not entitled to receive and did not receive the benefit of any interest on Treasury notes. There was no indebtedness of $ 10 million. The whole matter of "interest" was merely an empty bookkeeping device to create the illusion of indebtedness, interest, and long-term capital gain. However, the Court in affirming the Goodstein case, 267 F.2d 127">267 F. 2d 127, expressed the thought that Goodstein, despite the recognized shams, might be entitled to a deduction for some loss in a later year not before the Court. See also Lynch v. Commissioner, 273 F. 2d 867, affirming the Lynch and Julian cases ( George C. Lynch, 31 T.C. 990">31 T.C. 990, Leslie Julian, 10 31 T.C. 998">31 T.C. 998),199 both of which involved similar shams arranged by Livingstone.The Commissioner quotes language from the Tax Court opinion in the Egbert J. Miles case (31 T.C. 1001">31 T.C. 1001) to the effect that "if petitioner did purchase the bonds and incur an indebtedness he did so but for one reason, to realize a tax deduction" and that being so, the interest was not deductible within the intendment of section 23(b). That part of the opinion was not necessary in denying the deduction since the facts disclosed a repetition of the collusive shams in the Goodstein case. The Court of Appeals for the Second Circuit, in affirming the Lynch and Julian cases, did not rely on any such reasoning and did not rely upon Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, which, it said, "the government construes as establishing a doctrine200 forbidding generally the recognition for tax purposes of transactions entered into for the sole purpose of tax avoidance." It relied instead "on the more fundamental ground" that there was no genuine indebtedness. The Goodstein, Julian, Lynch, and Miles cases were all correctly decided on the "fundamental ground" that there was no real indebtedness in any of them but merely collusive shams to create a supposed appearance of indebtedness on which supposed interest was paid. Anything contrary to the holding here was not necessary in the Lynch, Julian, and Miles cases and is not binding in this case although those cases and the Goodstein case were correctly decided on their own facts.Knetsch v. United States, 272 F. 2d 200, certiorari granted 361 U.S. 958">361 U.S. 958, decided by the Court of Appeals for the Ninth Circuit, involved a transaction in which the taxpayer purchased 2 1/2 per cent annuity savings bonds from a life insurance company by borrowing the necessary money from the life insurance company at 3 1/2 per cent. The Court affirmed the judgment of the District Court which had held that the amount paid201 to the insurance company was not interest in fact but the purchase price of a tax deduction. The Court of Appeals said it agreed with the opinion in Weller v. Commissioner, 270 F. 2d 294. The Weller case affirmed 31 T.C. 33">31 T.C. 33 and also affirmed W. Stuart Emmons, 31 T.C. 26">31 T.C. 26. The taxpayers in the Emmons and Weller cases had purchased annuity contracts and borrowed money from banks to prepay at a discount all future premiums and then received the loan value which the contract would have accumulated up to the time the prepaid premiums would be due. They then used a part of this money to pay off the loans at the banks. The interest on the bank loans was not in controversy. The taxpayers were disallowed claimed deductions for "interest" on the amounts they allegedly borrowed from the insurance companies, since no money was in effect loaned to them 11 by the insurance companies. The Court of Appeals for the Fifth Circuit in United States v. Bond, 258 F.2d 577">258 F. 2d 577, in a situation similar to that involved in the Knetsch case, held that the202 interest on the borrowing from the insurance company was deductible. The payments involved in all of the above four cases were on alleged loans from the insurance companies so that the whole transaction in each case was between the taxpayer and the insurance company. No genuine indebtedness existed on which interest was paid. Such cases are distinguishable factually from the present case. The present taxpayer bought securities on the open market and borrowed money from banks without any collusion to avoid income taxes between him and any person with whom he dealt. His indebtedness was genuine and section 23(b) allows a deduction for interest paid on such indebtedness.Decision will be entered under Rule 50. OPPER; BRUCE; PIERCE Opper, J., dissenting: While I agree with much that is said by my brothers Bruce and Pierce, it seems to me this case should be decided squarely on the authority of George G. Lynch, 31 T.C. 990">31 T.C. 990, and Leslie Julian, 31 T.C. 998">31 T.C. 998, both affirmed (C.A. 2) 273 F.2d 867">273 F. 2d 867, and Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001, and what we said there. Only203 by repudiating one of the two grounds on which those cases rested can the present result be reached. The attempt to distinguish these and other cases by applying to them such unmeaningful labels as "sham" and "collusive" avoids the true crux of the problem. The fact that there was a "real" bank, or that there was actual liability on the notes, which were not of the nonrecourse character, will not do as a distinction.The present facts are, of course, not identical with those in all of the cases in this field. That there should be variations in detail from case to case is no more than can be expected. However, in W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, and Carl E. Weller, 31 T.C. 33">31 T.C. 33, both affirmed (C.A. 3) 270 F.2d 294">270 F. 2d 294, the insurance company was a "real" insurance company, and in Broome v. United States, (Ct. Cl., 1959) 170 F. Supp. 613">170 F. Supp. 613, one of the notes had no "nonrecourse" provision. In Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affd. (C.A. 1) 267 F.2d 127">267 F. 2d 127, and Danny Kaye, 33 T.C. 511">33 T.C. 511,204 there is no indication that the notes were not actual liability notes.These transactions had no genuine business, borrowing, or investment purposes. They were, in my opinion, not of the kind to which Congress intended the respective statutory provisions to apply. And the fact that a man named Livingstone may not have been involved 12 is certainly no basis for erecting a principle of law -- although the fact appears to be that, to some extent, his influence was also present here.The various elements which we observe in the present transactions, and which in one form or another exist in the other cases referred to, are the symptoms rather than the disease. The disease is lack of reality; the symptoms, which one would not necessarily expect to find in such a case, are the various steps which are either omitted entirely or taken in so offhand 1 a way that they are obviously mere window-dressing to conceal the lack of reality behind. But if every "i" were correctly dotted and every "t" meticulously crossed, the result would not be different. The transaction would remain one which it is not the purpose of the tax law to recognize. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465.205 I respectfully dissent.Bruce, J., dissenting: I do not agree with the conclusions of the majority respecting the transactions herein involving the C.I.T. notes, and accordingly dissent.In my opinion the Internal Revenue Code was, and is, intended to apply to transactions founded upon economic reality. Transactions which, standing alone and without regard for tax considerations, are not economically sound and are engaged in solely for the purpose of creating tax deductions which by means of the interplay between various sections of the Code will result in "tax-free income," are lacking in economic reality and, in my opinion, are not within the intendment of the taxing statute. Consequently such transactions should be ignored for tax purposes.It has long been recognized that transactions206 which may be valid and enforcible between the contracting parties from a commercial or property law standpoint may, nevertheless, be so lacking in economic reality as to be entitled to no recognition for income tax purposes. Cf. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; Helvering v. Clifford, 309 U.S. 331">309 U.S. 331; Higgins v. Smith, 308 U.S. 473">308 U.S. 473.In Commissioner v. Transport Trad. & Term. Corp., 176 F.2d 570">176 F. 2d 570, 572, reversing 9 T.C. 247">9 T.C. 247, certiorari denied 338 U.S. 955">338 U.S. 955, the Second Circuit Court of Appeals stated that the doctrine of Gregory v. Helvering was not limited to consideration of corporate reorganizations but had a much wider scope:13 it means that in construing words of a tax statute which describe commercial or industrial transactions we are to understand them to refer to transactions entered upon for commercial or industrial purposes and not to include transactions entered upon for no other motive but to escape taxation. * * In Gilbert v. Commissioner, 248 F.2d 399">248 F. 2d 399, 411207 (C.A. 2), Judge Learned Hand stated:If, however, the taxpayer enters into a transaction that does not appreciably affect his beneficial interest except to reduce his tax, the law will disregard it; for we cannot suppose that it was part of the purpose of the act to provide an escape from the liabilities that it sought to impose. * * These principles have recently been applied in a number of cases strikingly similar to the instant case. In Weller v. Commissioner, 270 F. 2d 294 (C.A. 3), affirming 31 T.C. 33">31 T.C. 33 and W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, and Knetsch v. United States, 272 F. 2d 200 (C.A. 9), certiorari granted 361 U.S. 958">361 U.S. 958, deductions for amounts paid to insurance companies as interest on loans on annuity policies were held lacking in commercial substance and therefore not allowable. But cf. United States v. Bond, 258 F. 2d 577 (C.A. 5). In Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affd. 267 F. 2d 127 (C.A. 1); George G. Lynch, 31 T.C. 990">31 T.C. 990,208 and Leslie Julian, 31 T.C. 998">31 T.C. 998, both affirmed sub nom. Lynch v. Commissioner, 273 F. 2d 867 (C.A. 2); Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001 (on appeal); Danny Kaye, 33 T.C. 511">33 T.C. 511; and Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613 (Ct. Cl., 1959), the purchases of notes with borrowed funds for which they were posted as collateral, where the evident purpose was merely to create tax deductions, were ignored as transactions devoid of substance and interest on the loans was held not to be deductible.In my opinion, the purchase of the C.I.T. notes in December 1952 is nothing but a dressed-up Goodstein transaction, the only difference being (1) that a "gimmick man" like Livingstone was not involved, and (2) that petitioner borrowed money from legitimate lending institutions instead of a Livingstone finance company. Although the "collusive sham" of the Goodstein, Lynch, and Julian cases is not present in the instant case, the transaction was no less a "sham" for income tax purposes. There is no doubt that petitioner would not have 209 purchased the C.I.T. notes in 1952 had he not been able to create a tax benefit as a result of the interplay between the capital gain and interest deduction provisions of the Code. This conclusion is inescapable from the majority's finding of fact that "Lee anticipated that the interest he would have to pay on the loans would exceed the gain he would have on the notes but he would have a net gain after taxes from the transaction." It is quite clear that without the favorable tax impact the purchase of the C.I.T. notes could have resulted in nothing but a loss. Accordingly the transactions involving the C.I.T. notes which gave rise to petitioner's interest 14 expenditures are obviously lacking in economic reality and are not, in my opinion, within the intendment of the statute.Needless to say, contrary to the views expressed by the majority herein, I do not regard anything that was said in the Miles case, supra, as being either inappropriate or unnecessary. In that case the evidence was insufficient to establish whether or not the transactions really occurred, and our opinion was based in part upon the assumption that they did occur and that legally enforcible rights210 were created. Accordingly, the language criticized was not mere dictum. In Woods v. Interstate Realty Co., 337 U.S. 535">337 U.S. 535, the Supreme Court stated that "where a decision rests on two or more grounds, none can be relegated to the category of obiter dictum."For the reasons discussed above, I respectfully dissent from the opinion of the majority herein, particularly with respect to the C.I.T. note transactions.Pierce, J., dissenting: I respectfully dissent from the Court's conclusions and holdings with respect to the principal issue, wherein it rejected the Commissioner's determination that petitioner is not entitled to the benefit of the interest deduction provision of section 23(b) of the 1939 Code, in connection with his transactions involving the C.I.T. notes and the United States Treasury notes.(1) This case, in my view, is one of major importance in the administration of our Federal income tax system. It presents squarely the question: Whether a taxpayer who is faced with large surtax liabilities under the income tax statutes, may successfully contrive to reduce such potential tax liabilities, at such time or times and by such211 amounts as he may himself elect, through use of preconceived step-by-step transactions which are not entered into for any business, investment, or personal purpose whatsoever, other than to avoid income taxes; which in themselves are not intended or expected to produce any gain, profit, or income, but rather are expected to produce losses; and from which the only benefit must come from an interplay of the provisions of the tax statutes, and from severing the "costs" and outlays for such transactions from the proceeds thereof, and then deducting such "costs" against the taxpayer's gross income from other sources, to which the anticipated large surtaxes would otherwise be applicable.The nub of such prearranged step-by-step transactions is to make arrangements with banks, at a relatively small "cost" or outlay by the taxpayer, for short-term "loans" aggregating several million dollars, which are rendered practically "risk proof" both to the 15 banks and to the taxpayer, by the following other steps of the preconceived plan: (1) Arrangements are made for the banks to immediately apply the amounts of such loans in payment for certain readily marketable investment notes of exceedingly212 high quality, which yield little or no interest and are therefore selling at a discount, but which have short-term maturities and will appreciate in value as they approach the early maturity dates; and further (2) for the taxpayer to prepay to the banks the "interest cost" of the loans to their maturities, authorize the banks to retain and apply all interest which may accrue on the securities during the periods of the loans, and also authorize the banks to satisfy the remaining principal out of the proceeds from sale of the securities at the conclusion of the entire transaction. Thus the banks will have on hand at all times, an amount represented by the prepaid interest and the value of the readily marketable high-grade securities, which will aggregate more than 100 per cent of the amounts of the loans. The period of the loans is arranged to extend for at least 6 months, so that capital gain benefits may be claimed by the taxpayer on the proceeds from disposition of the securities. And arrangements also are made for the loans to begin in one taxable year and end in another, so that the prepayments of interest and the receipts from disposition of the securities will not be reportable213 on any one income tax return of the taxpayer. 1With these preliminary steps for elimination of risk having been taken care of, little remains to be done, except for the taxpayer to set up the transaction on his income tax returns.In the C.I.T. transaction here involved, petitioner prepaid approximately $ 214 144,000 "interest cost" on loans aggregating $ 8,888,925, for the privilege of picking up appreciation on the pledged securities, in the lesser amount of about $ 107,450. He conceded on cross-examination, that he anticipated suffering an economic loss from the transaction (which mathematically had to be true); and the amount of this loss was about $ 36,500. However, the mechanism by which he expected to convert this loss into a tax advantage, was this: He severed his above-mentioned "interest cost" of the transaction from the anticipated appreciation on the C.I.T. notes, instead of offsetting one against the other to reflect his above-mentioned economic loss; and he then applied such "costs" as a deduction against 16 his gross income from other sources, to which the high surtaxes would otherwise be applicable. Thus, assuming that his surtax rate would otherwise have been about 75 per cent, he estimated that the actual cost to him of the transaction, after receiving the anticipated tax benefits from deduction of the $ 144,000 prepaid "interest," would be only 25 per cent thereof or about $ 36,000. He further anticipated that the $ 107,450 appreciation on the pledged securities215 would be taxed at the 25 per cent capital gains rate, so he could retain, after taxes, 75 per cent thereof or about $ 80,000. Accordingly, he concluded that from the entire step-by-step transaction, he would, if his plan were successful, not only obtain the valuable tax deduction of about $ 144,000, but also actually make approximately $ 44,000 (being the difference between the $ 80,000 retained after taxes out of the appreciation realized from the securities, and the $ 36,000 representing the "net cost" to him of carrying out the transaction). By repeating this process from time to time, or by increasing the amounts of the "loan" transactions, he could practically "write his own ticket" as to income tax liabilities. He was, in substance, purchasing income tax deductions.The United States Treasury note transaction was of substantially the same character. As to this, petitioner arranged with four banks for loans aggregating $ 5 million which were to bear interest at 3 1/2 per cent to their due date of March 15, 1955, in order to carry 1 1/2 per cent Treasury notes that were to mature on the due date of the loans. It was realized that the net 2 per cent "interest cost" of carrying216 the transaction to its conclusion would exceed the proceeds to be derived therefrom (the appreciation of the Treasury notes to their maturity); but the benefits were intended to be derived, as in the case of the C.I.T. notes, from deducting the "interest cost" from the petitioner's income from other sources. In this transaction, the petitioner contended that he might have derived an economic gain, if he could have sold the Government notes prior to their maturity and could have obtained a refund from the banks of part of the "interest" which he had prepaid. However, he had no legal right to obtain such an adjustment from the banks, and all four banks refused to terminate the transaction prior to its maturity, without being compensated therefor. Thus, the transaction still produced an economic loss.(2) The record in the instant case clearly establishes that the present transactions were not unique to the petitioner, and that they were not of the same character as those in which he normally engaged.Prior to the trial herein, counsel for both parties represented to this Court on motion, that this was a "key case"; and that it had 17 been selected for trial out of a group of217 13 cases pending before this Court, in which the taxpayers were represented by the same counsel, and in which there were common issues. Pursuant to the motion, this "key case" was advanced for trial.Petitioner had engaged in financial business for at least 36 years; but he conceded on cross-examination that he had never, prior to the years involved, entered into any transaction involving the type of arrangement here presented.When petitioner was asked how he became aware of this type of transaction, he replied that it was "common talk around Wall Street" -- which tends to indicate that transactions of this character were sufficiently unusual to stimulate discussion even in a major financial center.Other statements of petitioner on cross-examination show that the present transactions were entered into by petitioner following a discussion with a man named Livingstone, who was the architect of similar transactions involved in the "so-called 'Livingstone' cases." 2 Petitioner acknowledged that Livingstone came to his office "a short time prior" to the time when he (petitioner) entered into the present C.I.T. note transactions; and that Livingstone there described to petitioner and218 his partners the type of transactions involving Treasury notes which he had himself entered into.In addition to petitioner's entering into both the C.I.T. note transactions and the Treasury note transactions here involved, one of petitioner's partners entered into a C.I.T. note transaction, and more than half of the 18 partners of petitioner's firm entered into Treasury note transactions.Thus, the present case is of more widespread importance to the Federal tax system than might appear on first impression.(3) During the past 2 years, a multiplicity of cases involving tax avoidance by use of the interest deduction219 provisions of section 23(b), have been decided by this and other courts. These include: Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affd. 267 F. 2d 127 (C.A. 1); George G. Lynch, 31 T.C. 990">31 T.C. 990, affd. 273 F. 2d 867 (C.A. 2); Leslie Julian, 31 T.C. 998">31 T.C. 998, affirmed sub nom. Lynch v. Commissioner, supra (C.A. 2); Sonnabend v. Commissioner, 267 F. 2d 319 (C.A. 1), affirming T.C. Memo. 1958-178; Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001, on appeal (C.A. 2); John Fox, T.C. Memo. 1958-205; and Matthew M. Becker, T.C. Memo. 1959-19. Also, the Court of Claims recently decided a similar case, Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613, in which that court 18 expressly approved of the views of this Court in the Goodstein case, supra. See also W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, affirmed sub nom. Weller v. Commissioner, 270 F. 2d 294220 (C.A. 3); and Knetsch v. United States, 272 F. 2d 200 (C.A. 9), certiorari granted 361 U.S. 958">361 U.S. 958, in which the court affirmed the judgment of the District Court in which it was held that the "alleged interest was not interest in fact, but the purchase price of a tax deduction."All these cited cases, though they presented variations of fact, detail, and approach, involved the same basic question here presented. All were decided adversely to the taxpayer. All reflected (to use the phraseology of Justice Cardozo in Burnet v. Wells, 298 U.S. 670">298 U.S. 670) "the Government's endeavor to keep pace with the fertility of invention whereby taxpayers had contrived to * * be relieved of the attendant [tax] burdens." See also in this connection: Helvering v. Gregory, 69 F. 2d 809 (C.A. 2), affd. 293 U.S. 465">293 U.S. 465; and Helvering v. Clifford, 309 U.S. 331">309 U.S. 331.(4) I believe that it was never intended that the Internal Revenue Code should be employed as a vehicle by which high-income taxpayers might, through transactions221 like the present, reduce or indeed eliminate their share of the Federal tax burden. The purpose of the Code is to provide the Government with needed revenues through taxation of gains, profits, and income; and it should not be presumed to bear within itself the means for frustrating such purpose. The problem here, as I see it, is not whether, but by what approach, such transactions should be disapproved. I think that this Court, in deciding the present case, placed too much emphasis on the formalisms and labels under which the transactions were conducted; and that it failed to give adequate consideration of the realities of what actually was done, and what objectives were intended to be attained.There is no merit to the suggestion that courts are helpless to deal with such situations; and that, under the separation-of-powers doctrine, relief can be afforded only through action of Congress. Such a suggestion was rejected by the Second Circuit in Helvering v. Gregory, supra, wherein the court said:It is quite true, as the Board has very well said, that as the articulation of a statute increases, the room for interpretation must contract; 222 but the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. * * * Also, in Helvering v. Clifford, supra, the Supreme Court held that the mere fact that Congress, in dealing with a specific section of the statute, had chosen either to provide or not to provide for certain situations to which a "rule of thumb" might be applied, did not render the courts powerless to apply the general intent of the section 19 involved, in other situations for which Congress had not specifically provided. Hence the maxim of "Inclusio unius est exclusio alterius," upon which the majority of this Court has so heavily relied, is not applicable.(5) There would appear to be several avenues available for judicial approach to the present problem. One approach would be to hold that allowance of the claimed deductions under section 23(b) would violate the spirit and intent of the statute. In Holy Trinity Church v. United States, 143 U.S. 457">143 U.S. 457, the 223 Supreme Court said:It is a familiar rule, that a thing may be within the letter of the statute and yet not within the statute, because not within its spirit, nor within the intention of its makers. This has been often asserted, and the reports are full of cases illustrating its application. This is not the substitution of the will of the judge for that of the legislator, for frequently words of general meaning are used in a statute, words broad enough to include an act in question, and yet a consideration of the whole legislation, or of the circumstances surrounding its enactment, or of the absurd results which follow from giving such broad meaning to the words, makes it unreasonable to believe that the legislator intended to include the particular act. * * * [Emphasis supplied.]Another approach would be to regard the present transactions as mere shams, as was done in Eli D. Goodstein, supra, and the other cases hereinabove cited in connection therewith. Apposite to this approach is the following statement of the Supreme Court in Gregory v. Helvering, 293 U.S. 465">293 U.S. 465:The rule which excludes from consideration the motive of 224 tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.A third approach would be to treat petitioner's "interest" payments (which were his only outlay toward attaining his objective through the step-by-step transactions) as his "cost" of picking up the appreciation on the securities which he employed, and then offsetting such costs against his proceeds, in order to truly reflect the income or loss from the transaction as a whole. The fact that an item has been labeled "interest," even when all formalities have been meticulously observed, is not conclusive as to the item's true character. Emanuel N. (Manny) Kolkey, 27 T.C. 37">27 T.C. 37, affd. 254 F. 2d 51 (C.A. 7).I deem it unnecessary in this dissenting opinion, either to select or to develop the one solution which would be most appropriate. It seems sufficient to state respectfully, that of all the possible solutions, the one which in my view most clearly appears to be wrong, 225 is that of approving the claimed deductions.I would have approved the determinations of the Commissioner.Footnotes1. Statements in dissents hereto that Livingstone had something to do with this case are improper inferences from Stanton's testimony which I alone heard.↩1. Petitioner's failure to take the trouble to reduce to writing his agreements with the banks, or even to inquire as to their practice, indicates to me a lack of interest inconsistent with an operation having economic reality.↩1. Another feature of petitioner's C.I.T. transaction was his arrangement to "sell" the notes on dates which ranged from 4 to 6 days prior to the notes' maturities. It is obvious that few assignees, other than brokers interested in handling charges, would pay out approximately $ 9 million merely to receive less than 6 days' appreciation on the notes (which this Court, under the other issue of this case, has held to be ordinary income). Such transparent attempt to convert ordinary income into capital gain, is substantially the same device which was employed in the recent case of Commissioner v. Phillips, 275 F. 2d 33 (C.A. 4), reversing 30 T.C. 866">30 T.C. 866↩.2. This nickname of "Livingstone cases" was employed in petitioner's brief; and it has reference to such cases as the Goodstein, Lynch, Julian, Sonnabend, Broome, Miles, Fox, and Becker↩ cases, which are hereinafter mentioned. The nickname arises from the fact that in all these cases, the tax avoidance plans involved were developed by M. Eli Livingstone, whose activities are described in said cases.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623396/	SANTO J. RUIZ AND IRMA G. RUIZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRuiz v. CommissionerDocket No. 30252-88United States Tax CourtT.C. Memo 1990-342; 1990 Tax Ct. Memo LEXIS 369; 60 T.C.M. (CCH) 58; T.C.M. (RIA) 90342; July 9, 1990, Filed 369 Decision will be entered under Rule 155. Santo J. Ruiz and Irma G. Ruiz, pro se. William Galanis, for the respondent. COHEN, Judge. COHENMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined a deficiency of $ 9,775.78 in petitioners' Federal370 income taxes for 1984 and additions to tax of $ 154.47 under section 6651(a)(1), $ 683.44 under section 6653(a)(1), 50 percent of the interest due on $ 9,775.78 under section 6653(a)(2), and $ 2,443.94 under section 6661. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for 1984. Respondent has now conceded that petitioners are not liable for the addition to tax under section 6651(a)(1). The issues for decision are whether petitioners are entitled to deductions for cost of goods sold and travel expenses and whether petitioners are liable for the additions to tax under section 6653(a) and section 6661. FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Petitioners were residents of Chantilly, Virginia, at the time their petition was filed. At all material times, petitioner Santo J. Ruiz (petitioner) was employed full time at the Department of Health and Human Services. In 1984, petitioner Irma G. Ruiz was employed as a mortgage lender for American Home. During 1984, petitioner also inspected properties for Talmanhome Mortgage Corporation. 371 Normally, he provided "drive-by" inspections and reported on the condition of the home, although he would also enter a home for inspection if he were able to do so. The inspections were performed in Virginia, Maryland, and the District of Columbia at places between 10 and 160 miles from petitioners' home. The inspections were performed between 8:00 a.m. and 9:00 p.m. on weekdays and between 8:00 a.m. and 6:00 p.m. on Saturdays and did not require petitioner to be away from home overnight. If an inspection disclosed that work needed to be done on a property, petitioner might arrange for the work to be done but Talmanhome Mortgage Corporation would pay the providers of materials required for the work. During 1984, petitioners owned or used three automobiles, a 1967 Volkswagen Beetle, a 1979 Dodge, and a 1981 Ford station wagon. The vehicles were used in petitioner's inspection business as well as for personal purposes by petitioners. On their tax return for 1984, petitioners claimed $ 13,076 on Schedule C as cost of goods sold of the inspection business, including such items as changing locks to secure homes and cleaning expense. These expenses had been paid or reimbursed372 by Talmanhome Mortgage Corporation. The gross receipts from the inspection business reported by petitioners were $ 15,927, which did not include reimbursement from Talmanhome Mortgage Corporation. Petitioners also claimed on Schedule C $ 16,650 in car and truck expenses. Petitioners did not maintain accurate records of the local business mileage but computed their mileage based on estimated miles driven multiplied by 20.5 cents per mile, the standard rate allowed by the Internal Revenue Service in 1984. In the statutory notice of deficiency, respondent disallowed petitioners' claimed cost of goods sold and allowed a deduction for 5,000 miles driven at 20.5 cents per mile. OPINION Petitioners have the burden of proving that they are entitled to the deductions that they claim. Rule 142(a), Tax Court Rules of Practice and Procedure; Rockwell v. Commissioner, 512 F.2d 882 (9th Cir. 1975), affg. a Memorandum Opinion of this Court. Petitioner testified at trial, and he presented various records purportedly substantiating his automobile expense. With respect to the claimed cost of goods sold, petitioner admitted that he had been reimbursed by Talmanhome Mortgage373 Corporation. Thus he is not entitled to that expense. In support of the claimed automobile expenses, petitioner submitted certain receipts and reconstructions. He claimed that he had driven approximately 118,000 miles with respect to his property inspections in 1984. The computations contained inherently incredible assertions, which petitioner admitted were incorrect. At the conclusion of the trial, the Court asked respondent's counsel whether he agreed that petitioner's automobile expense was not subject to section 274(d), because the mileage was local transportation. See, e.g., O'Donoghue v. Commissioner, T.C. Memo. 1984-198; Miller v. Commissioner, T.C. Memo. 1982-491; LeBeau v. Commissioner, T.C. Memo. 1980-570. Because respondent's counsel did not agree with the Court's statement, he was directed to file a memorandum analyzing the evidence and citing authorities in support of his position. Respondent filed a brief in which he proposed findings of fact and reiterated his arguments about petitioners' failure to substantiate the claimed expenses, but he conceded that section 274(d) did not apply to petitioner's local transportation374 expense. Petitioners failed to file a reply brief. Based on the record as a whole, we conclude that petitioners are entitled to deduct as a business expense in 1984 a total of 12,000 miles at 20.5 cents per mile, of which 5,000 miles have already been allowed in the statutory notice. See Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). They have not persuaded us that they are entitled to any additional deductions. Based on petitioner's deduction of expenses that he had not incurred and his failure to maintain adequate records of his income and of the expenses that he did incur in the inspection business, we conclude that the additions to tax for negligence and for a substantial understatement of tax must be sustained. Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623397/	APPEAL OF SALO AUERBACH.Auerbach v. CommissionerDocket No. 1976.United States Board of Tax Appeals2 B.T.A. 67; 1925 BTA LEXIS 2561; June 15, 1925, Decided Submitted May 4, 1925. 2561 1. Expenditures for a new roof and for repairing boilers, made immediately upon the purchase of a building, being permanent in nature, are capital items and may be added to the cost of taxpayer's original investment, though not included in his return or claimed before the Commissioner. 2. Costs of repairs to a building which are temporary and recurrent in nature, and of janitor service, water, coal, interest on indebtedness, and fire insurance premiums are deductible as necessary expenses. Eugene Bernstein, Esq., for the taxpayer. J. Arthur Adams, Esq., for the Commissioner. LOVE 68 Before GREEN, LANSDON, and LOVE. This appeal is from a determination of a deficiency in income tax for the year 1921 in the sum of $786.70. The only questions in issue in this appeal are: (1) What was the cost price of a business property owned by the taxpayer and located in Chicago, Ill.? (2) Whether or not an element alleged to have been a part of the original investment in said property, but not included in the listing in taxpayer's income-tax return, nor presented to the Commissioner for review, was, in fact, a part of said investment, and if2562 so, may it now be considered by the Board? (3) Whether or not certain items were proper deductible items of expense, and if so, amount of same? It is alleged in the petition that in addition to the original cost of said building, as listed in taxpayer's return for the year 1921, he had to expend immediately after said purchase for additions and repairs the sum of $1,345, which amount, by inadvertence and oversight, was not included in his said return and never presented to the Commissioner for review, but which, in fact, brought the total investment in said property to the sum of $78,845 instead of $77,500, as listed by him in his said return and as presented to the Commissioner. Taxpayer asks the Board to include now said additional sum of $1,345 as a part of the investment in said building. FINDINGS OF FACT. On February 28, 1921, taxpayer consummated a deal for and purchased a business property consisting of a theater, stores, and offices and lot, for which he paid in cash, and by the assumption of indebtedness secured by mortgage on the property, $77,500. The value of the block of land, separate and apart from the building, was $15,000, leaving the original cost2563 of the building $62,500. In April, 1921, taxpayer expended in putting a new roof on said building the sum of $475, and for the patching and welding of the boiler $875, or a total of $1,345, which sum formed a part of the investment in said building never claimed by taxpayer in his return. The taxpayer expended the following amounts for the items named as current and necessary expenses during the taxable year: Repairing gutters on building$150.00Repairing concrete around building250.00Decorating and painting250.00Janitor service200.00Water110.00Coal1,250.002,210.00Interest on indebtedness1,988.18Premiums on fire insurance on building214.284,412.4669 DECISION. The deficiency should be recomputed in accordance with the following opinion. Final determination will be made on consent or on 10 days' notice, under Rule 50. OPINION. LOVE: The expense of putting new roof on building and repair of boilers was of a permanent nature, and hence constituted a capital expenditure and should be allowed as such. The items of repairing gutters on building, repairing concrete around building, and decorating and painting, 2564 being temporary and of frequent recurrence, were, as well as the items of janitor service, water, coal, interest, and premium on fire insurance, current necessary expense.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623398/	Kenneth P. Harrington and Arola Harrington v. Commissioner.Harrington v. CommissionerDocket No. 6107-69.United States Tax CourtT.C. Memo 1972-181; 1972 Tax Ct. Memo LEXIS 77; 31 T.C.M. (CCH) 888; T.C.M. (RIA) 72181; August 21, 197277 P is the sole shareholder of S, a construction firm which has elected to be treated as a "subchapter S" corporation. In December 1964, S, which reports construction income on the percentage of completion method, agreed to complete the construction of a race track, and the construction was substantially completed in August 1965. As part of an agreement relating to such construction, S, in April and May 1965, received stock in M, the corporation owning the race track. S also was to receive a note for $1,250,000 payable in 3 years and bearing interest at the rate of 6 percent per annum. During 1965, M was in financial difficulty, and by December 31, its liabilities exceeded the fair market value of its assets by $1.2 million, it could not pay its debts, and it had no reasonable expectation of obtaining additional funds in the future. Held: (1) S is entitled to a partial bad debt loss during the year 1965 with regard to the account receivable relating to the construction contract; (2) S does not have to accrue interest on the account receivable during 1965; (3) S received more than a security interest in the transferred stock and realized income on its receipt; and (4) The stock78 was worthless as of December 31, 1965. Joel Yonover, 3637 Grant St., Gary, Ind., for the petitioners. Bert L. Kahn, for the respondent. SIMPSONMemorandum Findings of Fact and Opinion79 SIMPSON, Judge: The respondent determined a deficiency of $1,983.675.60 in the joint Federal income tax of the petitioners for 1965. The issues to be decided are: (1) Whether Shamrock Engineering, Inc., may treat any portion of the Midway Enterprises, Inc., account receivable as worthless on December 31, 1965; (2) whether interest income was accruable on the Midway account receivable; and (3) whether any income was recognizable by Shamrock on the receipt of the Midway stock, and if income was recognizable, whether the stock received was worthless as of December 31, 1965. Findings of Fact Some of the facts have been stipulated, and those facts are so found. The petitioners, Kenneth P. Harrington and Arola Harrington, are husband and wife and maintained their legal residence in Valparaiso, Indiana, at the time their petition was filed in this case. They filed their 1965 joint Federal income tax return with the district director of internal revenue, Indianapolis, Indiana. Mr. Harrington will sometimes be referred to as the petitioner. Mr. Harrington has been in the construction business for over 25 years, and he has been the principal officer and sole shareholder of Shamrock80 Engineering, Inc. (Shamrock), since its incorporation in 1961. Shamrock is engaged principally in commercial, industrial, municipal, and underground construction, as opposed to residential construction. On its books and for Federal income tax purposes, Shamrock recorded income on the percentage of completion method. Income 889 was recorded monthly as earned and was based on engineer's estimates which were customarily made at the end of each month. In 1964, Shamrock elected to be treated for tax purposes as a small business corporation (subchapter S corporation). Shamrock undertook the completion of a track for horse racing in Colorado for Midway Enterprises, Inc. (Midway). Midway was incorporated in Colorado on February 28, 1963, and it was primarily organized for the purpose of operating tracks for horse racing with pari-mutuel betting. In Colorado, both horse and dog racing, which is the more popular form of racing, are regulated by the Colorado Racing Commission (the commission). The commission is composed of three members and an executive secretary, who serves as executive head of the commission. On or about March 15, 1963, Midway made an application to the commission for81 25 racing dates for the 1964 season. The proposed location of the racing track was approximately 20 miles south of Colorado Springs and 20 miles north of Pueblo, and it fronted on Interstate Highway 25. In its application, Midway stated that it would cost $490,746 to build the track and that such costs would be paid for with the proceeds of a securities underwriting in the amount of $750,000. It also projected that $91,160 would be wagered daily at the track and that the track would have a profit of $2,288 for each day it operated. The application further indicated that although many of the Midway directors were horse owners, none had experience as race track operators. Following receipt of the application, the executive director of the commission, Mr. Christensen, made a feasibility study of the proposed track site; he projected that $55,000 would be wagered daily at the track and that the track would lose $7,000 each day it ran, and concluded that the track would be unsuccessful. After Mr. Christensen was informed by the Colorado Attorney General's office that the projected economic failure of the track was not a grounds for denying Midway a license, the commission conditionally82 approved the Midway license. However, it did require Midway to post a $25,000 surety bond, rather than the normal $5,000 bond, and to hold $30,000 on deposit with the commission prior to any racing meet to secure the payment of expenses. Following the approval of the application, Midway purchased a 155-acre tract of land for $75,538.16 on which to build the track and entered into a contract with an architect to design the race track and prepare the necessary plans and blueprints. At about the same time, the initial subscribers of Midway common stock acquired 25,080 shares for $5 a share, and Midway purchased 320 acres of land adjoining the track site for $48,509, giving the seller 40 shares of stock in return for a credit of $200 against the purchase price. On or about November 15, 1963, Midway offered for sale 180,000 shares of its common stock at $5 per share in an attempt to raise, after commissions, $765,000. The proceeds were to be used to meet the $30,000 cash deposit requirement set by the commission and to construct the facilities required for racing. The offering circular stated that the $5 per share offering price was arbitrarily set, and Midway actually sold no more83 than 5,455 of the 180,000 shares offered. Early in 1964, Midway contracted for the completion of the racing plant at a cost of $858,000. Previously, it had contracted with another company for the construction of the stable area. To acquire funds to build these facilities, Midway, between October 15, 1963, and March 15, 1964, borrowed $430,000, including $275,000 from the Arkansas Valley Bank (the bank) secured by a deed of trust on the entire track. During this period, it also repaid $150,000 in loans, and as a result, on March 15, 1964, its balance sheet showed total assets of $430,850 and total liabilities of $305,250. During that same month, Midway entered into a best-efforts underwriting agreement for the sale of 160,000 shares of its common stock and $800,000 of its debentures. In September 1964, the underwriting was terminated. Prior to such termination, $24,300 of debentures, 4,860 common shares of stock at $5 per share, and warrants for the purchase of 4,860 common shares had been sold. In late summer 1964, Mr. Harrington was asked if Shamrock would be interested in building a race track in the West, and after it received the preliminary plans and specifications for the84 track, Shamrock expressed interest. Further discussions were held, and the petitioner was shown an alleged commitment letter of the Massachusetts Mutual Life Insurance Company (Massachusetts Mutual) for a $1,750,000 construction loan. During these discussions, Mr. Harrington requested a stock bonus for timely completion of the construction. On December 3, 890 1964, Shamrock sent a letter to Midway to confirm an agreement under which Shamrock agreed to advance funds to pay approximately $69,000 of Midway debts, and Midway agreed to enter into a contract with Shamrock for the construction of the racing plant at a cost not to exceed $1,320,000. In consideration for making such advances, Shamrock also was to receive an unspecified number of shares of Midway stock. On or about December 3, 1964, Shamrock issued a purchase order regarding the construction of the racing plant, and apparently some preliminary work was commenced in that month. On or about December 17, 1964, Mr. Harrington was informed that the commitment letter was fraudulent, and he so informed Midway on or before December 21, 1964. He was assured that either Massachusetts Mutual would honor the commitment letter or that85 other financing would be found, and Shamrock continued in the project. By December 30, 1964, the home office of Massachusetts Mutual had decided not to honor the commitment. Before reaching an agreement with Shamrock, Midway had been forced to stop construction of its race track because of a shortage of funds, and it had not opened for the 1964 racing season. On November 24, 1964, the commission notified Midway that its application for the 1965 racing season was being denied, but granted it 30 days within which to meet the statutory requirements for renewal. On December 2, 1964, Mr. Harrington and officers of Midway attended an informal meeting of the commission at which Midway's plans to sell a controlling interest to Mr. Harrington were discussed. On December 21, 1964, the commission issued an order requiring the posting of a construction performance bond and a showing of financial responsibility by Shamrock and Midway. Soon thereafter, the attorney for Midway sent a series of letters to the commission assuring it that Midway had adequate financing and that a performance bond had been obtained. On February 2, 1965, Midway was granted a license for the 1965 racing season. Prior86 to April 1, 1965, Midway was in need of working capital, and between January 1, 1965, and April 1, 1965, Shamrock made additional advances to or payments on behalf of Midway totaling $28,281. During the same period, Midway entered into an agreement with Berlo Vending Company (Berlo) under which Berlo was granted the exclusive right to all concessions for an annual stipulated sum. In addition, Berlo agreed to loan $150,000 to Midway, the loan to be secured by a second mortgage. At the beginning of April 1965, Midway entered into a contract with Shamrock, which provided that Shamrock would be paid $1,250,000 for completing the race track. The agreement was dated November 30, 1964, and it was approved by the Midway board of directors at their April 6, 1965, meeting. At that same board of directors meeting, Midway entered into another agreement with Shamrock, Mr. Harrington was elected to the Midway board of directors and then elected its chairman, and stock was issued to pay various debts. The agreement provided that whereas Midway owed Shamrock $1,250,000 for the construction of a race track, and whereas security was to be provided to Shamrock, Midway would execute a mortgage and mortgage87 note in the amount of $1,250,000 payable in 3 years and bearing interest at the rate of 6 percent per annum. Such mortgage was to be subordinate to the $275,000 mortgage to the bank, and $725,000 of the mortgage was to be subordinate to the Berlo mortgage. Midway also agreed to issue 135,262 shares of its common stock to Shamrock immediately and 227,000 shares to Shamrock on May 3, 1965. The mortgage and the note were never executed, but the shares were issued. On April 12, 1965, and June 29, 1965, Shamrock transferred the Midway shares it had received to Mr. Harrington. In accounting for the contract, Shamrock on April 30, 1965, debited accounts receivable-Midway $1,046,544.83 and credited sales a like amount, and on August 31, 1965, Shamrock considered the track completed and debited accounts receivable-midway $380,477.71, including extras, and credited sales a like amount. The stock which was issued for debts at the April 6, 1965, meeting was issued at $5 per share, and included 5,000 shares which were issued to pay debts owed to directors. Another 6,491 shares were issued to pay a debt owed to the Farmer's Acceptance Corporation. On April 26, 1965, an additional 520 shares were88 issued for costs incurred in building the track, and on May 28, 1965, 5,400 shares were issued to various Midway directors in order to raise $27,000. On May 7, 1965, the track opened, but the grandstand was not substantially completed until August 1965. On the opening day, Midway made an assignment of the concessionaire rents to Berlo, and the loan 891 from Berlo was completed. The proceeds of the loan were used to repay Shamrock for previous open account advances. During the 1965 season, 30 days of racing were held, 3 having been rained out, and 5 having been added when the rain prevented another track from racing. The average daily handle (that is, the amount wagered) during the 1965 racing season was approximately $47,250, and as of June 23, 1965, Midway was operating at a daily operating loss (before depreciation, interest, and deferred charges) of $5,764.16. On June 28, 1965, Midway borrowed an additional $150,000 from Berlo and gave Berlo its note, a deed of trust, and a second assignment of rents. On June 29, 1965, Mr. Harrington transferred 25,000 shares of Midway stock to Midway, and Midway debited Treasury stock $50,000 and credited surplus $50,000. Thereafter, Midway89 sold over 13,000 of such shares at $2 a share and a director purchased 7,000 of these shares. In August of 1965, Shamrock paid $100,000 of the $275,000 note of Midway which was payable to the bank and obtained an extension until April 11, 1966, on the remainder of the debt. On August 31, 1965, Midway repaid $120,000 which Shamrock had advanced it on open account. Following this repayment, Midway's balance sheet showed $4,270 in current assets and $2,174,747 of total assets, as compared to current liabilities of $442,628 and total liabilities of $2,155,923. At that time, Midway's liabilities exceeded the fair market value of its assets. On or about November 5, 1965, the former contractor and the architect filed an action in United States District Court to foreclose mechanics liens in the amount of approximately $140,000. Because of the litigation, the bank, prior to December 31, 1965, demanded that the $175,000 still owing on the note to it be paid. On December 31, 1965, Midway's balance sheet showed current assets of $2,273 and total assets of $2,143,787, as compared to $484,530 of current liabilities and $2,197,825 of total liabilities. Its liabilities exceeded the fair market90 value of its assets by over $1,200,000. Throughout 1965, the petitioner attempted to obtain third-party mortgage financing. In April and May, several financial institutions expressed an interest in financing the track, but none ultimately provided such financing. In July 1965, the petitioner hired a lawyer, who specialized in mortgage financing, to help him in his attempts to obtain mortgage money. They contacted banks, real estate brokers, insurance companies, and individuals, without success. The petitioner also attempted to sell his 85-percent stock interest in Midway and offered it for sale at a price of $1,750,000 in the Wall Street Journal of November 19, 1965, without success. As of December 31, 1965, the petitioner had abandoned any hope of acquiring additional funds for Midway. The 1966 racing season at Midway was financed by a director of Midway and by Shamrock. Due to a shortage of funds, the 1966 season lasted only 26 days. The average daily handle was $48,609.45, and the average daily operating deficit, before depreciation and interest, was $6,984.56. After the close of the 1966 season, the bank entered the district court litigation brought by the architect and the91 former contractor and sought a foreclosure of its deed of trust. A judgment of foreclosure was entered on November 8, 1966, determining the priority of liens as follows: (1) The architect and the former contractor, $70,303.06; (2) the bank, $188,165.60; and (3) Berlo, $264,72.57. On December 28, 1966, the bank purchased the property for $261,100.06, the amount of its lien, the liens before it, and costs. On July 7, 1967, Berlo redeemed the track property from the Sheriff's sale for the sum of $269,456.73 and deeded the subject property to Midway. Midway granted to Berlo a first deed in trust with respect to said property, and a new lease was executed between Midway as lessor and Berlo as lessee. On the same day, Midway made a further assignment of rents to Berlo in connection with the first deed in trust; and Mr. Harrington and Shamrock jointly and severally guaranteed performance by Midway to Berlo. In 1968, Shamrock forgave all but $100,000 of its outstanding claims against Midway in the amount of $2,027,859 so that a public offering of Midway's stock at 80 cents per share could be made. On its 1965 Federal Small Business Corporation income tax return, Shamrock deducted $1,179,903.2392 as the costs it incurred in building the racing facility and included $400,000.00 in income from the project. It did not accrue any interest income on the Midway account receivable even though Midway accrued interest expense on the debt. Neither Shamrock nor the petitioners reported any income with respect to the receipt of the Midway stock. 892 In his notice of deficiency, the respondent determined that the total Midway contract price was $3,238,302.54, including $1,811,310.00 as the value of the 363,262 shares of Midway stock, and that the entire price was includable in Shamrock's income for 1965. He also determined that Shamrock should have accrued $58,802.28 of interest income on the Midway indebtedness. The respondent further determined that the petitioner had understated his distributive share of Shamrock's income by $2,898.011.31. Opinion The basic issues for decision are: (1) Whether any portion of the Midway account was worthless as of December 31, 1965; (2) whether interest income was accruable on the Midway account receivable; and (3) whether any income was recognizable by Shamrock on the receipt of the Midway stock, and if income was recognizable, whether the stock93 received was worthless as of December 31, 1965. Section 166(a)(2) of the Internal Revenue Code of 1954 provides that: When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. This section gives the respondent discretion in determining the availability of a deduction for partial worthlessness of a debt. Portland Manufacturing Co., 56 T.C. 58">56 T.C. 58, 72-73 (1971). However, this discretion is not absolute, and, where the facts clearly indicate the "sagacity" of the taxpayer's business judgment in charging off a portion of the debt, it will be held that the respondent abused his discretion. Portland Manufacturing Co., supra, at 72-73. We believe that such facts are present in this case. As early as 1963, the secretary of the state racing commission had predicted that the track would fail, and, in 1963 and 1964, the Midway stock offerings had been significant failures. During 1965, Midway's financial position94 progressively worsened. In April, the construction contract was executed even though mortgage funds had not been obtained. The first racing season ended in July, and operating losses averaged approximately $5,700 per day. By August 1965, Midway's liabilities exceeded the fair market value of its assets, and Mr. Harrington had not succeeded in his attempts to obtain mortgage financing. In November, a suit was filed to foreclose liens against the track, and as a result, the bank demanded payment of the $175,000 which was owing to it. On December 31, 1965, Midway had $2,273 of current assets and did not have the funds to pay the bank's claim or the claims being asserted in the court action. Furthermore, as of December 31, after extensive efforts to obtain financing, the petitioner decided that there was no hope of obtaining additional funds for Midway, and we find that he was reasonable in that belief. In addition, Midway could not reasonably expect income from its operations in the near future; there was good reason to doubt whether Midway could ever operate successfully. Moreover, as Mr. Christensen testified, a track is doing well if it breaks even in 3 years, and one of the other95 2 commercial horse racing tracks in the State had been operating at a loss for over 20 years. Finally, the liabilities exceeded the fair market value of the assets by over $1.2 million. Not only have the petitioners shown that Midway could not pay its debts on December 31, 1965, that its liabilities exceeded both the book value and the fair market value of its assets, and that there was no reasonable hope for additional funds or for earning income in the foreseeable future, but they have also shown that the claimed bad debt deduction was reasonable in amount. If prior claims are subtracted from the fair market value of the assets, $326,810 would remain to pay the debt to Shamrock. If the claimed bad debt deduction is subtracted from the amount due to Shamrock on the contract, an account receivable of $400,000 would remain for tax purposes. Without doubt, the Midway account receivable became worthless at some time in 1965, 1966, or 1967. The respondent contended that the advances made in 1966 by Shamrock indicate that the contract debt was collectible as of December 31, 1965. However, it appears that these advances were nothing more than an attempt to keep alive a hope of realization96 on the account. See Krueger Broughton Lumber Co., 18 B.T.A. 1270">18 B.T.A. 1270 (1930). Considering all the evidence, we are convinced that Shamrock had good reasons for treating the Midway account receivable as partially worthless in 1965, and we, therefore, hold that the respondent abused his discretion in denying Shamrock a bad debt deduction. 893 Because we reach this holding, we need not discuss the petitioner's alternative contention that only $400,000 of the Midway account receivable was includable in the gross income of Shamrock. Both parties assume that Shamrock reports its interest income under the accrual method of accounting and seem to agree that if any accrual of the Midway account interest income is required for 1965, the date of such accrual is December 31, 1965. For interest income to be accruable, there must be a reasonable expectancy, at the time of the accrual, of receiving the interest. Chicago & North Western Railway Co., 29 T.C. 989">29 T.C. 989 (1958). See 2 Mertens, Law of Federal Income Taxation, sec. 12.95 (1967). In the present case, we find that no such97 expectancy existed. The debtor did not have the funds to pay its current debts, its liabilities exceeded the fair market value of its assets by over $1.2 million, and there was no reasonable expectation that the track would be profitable in the future or that proper financing could be found. In short, there was simply no source of funds from which it was reasonable to expect that interest would be paid, and accordingly, we hold that Shamrock was not required to include the interest in its gross income for 1965. The third issue to be decided involves the determinations of whether Shamrock received more than a security interest in the Midway stock which was transferred to it, what was the value of the transferred shares, and whether the shares were worthless as of December 31, 1965. The petitioner contends that the stock was transferred to Shamrock as security for the performance of Midway's promise to pay for the construction of the track. However, there were no apparent restrictions on Shamrock's ownership and control of the stock. Indeed, Midway had previously attempted to have Shamrock accept stock as compensation for building the racing track, and the corporate minutes of Shamrock98 indicate that thhe stock was received as compensation. Furthermore, Shamrock transferred the stock to the petitioner, and he advertised it as his own stock. Even the Midway corporate minutes refer to attempts to sell Mr. Harrington's stock. In addition, when Mr. Harrington transferred 25,000 of the shares back to Midway, Midway credited donated surplus, thus indicating that Mr. Harrington had owned the stock. In light of the financial condition of Midway, it appears that both Midway and Shamrock recognized that Midway's promise to pay $1,250,000 for the construction of the track was not worth its face amount and that, therefore, in addition to the note, the stock was transferred to Shamrock as compensation for its performance of the construction contract. Under these circumstances, we consider Mr. Harrington's testimony that he would have returned the stock if the debt was paid as nothing more than an indication that the other owners of Midway could repurchase the stock by paying the debt owed to Shamrock. We, therefore, conclude that Shamrock received more than a security interest in the stock. The parties have agreed that if Shamrock received more than a security interest in the99 stock, it would be taxable on the receipt of the stock to the extent of its fair market value. They further agree that the fair market value on April 6, 1965, when the first block was transferred, and on May 3, 1965, when the second block was transferred, was the same. However, the respondent contends that such value was $5 per share, and the petitioner argues that it was zero. We reject both these contentions. If the shares were worth $5 per share, the transferred stock would have been worth over $1,800,000. Yet, clearly, Shamrock was not entitled to this amount in addition to the promise to pay $1,250,000 which it received for completing the track. Nor do we believe that any reasonable investor would pay $1,800,000 for control of a corporation whose assets were worth less than $1,000,000, whose liabilities exceeded $2,000,000, and whose earning power was unproven. Furthermore, the sales of 50,000 shares at $5 per share, upon which the respondent relies, are not indicative of fair market value as of April or May of 1965. Over 25,000 of the shares were sold to the initial subscribers in 1963 before Shamrock had begun to build the race track or encounter any of its financial difficulties. 100 Another 10,000 shares were sold pursuant to public offerings in 1963 and 1964 in which less than 5 percent of the offered shares were sold. Another 10,000 shares were sold to directors and officers of Midway to repay loans that they had made. Still another 6,000 shares were issued to pay a debt owed to a nondirector-creditor, but considering the financial condition of Midway when these shares were issued in April 1965, and the number of shares transferred, such sale does not accurately represent the fair 894 market value of the stock transferred to Shamrock. The petitioners have also failed to support their suggested valuation. After June 29, 1965, over 5,000 shares were sold to the public at $2 per share. Although these shares were sold in blocks much smaller than those transferred to Shamrock and are not conclusive in determining the exact value of the stock in question ( Robertson v. Routzahn, 75 F. 2d 537 (C.A. 6, 1935), they do indicate that the stock had some value. Additional evidence indicating value includes the fact that the directors accepted stock in satisfaction of their claims, rather than forgive the debts, that when Mr. Harrington transferred 25,000101 shares to Midway, Midway debited its outstanding stock account $50,000 and credited donated surplus a like amount, and that Shamrock's minutes stated that the stock was compensation for services rendered. Furthermore, although Midway was in financial difficulty in April, there was still some hope for success. The first racing season had not yet begun. Several financial institutions were then considering financing the track. A major source of Midway's financial problems was its inexperienced management, and with the transfer of the Midway stock, Shamrock and Mr. Harrington apparently had the power to change this management. Considering all the evidence, including the financial condition of Midway and the size of the two blocks of stock which were issued, we find that the value of the stock in each block at the time of issuance was 50 cents per share. Such a valuation results in the conclusion that Shamrock received stock worth $181,131, in addition to the note in the amount of $1,250,000, as compensation for constructing the track. The final issue to be decided is whether the Midway stock was totally worthless as of December 31, 1965, so as to entitle the petitioner to a loss102 deduction for the stock which he held. Sec. 165(g)(1), Int. Rev. Code of 1954. After carefully examining the evidence, we find that as of December 31, 1965, the Midway stock was totally worthless. At that time, Midway could not pay its debts, its liabilities exceeded its assets by over $1,200,000, and as pointed out earlier, there was no reasonable expectation of future funds or profits. The respondent, however, points to the fact that the business continued to operate after 1965 as an indication that the stock was not worthless in 1965. Yet, the continued operation of a business does not itself prove value in its stock. Chares W. Steadman, 50 T.C. 369">50 T.C. 369 (1968), affd. 424 F. 2d 1 (C.A. 6, 1970), cert. denied 400 U.S. 869">400 U.S. 869 (1970); Frank C. Rand, 40 B.T.A. 233">40 B.T.A. 233 (1939), affd. 116 F. 2d 929 (C.A. 8, 1941), cert. denied 313 U.S. 594">313 U.S. 594 (1941). Nor does Mr. Harrington's offering to sell the stock in November of 1965 for $1,750,000 indicate that the stock had value at that time. He received no offers*103 to purchase it at that price, and considering the financial condition of Midway, we find it impossible to believe that he really hoped to receive any offers. Clealy, the stock became worthless at some time, and the petitioner had a reasonable basis for determining that the stock was wholly worthless in 1965. Although some Midway stock was sold to the public in 1968 at 80 cents per chare, the sales occurred only after approximately $2,000,000 of the debts owed to Midway were forgiven, and such sales therefore do not indicate that the stock had value as of December 31, 1965. Ainsley Corporation v. Commissioner, 332 F. 2d 555 (C.A. 9, 1964), revg. on another point a Memorandum Opinion of this Court. Hence, we find that the stock was worthless in that year and hold that the petitioners are entitled to a loss deduction with respect to the stock. On December 31, 1965, the stock was held by Mr. Harrington, and as the petitioner has presented no sound reasons for permitting Mr. Harrington an ordinary loss deduction, we hold that he is entitled to only a capital loss deduction. Decision will be entered under Rule 50. 89595	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623399/	ROY U. SCHENK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSchenk v. CommissionerDocket No. 1249-75.United States Tax CourtT.C. Memo 1976-363; 1976 Tax Ct. Memo LEXIS 39; 35 T.C.M. (CCH) 1652; T.C.M. (RIA) 760363; November 30, 1976, Filed 39 Petitioner executed a special consent (Form 872-A) extending the period of limitation on assessment but altered it by providing that the consent would terminate upon notice by him to the Commissioner. Petitioner did not attempt to mislead the Internal Revenue Service. An appellate conferee accepted the consent on behalf of of the consent and a statutory notice was subsequently mailed to petitioner. Held, respondent failed to prove circumstances of acceptance by the appellate conferee and the consent agreement between the parties will not be reformed to change the terms appearing on its face. Assessment of additional tax is, therefore, barred by expiration of period of limitation on assessment. Roy U. Schenk, pro se. Joseph R. Peters, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined deficiencies in income tax against petitioner for the taxable years 1969 and 1970 in the amounts of $280.11 and $900.34, respectively, and additions to tax for those years under the provisions of section 6653(a) 1 of the Internal Revenue Code of 1954, as amended, 2n the respective amounts of $63.26 and $45.02. Petitioner claimed an overpayment of $250.85 for the taxable year 1969. The issues presented for decision are: (1) whether assessment of additional income tax and additions to tax41 for both years is barred by expiration of the period of limitations on assessment; and, if not, (2) whether petitioner is entitled to claim as dependency exemptions four soldiers who served in the war in Viet Nam; (3) whether petitioner furnished over one-half of the support of his four children to entitle him to claim them as dependents; (4) whether petitioner is entitled to deduct $10,497 on his income tax return for 1970 as a war protest; (5) whether deductions claimed by petitioner as job-seeking expenses are deductible as ordinary and necessary business expenses; and (6) if the Court should find that petitioner underpaid his tax, whether such underpayment was due to negligence or intentional disregard of rules and regulations. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated by reference. Only the facts necessary to an understanding of the issues decided will be set out herein. Petitioner resided in Madison, Wisconsin when he filed his petition. He filed his original Federal42 income tax return for the taxable year 1969, his amended return for that year and his return for the taxable year 1970 with the Midwest Service Center of the Internal Revenue Service at Kansas City, Missouri. A statutory notice of deficiency was mailed by the Commissioner to petitioner on November 22, 1974 covering the taxable years 1969 and 1970. That statutory notice gave rise to this proceeding and was executed on behalf of the Commissioner by the Chief of the Appellate Branch Office of the Assistant Regional Commissioner, Appellate. Such notices of deficiency issued by the appellate division, as distinguished from those issued by the district director, result from the failure of negotiations between the taxpayer and the appellate division to resolve differences as to the taxpayer's correct tax liability. Before petitioner's return for 1969 was before the appellate division petitioner was negotiating with the district director's office. On March 27, 1973 petitioner executed a "Consent Fixing Period of Limitation Upon Assessment of Income Tax" (Form 872), extending until December 31, 1973 assessment of additional tax for the taxable year 1969. That consent was executed on43 April 3, 1973 on behalf of the district director by the chief of the review staff. Some time prior to October 4, 1973, petitioner executed an additional Form 872 extending the period of limitations as to the taxable year 1969 to June 30, 1974, and before transmitting the form to the district director's office, he inserted the following language on the Form 872: This consent is restricted to the disputed issues, namely: house depreciation, number of dependents, job hunting expenses and alleged fraud. On October 4, 1973 the district director's office returned the consent Forms 872 to petitioner accompanied by the following letter: Mr. Roy U. Schenk, 516 South Orchard Street, Madison, Wisconsin 53715 Dear Mr. Schenk: The signed Consent Forms, 872, which you recently submitted to my office are returned without execution because the restrictions you have incorporated into the consent are not acceptable. New Forms 872 are enclosed in the event you wish to execute consents without such restrictions. By extending the limitation period, you will have time, if you choose, to present your views at conferences at District and Regional levels. If signed, unaltered consents44 are not returned within the next ten days, we will assume that you do not desire a District Conference or Appellate Hearing, and will issue the Statutory Notice of Deficiency required by Section 6212 of the Internal Revenue Code. Very truly yours, /s/ P. E. Coates P. E. Coates District Director Enclosures - Old Forms 872 New Forms 872 Envelope On October 9, 1973, petitioner executed a consent Form 872 which was unaltered. The chief of the review staff executed the consent on behalf of the district director on October 11, 1973. Such consent extended the period of limitations on assessment of additional income tax for the taxable year 1969 to June 30, 1974. The "jurisdiction" for consideration of petitioner's income tax return for 1969 was transferred from the district director's office to the appellate division which also acquired "jurisdiction" over petitioner's return for the taxable year 1970. Subsequent to October 3, 1973 and before February 22, 1974, the appellate division tendered to petitioner "Special Consent Fixing Period of Limitation Upon Assessment of Tax," Form 872-A, covering the taxable years 1969 and 1970. When tendered to petitioner45 the printed forms contained the following language: That the (amounts) of any Federal income tax due under any (returns) made by or on behalf of the above-named (taxpayers) for the tax (years) ended December 31, 1969 and December 31, 1970 under existing or prior revenue acts, may be assessed at any time on or before the 90th day after (1) mailing by the Internal Revenue Service of written notification to the (taxpayers) of termination of Appellate Division consideration, or (2) receipt by the Regional Appellate Division branch office considering the case of written notification from the (taxpayers) of election to terminate this agreement, except that if in either event a statutory notice of deficiency in tax for any such (years) is sent to the (taxpayers), the running of the time for making any assessment shall be suspended for the period during which the making of an assessment is prohibited and for 60 days thereafter. * * * Petitioner executed the Forms 872-A on February 22, 1974, and at that time altered all copies of the form by erasing the "9" in "90th day" and by typing in a zero, thereby changing all copies of the form to read as follows: That the (amounts) of any46 Federal income tax due under any (returns) made by or on behalf of the above-named (taxpayers) for the tax (years) ended December 31, 1969 and December 31, 1970 under existing or prior revenue acts, may be assessed at any time on or before the 00th day after (1) mailing by the Internal Revenue Service of written notification to the (taxpayers) of termination of Appellate Division consideration, or (2) receipt by the Regional Appellate Division branch office considering the case of written notification from the (taxpayers) of election to terminate this agreement, except that if in either event a statutory notice of deficiency in tax for any such (years) is sent to the (taxpayers), the running of the time for making any assessment shall be suspended for the period during which the making of an assessment is prohibited and for 60 days thereafter. * * Petitioner returned the Forms 872-A to the appellate division and did not advise anyone of the alteration because he assumed that if the appellate division would not accept the Form 872-A as altered, that it would be returned to him.He did not attempt to mislead the Internal Revenue Service. Mr. Ernest A. Kukla, an appellate conferee,47 on February 26, 1974, executed the Forms 872-A received from petitioner on behalf of the Commissioner pursuant to authority delegated to him, and returned to petitioner a copy which was executed by both petitioner and Mr. Kukla. That copy retained the alteration of "90th" to "00th." On September 26, 1974, petitioner advised the appellate division by letter that he had elected to terminate the special consent as to 1969 and 1970 and receipt of his election to terminate the consent was acknowledged on behalf of the appellate division on the same date. OPINION Section 6501(a) of the Code provides (with certain exceptions not material here) that income tax shall be assessed within three years after the return was filed.Section 6501(b)(1) provides that, for the purposes of section 6501, a return filed before the due date shall be considered as being filed on the date it is due. Accordingly, the period of limitation during which income tax could be assessed against petitioner (absent extensions of time) for the taxable year 1969 expired on April 15, 1973, and for the taxable year 1970, it expired on April 15, 1974. The statutory notice of deficiency covering 1969 and 1970 was mailed48 to petitioner on November 22, 1974. Section 6501(c)(4) of the Code provides that the period of limitation will not expire until a date that the taxpayer and the Secretary of the Treasury or his delegate agree upon in writing if such agreement is made before the period is due to expire. The parties do not dispute the fact that by written agreement (Form 872) they extended the period of limitation for the taxable year 1969 to June 30, 1974. Beyond June 30, 1974 the parties do not agree upon the expiration of the period of limitation on assessment. When the taxpayer makes a prima facie case by alleging that assessment is barred by expiration of the period of limitation on assessment by proving the filing date of the return, the Commissioner must go forward with countervailing proof to show that for some reason the period of limitation had not expired when the Commissioner issued his statutory notice of deficiency. The petitioner's burden is discharged by introducing the returns in evidence. Farmers Feed Co.,10 B.T.A. 1069">10 B.T.A. 1069 (1928); Bonwit Teller & Co.,10 B.T.A. 1300">10 B.T.A. 1300 (1928); T.W. Warner Co.,19 B.T.A. 872">19 B.T.A. 872 (1930); Samuel G. Robinson,57 T.C. 735">57 T.C. 735 (1972).49 The parties here stipulated the income tax returns and the respondent in his answer alleged that they were timely filed. The Commissioner's burden of going forward with the proof is discharged by introducing into evidence a consent, valid on its face, which extends the period of limitation for assessment up to the date of mailing of the statutory notice of deficiency. Concrete Engineering Co.,19 B.T.A. 212">19 B.T.A. 212 (1930), affd. 58 F.2d 566">58 F.2d 566 (8th Cir. 1932). The controversy centers around the special consent Form 872-A described in detail in our findings of fact. If that form were effective to extend the period of limitation on assessment until 90 days after receipt of notice of termination by petitioner, then respondent has sustained his burden of proof. If not, the period of limitation expired before the statutory notice was mailed. The forms were prepared by the appellate division and tendered to petitioner, providing for an extension of time until 90 days after notification by petitioner that he elected to terminate the period of limitation on assessment. Petitioner altered the forms by erasing and typing in a zero which changed the 90-day period to50 no period at all and the appellate conferee executed the forms in their altered state and returned an executed copy to petitioner. Petitioner had previously altered a consent Form 872 by typing in language of restriction which the district director's office refused to accept.When petitioner altered the special consent Form 872-A he did not advise the appellate division of the alteration because he assumed that if it were not acceptable, it would be returned to him. The trial in this case consisted of two hearings, one at which the appellate conferee, Mr. Kukla, testified that he executed the special consent Form 872-A on behalf of the Commissioner. Mr. Kukla was not called as a witness in the subsequent hearing. The issue is simply one of fact, "hornbook" contract law and burden of proof. Petitioner executed and offered to respondent a special consent Form 872-A in an altered state. Respondent accepted it in the altered state but now contends that the offer of petitioner be amended to conform to the unaltered state of the Form 872-A. Respondent's position has no merit. A contract, to be valid, must embody the intent of the parties. Petitioner never intended to grant respondent51 the 90-day notice period he sought. We do not know what was the state of Mr. Kukla's mind when he executed the Form 872-A on behalf of the appellate division because respondent never asked him the question. Respondent neither recalled Mr. Kukla as a witness at the second hearing, nor did respondent explain whether Mr. Kukla was available, nor did respondent ask for a recess to locate Mr. Kukla. Under such circumstances we will not assume what Mr. Kukla's testimony would be. We do not know whether he noticed the alteration on the Form 872-A or not. The probabilities are that he did not notice the alteration because it would cause the period of limitation to expire immediately upon petitioner's election; nevertheless, we are unwilling to interpolate such testimony desired by respondent which might be unfavorable to a taxpayer not represented by counsel while respondent offers no explanation as to why such testimony was not elicited from his own employee. 2Interstate Circuit v. United States,306 U.S. 208">306 U.S. 208 (1939); Wichita Terminal Elevator Co.,6 T.C. 1158">6 T.C. 1158, 1165 (1946), affd. 162 F. 2d 513 (10th Cir. 1947). 52 As explained above, the burden of proving the extension of time is upon the respondent. He must prove that the agreement which he pleads and upon which he relies was actually entered into by the parties and that such agreement is valid and effects an extension of the statutory period within which he has the authority to assess. T. W. Warner Co.,19 B.T.A. 872">19 B.T.A. 872, 877 (1930). The Commissioner takes the risk of any defect in the documents upon which he relies as waivers. T. W. Warner Co.,supra.An alteration of a waiver made before it is executed by the parties does not invalidate the waiver in its altered state. F. A. Gillespie,20 B.T.A. 1068">20 B.T.A. 1068, 1088 (1930). In the instant case the unimpeached testimony of petitioner is that he altered the consent (often referred to as a waiver) before he returned it, executed, to the appellate division. The special consent Form 872-A was not ambiguous on its face. We cannot substitute another consent for that expressed by the parties. Constitution Publishing Co.,22 B.T.A. 426">22 B.T.A. 426, 428 (1931). The record is clear; i.e., petitioner made an offer for an extension of time on the53 terms of the altered form. We have no evidence of the terms of the acceptance by the representative of the Commissioner. If he accepted the offer knowing of the alteration, the period of limitation expired when petitioner advised him that he elected to terminate the extended period. If the representative of the Commission accepted petitioner's offer not realizing the alteration was made, the consent is invalid because there was no meeting of the minds to constitute a contract and the period of limitation expired because there was no extension. Respondent relies upon the following dicta in Daniel G. Cary,48 T.C. 754">48 T.C. 754, 765 (1967). Here the facts show that petitioner on the advice of his accountant concurred in by his attorney deliberately sent a document to the Internal Revenue Service which he and his representatives knew contained an error which he and his representatives considered material.Neither petitioner nor his representatives directed the attention of the Internal Revenue Service to the error in the instrument. Had no change been made in the instrument in the Internal Revenue Service, these facts might justify the conclusion that petitioner was estopped54 to deny that the document he submitted to the Internal Revenue Service was an extension of the statute of limitations on assessment for the year 1957 because of petitioner's misleading the respondent to respondent's detriment. * * * The dicta do not fit the facts in this case. The special consent Form 872-A which petitioner sent to the appellate division contained no error. It contained an alteration from the printed form. The record is devoid of evidence that petitioner in any way attempted to mislead the Internal Revenue Service by his alteration of the form. Based upon the record before us, we do not believe petitioner attempted to mislead the Internal Revenue Service. Respondent's characterization of petitioner's alteration as a misdeed and trickery is not in any way supported by the record. Respondent's files surely contained a retained copy of the letter mailed to petitioner rejecting the previous consent Form 872 because petitioner had altered it. It would be most unfair to impose some sort of estoppel against petitioner in this case because respondent's employees did not exercise reasonable diligence in reading the special consent form before it was executed on behalf55 of respondent. 3 The universal admonition of reading a contract before executing it should apply to employees of the Internal Revenue Service. Under the unusual and particular facts of this case we hold that the period of limitation on assessment expired before the Commissioner issued his statutory notice of deficiency to petitioner. As we have pointed out in numerous cases; e.g., Robert L. Anthony,66 T.C. 367">66 T.C. 367 (1976), a taxpayer is not permitted to refuse to pay his just share of the tax burden because he protests some action the government takes, such as fighting in Viet Nam. We do not condone petitioner's claiming soliders as four dependents because they fought in Viet Nam nor do we condone his deducting $10,497 as a protest to the war in Viet Nam. Although petitioner may be misquided in claiming such deductions, that does not mean his testimony as to the alteration of the Form 872-A is not to be believed. If we believed that petitioner attempted to mislead the Internal Revenue Service and if the Commissioner had properly pleaded estoppel and carried his burden of proof, the result in this case would probably be otherwise. 56 Petitioner offered no proof to support his claim for the overpayment which he alleged to be due for the taxable year 1969. Accordingly, no overpayment can be found. Because of our disposition of the statute of limitations issue, it is unnecessary to consider the other issues. Decision will be entered that there is no deficiency due from or overpayment due to petitioner. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Leslie D. Robertson,T.C. Memo 1973-205">T.C. Memo 1973-205↩.3. Respondent did not plead estoppel as required by Rule 39, Tax Court Rules of Practice and Procedure↩, nor did he claim surprise at trial or move to amend his pleadings after the trial.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623400/	KENNETH H. WINCHELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWinchell v. CommissionerDocket No. 17627-80.United States Tax CourtT.C. Memo 1983-221; 1983 Tax Ct. Memo LEXIS 565; 45 T.C.M. (CCH) 1376; T.C.M. (RIA) 83221; April 25, 1983. 565 On the 90th day after respondent mailed the notice of deficiency, P placed his petition in the hands of a private air express service, which hand-delivered it to the Court on the 91st day. Respondent did not move to dismiss the petition but answered it, denying P's assignments of error and most of his allegations of fact. The case was subsequently tried and briefed on the merits by the parties. Shortly thereafter the Court noticed that the petition may not have been timely filed. Accordingly, the parties were ordered to show cause why the case should not be dismissed for lack of jurisdiction. Held, the Court can and should at any time, on its own motion, question its jurisdiction to hear and decide a case. Held further, the period of time in which a taxpayer must file a petition with the Court begins to run from the date on which the notice of deficiency is mailed by the Commissioner and not from the date on which it is received by the taxpayer. Sec. 6213(a), I.R.C. 1954. Held further, the timely-mailing/timely-filing provisions of section 7502, I.R.C. 1954, do not apply where the taxpayer places the petition in the hands of a private air express service for delivery to the Court. 566 Blank v. Commissioner,76 T.C. 400">76 T.C. 400 (1981), followed. Held further, the petition was not timely filed and must therefore be dismissed for lack of jurisdiction. Charles F. Murray, for the petitioners. Benjamin A. de Luna, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge: This case is before us on the Court's own motion to dismiss for lack of jurisdiction. The issues for decision with respect thereto are as follows: 1. Whether the Court on its own motion may inquire into its jurisdiction to hear and decide a case after that case has been tried and briefed on the merits by the parties. 2. Whether the period of time given a taxpayer to file a petition with the Court begins to run from the date on which the notice of deficiency is mailed by the Commissioner or the date on which it is received by the taxpayer. 3. Whether the timely-mailing/timely-filing provisions of section 75021567 apply where the taxpayer places the petition in the hands of a private air express service for hand-delivery to the Court. FactsPetitioner resided in Breckenridge, Colorado at the time that he filed his petition in this case. He filed a Federal income tax return for the calendar year 1975 with the Internal Revenue Service. On Wednesday, June 18, 1980 respondent mailed a notice of deficiency to petitioner at this last known address in Colorado. In the notice respondent determined the followiong deficiency in petitioner's Federal income tax and additions to tax for 1975: Additions to TaxDeficiencySection 6651(a)(1)Section 6653(a)$341,662$85,416$17,958At 1:00 p.m. on Tuesday, September 16, 1980 petitioner's former attorney placed in the hands of a private air express service in Denver, Colorado, a 17-page petition disputing the deficiency and additions to tax. September 16 was the 90th day after respondent mailed the statutory notice and was not a legal holiday in the District of Columbia. At 9:50 a.m. on Wednesday, September 17, 1980 the express service hand-delivered the petition to the Court in Washington, D.C. After the petition was filed with the Court, a copy was served on respondent. However, respondent did not move with respect to the petition but filed an answer denying petitioner's 568 assignments of error and most of his allegations of fact. The parties subsequently tried this case and briefed the issues on the merits. At no time did either party suggest that we might lack jurisdiction to hear and decide the case. Issue 1. Jurisdiction to Determine JurisdictionShortly after this case had been briefed, the Court noticed that the petition may not have been timely filed. Accordingly, we issued an order to show cause why this case should not be dismissed for lack of jurisdiction. Both parties filed a response. Although neither questioned the propriety of our order, we think we should briefly address that matter in view of its importance. It is well settled that this Court can proceed in a case only if it has jurisdiction and that either party, or the Court sua sponte, can question jurisdiction at any time. Brown v. Commissioner,78 T.C. 215">78 T.C. 215, 218 (1982); Shelton v. Commissioner,63 T.C. 193">63 T.C. 193, 197-198 (1974); National Committee to Secure Justice, Etc. v. Commissioner,27 T.C. 837">27 T.C. 837, 839 (1957); First Nat. Bank of Wichita Falls, Trustee v. Commissioner,3 T.C. 203">3 T.C. 203, 215 (1944). As we stated in Wheeler's Peachtree Pharmacy, Inc. v. Commissioner,35 T.C. 177">35 T.C. 177, 179 (1960), 569 "questions of jurisdiction are fundamental and whenever it appears that this Court may not have jurisdiction to entertain the proceeding that question must be decided." In other words, we have jurisdiction to determine jurisdiction. Issue 2. Commencement of the Jurisdictional Filing PeriodIt is clear that the Court's jurisdiction to redetermine a deficiency in income tax depends on the issuance by the Commissioner of a notice of deficiency and the timely filing of a petition by the taxpayer. Sections 6212, 6213, and 7442; Brown v. Commissioner,78 T.C. at 220; Rule 13(a) and (c), Tax Court Rules of Practice and Procedure. Because the timely filing of a petition is a jurisdictional prerequisite, an untimely petition must be dismissed. Brown v. Commissioner, supra;Malekzad v. Commissioner,76 T.C. 963">76 T.C. 963, 965-966 (1981); see section 6213(c). Section 6213(a) prescribes the period within which a timely petition must be filed. It provides as follows: Within 90 days, or 150 days if the notice is addressed to a person outside the United States, after the notice of deficiency authorized in section 6212 is mailed (not counting Saturday, Sunday, or a legal holiday in the District of 570 Columbia as the last day), the taxpayer may file a petition with the Tax Court for a redetermination of the deficiency. * * * [Emphasis added.] See also section 301.6213-1(a)(1), Proced. & Admin. Regs. Petitioner admits that the notice of deficiency was mailed on June 18, 1980. However, he alleges that it was not received by him "until several days later." We are not sure whether he means to imply by this allegation that the period of time within which a petition must be filed with the Court begins to run from the date on which the statutory notice is received by the taxpayer. If that is his contention, it is without merit. Section 6213(a) clearly provides that the petition must be filed within a specified period after the notice of deficiency is mailed to the taxpayer, not after it is received by the taxpayer. See Traxler v. Commissioner,61 T.C. 97">61 T.C. 97, 98-99 (1973), modified 63 T.C. 534">63 T.C. 534 (1975). Issue 3. Applicability of Section 7502The petition in this case was hand delivered to the Court on the 91st day. We must therefore dismiss the case for lack of jurisdiction unless the timely-mailing/timely-filing provisions of section 7502 apply. 2572 That section treats a petition as 571 timely filed if it is timely mailed. See section 7502(a)(2)(B); section 301.7502-1(c)(1)(ii), Proced. & Admin. Regs. Petitioner contends that he "mailed" his petition to the Court "by express service" on September 16, the 90th day, and that it was therefore timely filed. We disagree. In Blank v. Commissioner,76 T.C. 400">76 T.C. 400 (1981), we considered the identical contention and rejected it. We held that "section 7502 does not apply when delivery is made by a private delivery service rather than by the U.S. Postal Service." 76 T.C. at 407. 3 That holding applies equally here and compels us to dismiss this case for lack of jurisdiction. Our dismissal of this case may seem like a harsh result. However, we cannot 573 ignore jurisdictional questions. What is truly regrettable is that dismissal of the petition could have very easily been avoided if it had been mailed on September 16 by certified or registered mail. 4 See section 7502(c); section 301.7502-1(c)(2), Proced. & Admin. Regs. The use of certified or registered mail would have guaranteed that the petition would be treated as timely-filed. We would then have had jurisdiction to hear and decide this case. 5574 To reflect the foregoing, An order dismissing the case for lack of jurisdiction will be entered.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect at the time of issuance of the statutory notice (June 18, 1980).2. SEC. 7502. TIMELY MAILING TREATED AS TIMELY FILING AND PAYING. (a) GENERAL RULE.-- (1) DATE OF DELIVERY.--If any return, claim, statement, or other document required to be filed, or any payment required to be made, within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed, or to which such payment is required to be made, the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document, or payment, is mailed shall be deemed to be the date of deliver or the date of payment, as the case may be. (2) MAILING REQUIREMENTS.--This subsection shall apply only if-- (A) the postmark date falls within the prescribed period or on or before the prescribed date-- (i) for the filing (including any extension granted for such filing) of the return, claim, statement, or other document, or (ii) for making the payment (including any extension granted for making such payment), and (B) the return, claim, statement, or other document, or payment was, within the time prescribed in subparagraph (A), deposited in the mail in the United States in an envelope or other appropriate wrapper, postage prepaid, properly addressed to the agency, officer, or office with which the return, claim, statement, or other document is required to be filed, or to which such payment is required to be made.↩3. See also Wilson v. Commissioner,T.C. Memo. 1980-258↩, where we reached exactly the same conclusion.4. Indeed, the petition could have merely been deposited in the mail in the United States with sufficient postage prepaid on September 16. If the envelope were postmarked on that day, the petition would have been treated as timely-filed. See section 7502(a)↩. As stated above, the risk that the petition would not have been postmarked on the critical day could have been overcome by the use of certified or registered mail. See section 301.7502-1(c)(2), Proced. & Admin. Regs. 5. Of course, petitioner can still obtain judicial review of the substantive issues, but he will first have to pay the deficiency determined by respondent, file a refund claim, and then sue within the statutory period for the refund in the appropriate United States District Court or the United States Claims Court. See sections 7422(a) and 6532(a); Flora v. United States,362 U.S. 145">362 U.S. 145↩ (1960).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623401/	Clifford R. Allen, Jr., Petitioner, v. Commissioner of Internal Revenue, RespondentAllen v. CommissionerDocket No. 17721United States Tax Court12 T.C. 227; 1949 U.S. Tax Ct. LEXIS 268; February 24, 1949, Promulgated 268 Decision will be entered under Rule 50. 1. Family Partnership -- Husband not a Partner -- Income Taxable to Wife. -- The taxpayer was not a member of and had no interest in two partnerships formed by his wife and others and is not taxable on his wife's share of the income therefrom, even though she performed no vital services for the partnerships and the capital which she contributed to the one partnership was given to her by the taxpayer shortly before the formation of the partnership.2. Assignment of Income -- Taxable to Assignor. -- Where the taxpayer gave his wife the right to receive his share of the income from coin-operated machines which were owned by others and placed in his restaurant, such income is taxable to him. Clifford R. Allen, Jr., pro se.F. M. Thompson, Jr., Esq., for the respondent. Murdock, Judge. Opper, J., dissents on the first issue. MURDOCK 227 The Commissioner determined deficiencies of $ 5,785.24 for 1943 and $ 5,965.11 for 1944 in the petitioner's income tax. The only issues for decision are whether the Commissioner erred in adding to the petitioner's income for each year income received by the petitioner's 228 wife269 from a partnership of which she was a member and income which she received from pinball machines and Victrolas located in a restaurant operated by the petitioner.FINDINGS OF FACT.The petitioner is an individual who resides in Nashville, Tennessee. His income tax returns for 1943 and 1944 were filed with the collector of internal revenue for the district of Tennessee.The petitioner was engaged in several businesses in Nashville during the taxable years. He had had experience in the restaurant and cafeteria business.He, together with several of his employees and associates in Nashville, investigated the possibilities of opening a cafeteria in Memphis.The petitioner, J. B. Hunt, and Beulah M. Hunt organized a corporation known as Southland Cafeteria of Memphis, Inc., in November 1942, with capital stock of $ 5,000, divided into 50 shares. The petitioner subscribed and paid $ 3,300 for 33 shares of the stock. The Hunts, who were husband and wife, subscribed and paid $ 1,700 for 17 shares of the stock.A property in Memphis equipped for the operation of a cafeteria was leased and operations were begun in 1942. The operation of that cafeteria was unsuccessful at first and about270 one-half of the original investment was lost during the first two months.Beulah Hunt had to retire because of ill health in January 1943. She had originally refused to go into the Memphis enterprise if Maude Stark was to be interested also, but she consented in January 1943 to the sale by the petitioner of a part of his interest in the corporation to Maude Stark. The petitioner, on February 1, 1943, sold 7 shares to Maude Stark for $ 700 and gave 26 shares to his wife, Nancy Louise Allen, as a gift. He immediately resigned as an officer and director of the corporation and thereafter took no part in the operation of the cafeteria in Memphis.Hunt, with the assistance of a man named Mulder, managed the cafeteria.A partnership was formed on March 1, 1943, by J. B. and Beulah Hunt, Nancy Allen, and Maude Stark. The partnership took over the operation of the Memphis cafeteria and operated it during the last 10 months of 1943 and all of 1944. The petitioner was never a member of that partnership and never had any interest of any kind in it. He never received any financial benefit from the partnership or from the corporation after February 1, 1943. He made a few trips to Memphis271 during the taxable years and on those occasions visited 229 the cafeteria for brief periods. He gave such advice on those occasions to those operating the Memphis cafeteria as they requested.The income from the operation of the Memphis cafeteria amounted to $ 13,981.26 for the last 11 months of 1943 and $ 12,379.81 for 1944, of which Nancy Allen's share was $ 5,645.68 for 1943 and $ 4,876.93 for 1944.J. B. and Beulah Hunt, Nancy Allen, and Maude Stark, as individuals, obtained a concession on June 28, 1943, from Sefton Fibre Can Co. of Memphis and the Ordnance Department of the United States Army to operate a cafeteria in the plant of Sefton Fibre Can Co. near Memphis. The Ordnance Department supplied the equipment and the Sefton Fibre Can Co. supplied the space. The four individuals agreed to operate the cafeteria for whatever profit or loss they might derive therefrom. They entered into an agreement among themselves on June 28, 1943, to operate that business as a partnership in which the Hunts would have a one-half interest, Nancy Allen a 39.4 per cent interest, and Maude Stark a 10.6 per cent interest. Those interests were the same as their interests in the partnership272 operating the Southland Cafeteria of Memphis.The income from the operation of the cafeteria at the Sefton Fibre Can Co. plant amounted to $ 11,662.16 for 1943 and to $ 14,495.70 for 1944, of which Nancy Allen's share was $ 4,594.15 for 1943 and $ 5,710.42 for 1944. The petitioner never had any interest in the operation of the Sefton cafeteria.Nancy Allen had formerly assisted her husband for about two years while he was operating a cafeteria in Nashville. She had received no compensation. She acquired some knowledge of the cafeteria business from that experience. She prepared some recipes and menus which she sent to the Memphis cafeteria. She made two trips to Memphis during the taxable years in connection with the operation of the Memphis cafeteria. She received reports from the Memphis cafeteria showing the daily menus.The petitioner was engaged during the taxable years and for some time prior thereto in the operation of the Southland Cafeteria in Nashville. He was sole owner at the beginning of 1943. There were in that cafeteria at that time several pinball and record-playing machines which could be operated by the deposit of a coin. The machines were not owned by the273 petitioner. The arrangement between the owner of the machines and the petitioner was that the owner of the machines would take 50 per cent of the money deposited in the machines and the petitioner would take the other 50 per cent. 230 The manager of the restaurant, employed by the petitioner, was always present when the owner of the machines came to take the money from the machines and this manager received the 50 per cent which was to go to the petitioner. The petitioner told his wife in the latter part of 1942 that she could have the benefit of the pinball and record-playing machine concessions in the Southland Cafeteria in Nashville. Thereafter she agreed with the manager of the cafeteria that he could have 10 per cent of her share for being present when the money was taken from the machines and seeing that one-half came to her.The petitioner sold a one-third interest in the Nashville cafeteria to the Starks on January 10, 1943, and entered into an agreement with them in which it was provided that Nancy Allen was to receive two-thirds of the net revenue from the coin machines after paying the manager's share of 10 per cent, and the remainder was to be paid to the Starks. 274 The petitioner and the Starks took in another partner on March 1, 1944, in the operation of the Southland Cafeteria of Nashville. The partnership agreement was in part as follows:Mr. Allen * * is to be manager of the business and is to receive $ 40.00 a week, plus 60 per cent of any cash gained by the business each month, including the revenue from the Victrola, pin-ball, vending and other machines in the grill room, the revenue from which is the property of and is to be divided between his wife, Mrs. Nancy Louise Allen, and Mr. and Mrs. Stark.The money which Nancy Allen received from the operation of the Memphis cafeteria, the Sefton cafeteria, and the coin machines in the Southland Cafeteria of Nashville was deposited by her in her personal account in a bank in Nashville.The Commissioner, in determining the deficiencies, included in the income of the petitioner $ 10,615.71 for 1943 and $ 10,451.05 for 1944 representing Nancy Allen's share of the income of the Memphis cafeteria and the Sefton cafeteria, and he also included in the income of the petitioner $ 991.38 for 1943 and $ 389.99 for 1944 representing income from pinball and record-playing machines received by Nancy Allen. 275 Nancy Allen had reported all of those amounts on her separate income tax returns.OPINION.The Commissioner has taxed Nancy Allen's share of the income of the Memphis and Sefton cafeteria operations for 1943 and 1944 to the petitioner, but has failed to advance any legal justification for his action. The income in question was earned by 231 partnerships of which the petitioner was not a member and from which he was not entitled to receive anything. This is not a family partnership case like the cases of , and , in which a husband sought to escape tax on income which he earned. The petitioner in the present case did not earn the income in question. It does not appear that capital was a material income-producing factor or that the petitioner's wife contributed services vital to the two partnerships, but that is not determinative where, as here, the income can not be attributed either to capital contributed by the husband or to services performed by him. .276 This is a stronger case for the taxpayer than .The remaining question is whether the Commissioner erred in taxing to the petitioner income from the pinball and record-playing machines claimed by his wife to be her income. The petitioner testified that he gave his wife the pinball and Victrola "concession" in his restaurant. Actually he had already arranged for the owner of the machines to have the concession, and, so far as this record shows, there was never any dealing between the wife and the owner of the machines. The owner of the machines was required to pay for the privilege of having his machines stand in a restaurant owned by the petitioner. He agreed to pay one-half of the intake of the machines for that privilege. It does not appear that the petitioner gave to his wife any capital asset producing income or that he did anything more substantial than simply to allow her to take a part of what he was entitled to receive for permitting the machines to stand in his restaurant. Furthermore, shortly after he made this statement to his wife he took in partners and gave them a one-third interest in the277 restaurant. These people took a one-third interest in the one-half of the intake of the machines. In other words, the petitioner reduced the share which his wife was to take from the machines. A later partnership agreement is not entirely clear on this point, but these two agreements show that the petitioner dealt with the income from the machines as his own. Although his wife was made a party to the agreements, she received no consideration for giving up a part of the income from the machines. It has been held that one can not escape tax on income by giving the income away. ; . The evidence on this point does not show any error in the determination of the Commissioner.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623402/	Helen M. Lutter, Petitioner v. Commissioner of Internal Revenue, RespondentLutter v. CommissionerDocket No. 5658-71United States Tax Court61 T.C. 685; 1974 U.S. Tax Ct. LEXIS 149; 61 T.C. No. 72; February 27, 1974, Filed 149 Decision will be entered for the respondent. Petitioner, the mother of two minor children, received aid to families with dependent children (ADC) and medical assistance grants from the State of Illinois. Held: ADC and medical assistance welfare payments do not constitute support provided by petitioner to her children for purposes of the dependency exemption under sec. 151(e), I.R.C. 1954. The grants are provided by the State of Illinois and the Federal Government for the support and benefit of the dependent children themselves and, therefore, represent support received from a source independent of the petitioner. J. Nelson Young, for the petitioner.James D. Thomas150 , for the respondent. Goffe, Judge. GOFFE685 The Commissioner determined a deficiency in the Federal income tax of petitioner in the amount of $ 227 for the taxable year 1969. The sole issue presented for decision is whether the petitioner furnished over half of the support of her two minor children, thus entitling her to dependency exemptions for them under section 151 of the Internal Revenue Code. 1FINDINGS OF FACTSome of the facts have been stipulated. The stipulation of facts and exhibits are incorporated herein. Helen M. Lutter, hereinafter referred to as petitioner, resided in Urbana, Ill., at the time of filing her petition in this proceeding. Her Federal income tax return, a separate return filed as a married person, for the taxable year 1969, was filed with the district director of internal revenue at Springfield, Ill.Throughout 1969 petitioner's two minor children, Vincent and Lorna, ages 151 15 and 9, respectively, resided with her in an apartment located in Champaign, Ill. The petitioner was married, but her husband did not reside with her and did not contribute toward the support of the children. During the taxable year 1969 the petitioner received "Aid to Families with Dependent Children" (ADC) benefit payments in the amount of $ 2,153.97, and medical assistance in the amount of $ 439.87 from the State of Illinois, pursuant to the provisions of subchapter 4, part A, of the Federal Social Security Act and article 4 of the Illinois Public Aid Code. The medical assistance payments were made directly to the persons providing the medical care. Neither the petitioner nor her children received additional income or financial support from any other source during the taxable year except 686 a salary earned by petitioner in the amount of $ 2,442.65 from the University of Illinois. Petitioner would not have been entitled to the grants unless she had dependent children. The welfare benefits were applied by petitioner approximately equally for the support of petitioner and her children.Grant payments and medical assistance received by petitioner in 1969 met the requirements152 for funding by the Federal Government pursuant to the provisions of the Social Security Act and the applicable regulations issued by the Department of Health, Education, and Welfare.The Champaign County Department of Public Aid, from whom petitioner received her ADC payments, never found it necessary to resort to the protective payee device or any other measure in petitioner's case to ensure that the payments would be used in the best interests of petitioner's children. Protective payments are payments made in behalf of the child to a designated person who is interested in or concerned with the welfare of the child and its family. The substitute payee may spend the grant for the child or personally supervise the parent or relative in the use of the grant, depending upon the circumstances of each case. Such payments may be resorted to in cases only when it has been clearly determined that a recipient of a grant persistently mismanages his or her assistance payments to the detriment of the children.Evidence of mismanagement of funds must be specific and include the following factors: (1) Continued inability to plan expenditures wisely and to spread necessary expenditures over the153 usual assistance planning period; (2) persistent and deliberate failure to meet obligations for rent, food, school supplies, and/or other essentials; (3) repeated evictions or incurrence of debts with attachment or levies made against current income; and (4) continued evidence that the children are not properly fed or clothed and that expenditures for them are made in such a way as to threaten their chances for healthy growth and development.The number of individuals for whom protective payments are made who can be counted as recipients for Federal financial participation in any month is limited to 10 percent of the number of other ADC recipients in the State for that month. The State may determine a percentage limitation to be utilized in its administrative subdivisions if the percentage limitation for the State as a whole is not exceeded.Petitioner was aware of her obligation to use the ADC payments for the benefit of her children. However, she received no directions from the Illinois Department of Public Aid with respect to amounts she was permitted to spend for rent, food, clothing, or other items, nor was she required by such department to make an accounting to the department154 with respect to such expenditures. She was free to spend the 687 grant payments for the benefit of her children in any manner that she saw fit. The money could be used for her living expenses if such expenditures were in the best interests of her children.The petitioner served the Champaign County Department of Public Aid as a volunteer worker in assisting other recipients of ADC grant payments who requested help in resolving problems of budgeting and financial management.In his statutory notice of deficiency the Commissioner disallowed the dependency exemptions claimed by petitioner with the explanation that "Since State benefit payments are based solely on need, welfare payments to an individual are considered as having been spent by the recipient for his support, regardless of how the payments were utilized. Therefore, the exemption claimed is not allowable."OPINIONThe precise question presented is whether ADC payments and medical assistance from the State of Illinois received by petitioner for her children constitute support of the children by petitioner for purposes of deductions for dependency exemptions under section 151. There is no dispute as to the facts. 155 If such payments represent support furnished by petitioner to her children, she has furnished over half of their support and is entitled to the deductions because she otherwise qualifies.The Federal and Illinois statutes providing for the payments received by petitioner provide an insight into the question presented here.The Social Security Act provides for appropriations for ADC grants and child welfare services to enable each State to furnish financial assistance, rehabilitation, and other services as far as practicable under the conditions in that State, to needy dependent children and the parents or relatives with whom they are living. 42 U.S.C. secs. 601-610. The purposes of the grants are to encourage the care of dependent children in their own homes or in the homes of relatives; to help maintain and strengthen family life; and to help such parents or relatives attain or retain the capability for the maximum self support and personal independence consistent with the maintenance of continuing parental care and protection. The term "aid to families with dependent children" is defined in the Act as follows:(b) * * * money payments with respect156 to, * * medical care in behalf of or any type of remedial care recognized under State law in behalf of, a dependent child or dependent children, and includes (1) money payments or medical care or any type of remedial care recognized under State law to meet the needs of the relative with whom any dependent child is living * * , and (2) payments with respect to any dependent child (including payments to meet the needs of the relative, and the relative's spouse, with whom such child is living, and the needs of any other individual living in the same home if such 688 needs are taken into account in making the determination under section 602(a) (7) of this title) which do not meet the preceding requirements of this subsection, but which would meet such requirements except that such payments are made to another individual who (as determined in accordance with standards prescribed by the Secretary) is interested in or concerned with the welfare of such child or relative, or are made on behalf of such child or relative directly to a person furnishing food, living accommodations, or other goods, services, or items to or for such child, relative, or other individual, but only with 157 respect to a State whose State plan approved under section 602 of this title includes provision for --(A) determination by the State agency that the relative of the child with respect to whom such payments are made has such inability to manage funds that making payments to him would be contrary to the welfare of the child, and, therefore, it is necessary to provide such aid with respect to such child and relative through payments described in this clause (2);(B) undertaking and continuing special efforts to develop greater ability on the part of the relative to manage funds in such manner as to protect the welfare of the family;(C) periodic review by such State agency of the determination under clause (A) to ascertain whether conditions justifying such determination still exist, with provision for termination of such payments if they do not and for seeking judicial appointment of a guardian or other legal representative, as described in section 1311 of this title, if and when it appears that the need for such payments is continuing, or is likely to continue, beyond a period specified by the Secretary;(D) aid in the form of foster home care in behalf of children described in section158 608(a) of this title; and(E) opportunity for a fair hearing before the State agency on the determination referred to in clause (A) for any individual with respect to whom it is made; [42 U.S.C. sec. 606(b).]The Social Security Act provisions relating to ADC payments provide that if a State agency has reason to believe that any ADC payments are not being used or may not be used in the best interests of the child, the State agency may provide for counseling and guidance services with respect to the use of such payments and the management of other funds by the relative receiving the payments as deemed advisable "in order to assure use of such payment in the best interests of such child." The State agency may also provide for warning such relative that continued failure to use the payments for the child's benefit will result in (1) the substitution of protective payments as outlined in section 606(b)(2), 42 U.S.C.; (2) the seeking of the appointment of a guardian or legal representative; or (3) the imposition of criminal or civil penalties authorized under State law if it is judicially determined that the relative is not using or has not used the 159 payments for the benefit of the child.The Illinois Public Aid Code provides that if the ADC payments for basic maintenance are not being used in the best interests of the child and the family and if there is a present or potential damage to the standards of health and well-being which the grant is intended to assure, counseling and guidance services must be provided the parent or relative with respect to the use of the grant and the management 689 of other funds available to the family as necessary "to assure use of the grant in the best interests of the child and family." If mismanagement of the grant continues, the county department is required to initiate one of the following actions:1. Provide for protective payment to a substitute payee.2. Provide for issuance of the grant, wholly or in part, in the form of disbursing orders.3. File a petition under the "Juvenile Court Act" for an Order of Protection for the child.4. Institute a proceeding for the appointment of a guardian or legal representative for the purpose of receiving and managing the public aid grant.5. File a neglect petition requesting the removal of the child.It appears to us that the primary purpose of160 the statutes, both Federal and Illinois, is to protect dependent children by payments to the parents or relatives with whom they reside.The payments depend upon the existence of dependent children; they may be paid to someone other than the parent for the benefit of the child; and the payments are based upon the number of children and are earmarked for the children.The parties here disagree on the purpose of the statutes described above. Petitioner contends that the statutes are designed to protect the family unit by giving to the parent funds to insure that the family may remain together to best provide for all the needs of the child. Such funds, reasons petitioner, constitute support of the child furnished by the parent. Respondent contends that the funds are provided by the Government directly to the dependent child by entrusting in the parent, or other relative, wise expenditures of the funds for the benefit of the child.Both parties stress the importance of the provisions for insuring that the payments are expended for the best interests of the dependent child. The States are required to provide for protective payees in the event the parent does not show sufficient responsibility161 in expending the funds for the benefit of the child. 45 C.F.R. sec. 234.60 (1972).We agree with respondent that the parent is, in effect, accountable to the State for the expenditures for the benefit of the child. It is true that the parent receiving the ADC payments has the freedom to determine day-to-day expenditures, and we recognize that the status of the parent is not that of a trustee or a guardian as being chargeable for past wrongdoing. Nevertheless, the wisdom of the parent in applying the funds for the benefit of the child is subject to scrutiny and lack of responsibility is dealt with prospectively.Petitioner attaches significance to the fact that Illinois law imposes a legal duty on all parents to support their minor children, regardless of the source of support. We recognize the existence of such a duty but point out that the Illinois courts apply such sanctions as they may deem appropriate in each case. The sanctions provided for ADC, however, 690 are distinct from the sanctions imposed for failure to support; they are imposed upon the unwise expenditure of ADC funds, not the failure of the parent to generally provide for the child's support.Petitioner 162 stresses the fact that the protective payee provision is an extraordinary measure sparingly applied and was not applied in her case. However limited the provision might be, it nevertheless exists. The extent of its application and its application to petitioner's situation do not detract from its obvious purpose to protect the interests of the dependent child.Petitioner asserts that she had a legally enforceable economic right to receive the welfare benefits under the holding of Goldberg v. Kelly, 397 U.S. 254">397 U.S. 254 (1970), and that the payments must be accorded the same status as additional earnings or gifts received by petitioner which were applied to the support of herself and her children. She emphasizes that she enjoyed the same degree of freedom and control with respect to the expenditure of the ADC funds as do other parents in the expenditures of their resources for their family support.Goldberg v. Kelly, supra, involved the very narrow constitutional question of whether the due process clause of the 14th amendment required an evidentiary hearing before welfare benefits could be terminated. The Supreme Court163 held that such a hearing was required to insure continuation of the recipient's bare necessities and such consideration outweighed the Government's interest in a summary adjudication. The Court in a footnote at 397 U.S. 262">397 U.S. 262 fn. 8, observed that welfare benefits should be regarded as a property rather than a gratuity. The Court did not, however, determine the recipient of the benefit although it may have described the nature of the benefit. Our conclusion that the benefit belongs to the dependent child, not the parent, does not conflict with the rationale of Goldberg v. Kelly, supra.We see little difference between ADC benefits for the child paid to the parent and support in kind furnished by an institution.We held in Hazel Newman, 28 T.C. 550">28 T.C. 550 (1957), that although only the taxpayer paid funds to certain institutions for the support of her niece and nephews, she was not entitled to claim the minor children as exemptions because such payments constituted less than one-half of the total dollar value of the support provided by the institutions. See also John L. Donner, Sr., 25 T.C. 1043">25 T.C. 1043 (1956).164 We hold, therefore, that the ADC benefits were received by petitioner for the benefit of her minor children and constitute "support" by the State of Illinois, not "support" furnished by petitioner. Petitioner has, therefore, not furnished over one-half of the support of her two minor children and is not entitled to claim them as dependents on her Federal income tax return for the taxable year 1969.Decision will be entered for the respondent. Footnotes1. All statutory references are to the provisions of the Internal Revenue Code of 1954, as amended.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623403/	GEORGE H. RICHARDS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRichards v. Comm'rNo. 18523-99SUnited States Tax Court2002 Tax Ct. Summary LEXIS 2; 2002 T.C. Summary Opinion 3; January 14, 2002, Filed 2 PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b), THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE. George H. Richards, pro se.Monica J. Miller, for respondent. Panuthos, Peter J.Panuthos, Peter J.PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.Respondent determined a deficiency in petitioner's Federal income tax for the taxable year 1997 of $ 1,334. At some point before trial, petitioner conceded the adjustment in the notice of deficiency; however, each party made additional claims. The issues remaining for decision are: (1) Whether petitioner is entitled to the claimed dependency exemption deductions; (2) whether petitioner is entitled to head-of-household filing status; (3) whether3 petitioner is entitled to the additional claimed alimony deduction; and (4) whether petitioner is entitled to the claimed Schedule C, Profit or Loss From Business, expense deductions.Some of the facts have been stipulated, and they are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference.Petitioner lived in Clearwater, Florida, at the time he filed his Tax Court petition.BackgroundPetitioner was employed by an architectural firm as a licensed architect during 1997. Petitioner and his wife, Virginia Richards (Ms. Richards), had three children, Matthew, Brigid, and Shannon, who in 1997 were ages 17, 13, and 11, respectively. Petitioner, Ms. Richards, and their children lived together in the marital home until July 25, 1997, when petitioner and Matthew moved out. Although Matthew moved into a new residence with petitioner in July 1997, the record is unclear as to whether Matthew continued to live with petitioner for the remainder of 1997. Ms. Richards continued to live in the marital home with Brigid and Shannon for the remainder of the year.Ms. Richards was awarded permanent custody of all three children. Petitioner and Ms. 4 Richards were divorced in August 1998. Effective August 1, 1997, petitioner was obligated to pay $ 784.62 biweekly in alimony and $ 346.84 biweekly in child support pursuant to the terms of the Report and Recommendation of General Master on Motion for Temporary Relief (the Report) and the Order of the Pinellas County Circuit Court (the Order). Petitioner did not pay the full amount of the alimony as scheduled. The records that petitioner submitted, including a Family Law Case History from Pinellas County, photocopies of petitioner's calendar with handwritten notes and calculations, photocopies of petitioner's handwritten checking account balance sheets, and Ms. Richards's handwritten notes with photocopies of canceled checks that respondent submitted indicate that petitioner made the following alimony and child support 5 payments:DateAlimonyChild Support8/4/97$ 253.16$ 346.848/17/97437.78346.848/30/97---346.849/12/97---346.849/14/97346.84---9/26/97---346.8410/6/97253.16346.8410/24/97---346.8411/10/97359.63346.8411/24/97359.63346.8412/9/97359.63346.8412/21/97359.63346.84Total2,729.463,815.24 [7] In addition to6 his employment with the architectural firm, petitioner performed architectural computer-aided design (CAD) drafting services in the evenings. During the period he resided at the marital home, petitioner performed the CAD drafting on his computer at a computer desk in a room in the marital home that he exclusively used as his home office. The square footage of the room in which petitioner performed the CAD drafting was 13 percent of the square footage of the marital home. After petitioner moved on July 25, 1997, he performed the CAD drafting in the kitchen area of each of the rental units in which he lived. Petitioner often drove from his residence to a client's office to deliver his completed work. Petitioner wanted to develop an Internet Web site to promote his CAD drafting business and to allow him to work from any location. This Web site was never completed.Petitioner filed a 1997 Federal income tax return 1 in which he claimed, among other items, head-of-household filing status, dependency exemption deductions for his three children, and an alimony deduction of $ 2,515.7 Petitioner filed an amended 1997 Federal income tax return dated May 15, 2000, in which he increased the amount of his alimony deduction to $ 4,991. With his amended return petitioner included a Schedule C relating to his drafting activity on which he reported gross income of $ 3,840 and a net loss of $ 1,548. Petitioner deducted the following expenses on his 8 Schedule C:ExpenseAmountCar and truck1 $186Depreciation and sec. 179 expense3,485Office expense57Rent or lease—vehicles, machinery, and equipment189Rent or lease—other business property1 401Repairs and maintenance30Supplies181Taxes and licenses90Utilities289Other expenses (books)16Expenses from business use of house464Total5,388Ms. Richards filed a separate income tax return for9 the 1997 tax year. On Schedule A, Itemized Deductions, attached to her return, she claimed deductions for both mortgage interest and real estate taxes. Ms. Richards initially claimed dependency exemption deductions on her 1997 return for Brigid and Shannon, but she did not claim dependency exemption deductions on her amended return.After trial, respondent filed (1) a motion to file an answer to conform the pleadings to the proof, which the Court granted, and (2) an answer to amended petition.DiscussionAs a preliminary matter, we note that petitioner conceded the adjustment determined in the notice of deficiency. After the issuance of the notice of deficiency, in the amended petition and at trial, petitioner raised the issues concerning his Schedule C expenses and his increased alimony deduction; accordingly, petitioner bears the burden of proof on those issues. 2 Rule 142(a)(1).10 In his answer to amended petition, respondent denied the allegations in the amended petition and made affirmative allegations that petitioner was not entitled to dependency exemption deductions and head-of-household filing status. These are new matters for which respondent bears the burden of proof. Id.Issue 1. Dependency Exemption DeductionsA dependent is defined as an individual, such as a son or daughter of the taxpayer, over half of whose support for the calendar year was received from the taxpayer. Sec. 152(a)(1); sec. 1.152-1(a), Income Tax Regs. As relevant here, the child must not have attained the age of 19 by the close of the calendar year. Sec. 151(c)(1)(B)(i).Support includes food, shelter, clothing, medical and dental care, education, and the like. Sec. 1.152-1(a)(2)(i), Income Tax Regs. The total amount of support for each claimed dependent furnished by all sources during the year in issue must be established by competent evidence. Blanco v. Commissioner, 56 T.C. 512">56 T.C. 512, 514 (1971). The amount of support that the claimed dependent received from the taxpayer is compared to the total amount of support11 the claimed dependent received from all sources. Sec. 1.152-1(a)(2)(i), Income Tax Regs. It must also be established that the taxpayer provided more than one-half of the total support for each claimed dependent. Secs. 151 and 152; sec. 1.152-1(a)(1), Income Tax Regs.In the case of a child who receives over half of his support from parents who are divorced or legally separated under a decree of divorce or separate maintenance under section 152(e)(1)(A)(i), or separated under a "written separation agreement" under section 152(e)(1)(A)(ii), 3 and the child is in the custody of one or both parents for more than one-half of the calendar year, then such child shall be treated as receiving over one-half of his support from the parent having custody for a greater portion of the calendar year. Sec. 152(e)(1).12 The custodial parent is the parent who has custody of a child for the greater portion of the year. Id. The noncustodial parent may claim the dependency exemption deduction, and a dependent may be treated as having received over one-half of his support from the noncustodial parent, if the custodial parent signs a written statement that she will not claim the child as a dependent for the taxable year, under section 152(e)(2)(A). The noncustodial parent must then attach this waiver to his return. Sec. 152(e)(2)(B); sec. 1.152-4T(a), Q& A-3, Temporary Income Tax Regs., 49 Fed. Reg. 34459 (Aug. 31, 1984).Respondent argues (and has the burden of proving) that petitioner is not entitled to the dependency exemption deductions claimed for his three children. Respondent has not argued that petitioner and Ms. Richards were not legally separated under section 152(e)(1)(A)(i), or that there was no "written separation agreement" under section 152(e)(1)(A)(ii). Respondent did not present evidence that anyone, including Ms. Richards, other than petitioner provided any support for the children. See sec. 1.152-1(a)(2)(i), Income Tax Regs.Respondent did not13 present evidence that Matthew did not live with petitioner for a greater portion of the year and, therefore, has not met his burden of proof. Accordingly, petitioner was the custodial parent for Matthew in 1997 under section 152(e)(1). Therefore, petitioner provided over half of Matthew's support, and he is entitled to a dependency exemption deduction for Matthew for 1997. See sec. 152(a)(1).Ms. Richards was the custodial parent for Shannon and Brigid in 1997. As previously indicated, petitioner, as the noncustodial parent, would be entitled to the dependency exemption deductions for Shannon and Brigid only if he attached the proper waiver signed by Ms. Richards to his return. Respondent neither asserted nor presented evidence that petitioner failed to attach a waiver signed by Ms. Richards to his return as required by section 152(e)(2). While we recognize that proof of a negative may be difficult, a copy of a transcript indicating that no such waiver was attached to the 1997 return would have provided some evidence on this matter. Cf. Kessler v. Commissioner, T.C. Memo. 1977- 117 (determining that the taxpayer, who had the burden of proof, met the burden of proving14 the negative by providing credible testimony). The copy of petitioner's electronically filed 1997 return produced to the Court does not indicate whether petitioner attached a waiver or subsequently mailed a waiver to the Internal Revenue Service. We are unable to find that a waiver was not attached or mailed separately, along with Form 8453, U.S. Individual Income Tax Declaration for Electronic Filing. 4 Thus, we cannot conclude that respondent met his burden of proof.15 Accordingly, petitioner is allowed the claimed dependency exemption deductions.Issue 2. Head-of-Household Filing StatusFor a taxpayer to qualify for head-of-household filing status, he must satisfy the requirements of section 2(b). An individual shall be considered a head of household if he is not married at the close of the taxable year, is not a surviving spouse, and, in relevant part, maintains as his home a household which constitutes for more than one-half of the taxable year the principal place of abode of a child as a member of such household. Sec. 2(b)(1)(A)(i). An individual maintains a household only if he furnishes over half of the costs of maintaining the household during the taxable year. Sec. 2(b)(1); sec. 1.2-2(b)(1), Income Tax Regs. The costs of maintaining the household include property taxes, mortgage interest, utility charges, upkeep and repairs, property insurance, and food consumed on the premises. Sec. 1.2-2(d), Income Tax Regs.An individual who is married shall not be considered married if he is legally separated from his spouse under a decree of divorce or of separate maintenance. Secs. 2(b)(2)(B) and (c), 16 7703(a).Petitioner claimed head-of-household filing status on his 1997 return. Respondent has argued (and has the burden of proving) that petitioner is not entitled to the claimed head-of-household filing status.Although petitioner was married in 1997, he will not be treated as married for purposes of section 2 because, as discussed above with respect to section 152(e)(1)(A), there has been no argument or facts produced that indicate that petitioner and Ms. Richards were not legally separated under a decree of separate maintenance.The facts of the case indicate that petitioner furnished over one-half of the costs of maintaining the household at the marital home (e. g., he paid the mortgage, real estate taxes, and utilities). Petitioner's marital home constituted a household that was the principal place of abode for at least one-half of the year for all three of his children, for whom he is entitled to dependency exemption deductions under section 151, as discussed above. Accordingly, petitioner is eligible for head-of-household filing status.Issue 3. AlimonyA taxpayer is allowed as a deduction an amount equal to the amount paid that constitutes "alimony"5 or a "separate17 maintenance [payment]" paid during his taxable year under section 215(a). Alimony is defined as a payment in cash that satisfies a four-part test set forth in section 71(b)(1).Respondent does not dispute that petitioner was responsible for paying alimony to Ms. Richards, and we are satisfied that the payments constitute alimony for purposes of sections 215 and 71(b). Respondent disputes the amount petitioner claimed as an alimony deduction on his amended return.Payments that constitute support of minor children are not included in the definition of alimony and are not deductible. Secs. 71(c), 215(b). If any payment that is made is less than the full amount specified in the instrument, then the payment amount that does not exceed the sum payable for support shall be considered a payment for child support. Sec. 71(c)(3); Blyth v. Commissioner, 21 T.C. 275">21 T.C. 275, 279 (1953).Pursuant to the terms of the Report and the Order, petitioner was directed to18 make biweekly payments to Ms. Richards of $ 784.62. Petitioner produced documents indicating that he paid Ms. Richards alimony of $ 2,729.466 in 1997; therefore, petitioner is allowed a deduction for alimony in that amount.Issue 4. Schedule C Expense DeductionsDeductions are a matter of legislative grace, and a taxpayer must establish his right to the deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79">503 U.S. 79, 84 (1992).Under section 162, a deduction is allowed for ordinary and necessary expenses that are paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). Section 167 allows a depreciation19 deduction for property used in a trade or business or held for the production of income. Sec. 167(a).Generally, a taxpayer is required to substantiate deductions by maintaining books and records sufficient to establish the amount of his deductions. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs. If a taxpayer is unable to fully substantiate the expenses incurred in his trade or business but there is evidence that deductible expenses were incurred, the Court may nevertheless allow a deduction based upon an approximation of expenses. Ellis Banking Corp. v. Commissioner, 688 F.2d 1376">688 F.2d 1376 (11th Cir. 1982), affg. in part and remanding in part T.C. Memo. 1981-123; Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731">85 T.C. 731, 742-743 (1985).Respondent does not dispute and we conclude that petitioner was in the trade or business of performing architectural CAD drafting services in 1997. Respondent argues that petitioner failed to substantiate the expenses for which he claimed deductions on his Schedule C. We shall discuss each claimed expense below.A. Car and Truck ExpensesPetitioner20 claimed a deduction of $ 186 on his Schedule C for car and truck expenses. It is not clear from his Schedule C or the attached Form 4562, Depreciation and Amortization, whether the claimed amount represents depreciation for his Nissan Altima automobile, a standard mileage allowance, or actual expenses such as gasoline and tolls.To deduct expenses, such as depreciation, with respect to "listed property" under section 280F(d)(4)(i), which includes an automobile, the taxpayer must comply with strict substantiation requirements under section 274(d)(4). Section 274 requires, in relevant part, that the taxpayer substantiate by either adequate records or sufficient corroborating evidence the following items: (1) The amount of the claimed expense; (2) the time and place of the use of the property; and (3) the business purpose of the expense. Sec. 274(d); sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Even if such an expense is otherwise deductible, the deduction for the listed item may be denied if the substantiation is insufficient to support it. Id. The substantiation requirements under section 274 override the21 general substantiation requirements of section 6001 and Cohan v. Commissioner, supra.A self-employed individual may deduct a mileage allowance under section 62(a)(1), section 1.274-5T(c)(2)(ii), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985), and section 1.274(d)-1, Income Tax Regs.Dehr v. Commissioner, T.C. Memo. 1998-441. A deduction for a mileage allowance requires the same substantiation under section 274 as set forth above (i. e., amount, time and place, and business purpose). The amount of the mileage can be substantiated by any reasonable means, such as using a contemporaneous business log, or otherwise establishing the miles driven. Smith v. Commissioner, 80 T.C. 1165">80 T.C. 1165 (1983). The Commissioner is authorized to establish the standard mileage rate that is deemed to satisfy the substantiation requirements and has done so for 1997. Sec. 1.274(d)-1(a), Income Tax Regs.; Rev. Proc. 96-63, 1996-2 C. B. 420.Actual allowable expenses such as gasoline and tolls are deductible if incurred in a trade or business and if22 they do not constitute personal commuting expenses. Sec. 162; Green v. Commissioner, 59 T.C. 456">59 T.C. 456 (1972); sec. 1.162-1(a), Income Tax Regs.Petitioner's Nissan Altima qualifies as "listed property" under sections 274(d)(4) and 280F(d)(4)(A)(i). Petitioner has not provided any facts in support of depreciation of the automobile. Therefore, the deduction for depreciation of the automobile is denied.Petitioner produced a handwritten list approximating his miles driven and tolls paid. This list provides no assistance as to whether petitioner has claimed as a deduction a standard mileage rate or actual expenses. To the extent that this list reflects mileage, it does not appear to be a contemporaneous log. See Smith v. Commissioner, supra. It also fails to establish petitioner's time, place, and business purpose of the miles driven. Therefore, petitioner has not substantiated the deduction for a mileage allowance, and it is denied.To the extent that petitioner's handwritten list reflects actual expenses associated with the automobile, petitioner has not substantiated any expenses except for tolls of $ 24, which we allow as a deductible23 expense.Accordingly, except with respect to the $ 24 deduction for tolls, petitioner has failed to substantiate these deductions, and they are denied.B. Depreciation and Section 179 ExpenseA taxpayer may elect to deduct as a current expense the cost of any "section 179 property" which is acquired by purchase for use in the active conduct of a trade or business. Sec. 179(a), (d)(1). Section 179 property is tangible property to which section 168 applies and which is section 1245 property. 7Sec. 179(d)(1); sec. 1.179-4(a), Income Tax Regs.Computer equipment is "listed property" under section 274(d)(4), as defined under section 280F(d)(4)(A)(iv), unless it falls under the exception in section 280F(d)(4)(B). Computer equipment is excepted from the definition of listed property under section 274 (and will, therefore, not be subject to24 the substantiation requirements for listed property under section 274 and section 1.274-5T(b)(6), Temporary Income Tax Regs., supra) if it is used exclusively at a regular business establishment and owned or leased by the person operating such establishment. Sec. 280F(d)(4)(B). A regular business establishment includes a home office for which the requirements of section 280A(c)(1) are met. Id.Section 179 has its own substantiation and election requirements. The taxpayer must maintain records reflecting how and from whom the section 179 property was acquired, and when it was placed in service. Sec. 1.179-5(a), Income Tax Regs. The taxpayer is also required to elect on his first return for the taxable year or on a timely filed amended return as a separate item the total section 179 expense deduction claimed with respect to all section 179 property selected and the portion of that deduction allocable to each specific item. Id.Petitioner indicated on Form 4562 attached to his Schedule C that he elected to deduct computer equipment as a current expense under section 179. Petitioner's computer equipment qualifies as section 179 property25 because it is tangible property to which section 168 applies. Secs. 167(a)(1) and 168(f). The computer equipment also qualifies as section 1245 property. Sec. 1245(a)(3).Petitioner's computer equipment is not listed property under section 274(d)(4) because it falls under the home office exception to section 274 under section 280F(d)(4)(B) and section 280A(c)(1), as discussed below. Therefore, the computer equipment is not subject to the substantiation requirements of section 274. Nevertheless, the computer equipment is subject to the substantiation and election requirements of section 179 and general substantiation requirements.Although petitioner produced many receipts reflecting purchases of computer equipment, all receipts except one reflect a subsequent tax year and cannot be used to substantiate purchases of property for 1997. The one receipt from 1997 indicates a purchase of computer equipment of $ 32.09.Petitioner failed to maintain records reflecting the cost of the computers, the use of the property, the date of the use, the business purpose of the property, from whom the equipment was acquired, and when the computer equipment was placed in service, as required by section 1.179-5(a), Income Tax Regs.26 In addition, petitioner's amended return was dated May 15, 2000, and filed sometime thereafter. Petitioner's 1997 return was due on April 15, 1998, so the amended return was not timely filed. Accordingly, petitioner is denied the deduction for his computer equipment.C. Expenses From Business Use of HomePetitioner deducted depreciation of the marital home, a casualty loss, mortgage interest, real estate taxes, insurance, and utilities in connection with the business use of his home on Form 8829, Expenses for Business Use of Your Home, attached to his return.Deductions for expenses attributable to the taxpayer's business use of his home are disallowed unless they fit within the exceptions under section 280A. Sec. 280A(a). A deduction may be allowed to the extent the item is allocable to a portion of the home which is exclusively used on a regular basis as the principal place of business for his trade or business. Sec. 280A(c)(1)(A).Deductions for expenses related to the business use of a taxpayer's home are further limited by section 280A(c)(5) to the excess of the gross income derived from the use of the home office over the deductions allocable to the home office that are otherwise27 allowable.As the facts indicate, during the period from January 1 through July 25, 1997, petitioner used a room in the marital home exclusively as his work space for his drafting activity. Petitioner also used the room as such on a regular basis throughout this period.After petitioner moved from the marital home, he performed his drafting in the kitchen of each of his subsequent apartments. Because petitioner did not use a portion of each rental unit exclusively for his drafting activity, petitioner is not allowed a deduction after July 25, 1997.Petitioner and respondent agreed that petitioner is allowed a deduction for home mortgage interest and real estate taxes of $ 2,555 and $ 683, respectively, for 1997. Accordingly, the portions of the mortgage interest and real estate taxes that are allocable to the portion of petitioner's marital home devoted to his home office during the period from January 1 through July 25, 1997, are expenses in connection with the business use of his home and deductible on Schedule C.828 Petitioner claimed a deduction for utilities as part of his deduction for the business use of his home and also as a separate expense on the Schedule C. Petitioner failed to explain why he deducted the same item twice or that the items are not, in fact, duplications. The deduction for utilities is allowed as an expense with respect to the home office only.Petitioner has not substantiated his basis in the marital home, the casualty loss, or the insurance. Accordingly, the home office expense deduction with respect to these items is disallowed.D. Office Expense, Supplies, Taxes and Licenses, Utilities, and Other Expenses [58] We are satisfied that petitioner has provided credible evidence relating to the following CAD drafting expenses: Office expenses of $ 57; supplies of $ 181; taxes and licenses of $ 90; utilities of $ 289; and books of $ 16. These amounts are deductible under section 162.Petitioner provided evidence concerning the attempted creation of his Web site. Because petitioner primarily intended for the Web site to promote his CAD drafting services, it is a deductible advertising expense under section 162.Petitioner has29 failed to provide any facts concerning the expenses relating to the following claimed deductions: Rent or lease of vehicles, machinery, and equipment; rent or lease of other business property; and repairs or maintenance. Accordingly, these expenses are disallowed.Reviewed and adopted as the report of the Small Tax Case Division.To reflect the foregoing,Decision will be entered under Rule 155. Footnotes1. The return was electronically filed. This is relevant with respect to the issue of whether a waiver was attached to the return, as will be discussed infra . Sec. 152(e)(2)(B)↩.1. The exact amount of this expense is unclear from the copy of the Schedule C but has been derived using the total.↩2. Sec. 7491 does not apply to shift the burden of proof to respondent on these issues because petitioner has neither alleged that sec. 7491 is applicable nor established that he complied with the requirements of sec. 7491(a)(2)(A) and (B) to substantiate items, maintain required records, and fully cooperate with respondent's reasonable requests.↩3. Sec. 152(e)(1)(A)(iii)↩ concerns parents living apart at all times during the last 6 months of the taxable year. This section is not applicable because petitioner was not living apart from Ms. Richards at all times during the last 6 months of 1997.4. Respondent asserts in his answer to amended petition that Ms. Richards initially claimed two children as dependents; accordingly, respondent concluded that she did not sign a waiver. We note that while Ms. Richards initially claimed her two daughters as dependents on her separate income tax return, she did not claim the children as dependents on her amended return for the 1997 tax year and she testified at trial that she was not entitled to. Ms. Richards's treatment of the dependency exemption deductions on her original and amended returns does not affect the outcome of this issue as to petitioner. Nevertheless, allowing petitioner the dependency exemption deductions does not create a result inconsistent with Ms. Richards's treatment of this item.↩5. The Order refers to the payments as "alimony".↩6. We have credited petitioner with a payment of alimony of $ 346.84 on Sept. 14, 1997. While it may appear that this payment was child support, petitioner met his child support obligation for September 1997 and was not otherwise in arrears. Moreover, petitioner did not designate the payment as child support as he had done with the payments on Sept. 12 and 26, 1997.↩7. Sec. 1245 property is defined in sec. 1245(a)(3) as property subject to the allowance for depreciation under sec. 167↩, including personal property.8. The remaining portion of the mortgage interest and real estate taxes may be deductible by petitioner under sec. 163(h)(3) and sec. 164(a)(1), respectively.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623406/	HARRISBURG HOSPITAL, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Harrisburg Hospital, Inc. v. CommissionerDocket No. 19625.United States Board of Tax Appeals15 B.T.A. 1014; 1929 BTA LEXIS 2751; March 21, 1929, Promulgated 2751 1. An amount was paid by a corporation for selling its capital stock. Although the amount paid was in excess of the amount received from the sale of capital stock, held, no deductible loss resulted. 2. During the years 1922 and 1923 petitioner made expenditures for stenographic hire, miscellaneous office supplies, insurance, advertising and taxes amounting to $1,200.47, of which amount $227.54 represented county and municipal taxes. Held, that all the items except taxes were expenditures in connection with the erection of the hospital and the sale of capital stock, and were not ordinary and necessary expenses of doing business, and, therefore, were not deductible in the years 1922 and 1923. The item of $227.54 for taxes was not a capital item but was deductible during the years when paid or accrued. However, the petitioner in 1922 and 1923 was not engaged in the operation of any trade or business regularly carried on by it and, therefore, does not come within the provisions of section 206(e) and (f) of the Revenue Act of 1924. Allen H. Gardner, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. TRAMMELL 1014 2752 In this proceeding the petitioner seeks a redetermination of a deficiency in income tax for the year 1924 in the amount of $648.32. It alleges error on the part of the Commissioner: (1) In failing to allow as a deduction from gross income in the year 1924 an amount of $3,332.90 representing the difference between the amount of 1015 $4,243.90 paid the Edward J. McCormick Co. for conducting a stock-selling campaign in 1922, and the amount of $911 which was finally collected by the petitioner from the subscribers; (2) in failing to find that the petitioner sustained net losses in the years 1922 and 1923 in the aggregate amount of $1,200.47, and to allow that amount as a deduction from gross income for the year 1924; (3) in failing to find that the petitioner sustained the net loss of $3,330.90 in the year 1924, which amount represents the difference between $4,243.90, the amount paid the Edward J. McCormick Co. for conducting a stock-selling campaign in 1922, and $911, the amount collected by the petitioner from subscribers to capital stock resulting from the campaign. FINDINGS OF FACT. The petitioner is a corporation organized in the year 1921 under the laws of the State2753 of Illinois for the purpose of operating a hospital for profit. Its address was Harrisburg, Ill. During the period from 1922 until February, 1924, the hospital was in process of construction and arrangements were being perfected looking toward the operation thereof. No income, gross, net or otherwise, was received by the petitioner until February, 1924, at which time the construction of the hospital building was completed and the operation of the hospital begun. In the year 1922 the petitioner, in order to raise additional capital, entered into a contract with the Edward J. McCormick Co., Chicago, Ill., in which it was agreed that the petitioner would pay the said Edward J. McCormick Co. the sum of $3,000 to conduct a campaign for the sale of the petitioner's capital stock and, further, that the petitioner would pay certain other expenses of the campaign in an additional amount not to exceed $1,800. Pursuant to this contract the Edward J. McCormick Co. conducted a stock-selling campaign during the months of May and June, 1922. The petitioner during the year 1922 paid out pursuant to the contract the amount of $4,243.90. The total amount of stock subscriptions secured through2754 the efforts of the Edward J. McCormick Co. aggregated $1,310. Of this amount only $911 was ever collected by the petitioner from the subscribers. The payments comprising this amount were collected during the years 1922, 1923, and 1924, the last payment being made in February, 1924. It was determined by the petitioner in the year 1924 that no further amounts could be realized as a result of the stock-selling campaign and that the above-mentioned contract had no further value. The amount of $3,332.90, the difference between the amount paid under the contract, or $4,243.90, and the amount realized therefrom or $911, was included in a deduction from gross income of $6,489.97 1016 claimed by the petitioner in its return of income for 1924. This deduction was disallowed by the respondent in determining the deficiency. During the years 1922 and 1923 the petitioner paid the following amounts: Stenographic hire$595.00Miscellaneous supplies117.53Stationery and printing133.37Postage61.30Insurance42.50Advertising17.00Telegrams$4.98Safety deposit box rental1.25County and municipal taxes227.54Total1,200.47None of the above2755 amounts were allowed as deductions by the respondent in determining the petitioner's net income for 1924. The stenographer's duties included the writing of letters to obtain information relating to the erection of the hospital and the outfitting thereof and keeping a record of stock subscriptions that were being paid for by partial payments, giving receipts, and performing general office work. The item of miscellaneous supplies, $117.53, covered supplies that were needed during the period of construction, including office furniture and the cost of removing an old house from the hospital lot and mowing the weeds from the lot in accordance with instructions from the chief of police; the item of $61.30 postage represented the cost of stamps; item for insurance, $42.50, was paid for tornado insurance during the erection of the building; advertising, $17, represented the cost of newspaper announcements relating to the erection of the hospital; telegrams, $4.98, represented the amount spent for telegrams to contractors and to supply houses to get quotations on the costs; the item of $227.54 for taxes represented county and municipal taxes, no part of which represented taxes assessed2756 against local benefits of the kind tending to increase the value of the property assessed. The expenditures made in 1922 and 1923, consisting of stenographic hire and all other items, except taxes, and amounting to $972.93, were expenditures connected with stock subscriptions and the construction of the hospital. OPINION. TRAMMELL: The expenditure of $4,243.90 to the Edward J. McCormick Co. as compensation for services in carrying on the selling campaign in an effort to sell the petitioner's capital stock is not an ordinary and necessary expense. See ; ; . Nor in our opinion does the difference between the amount paid for conducting the stock-selling campaign and the 1017 amount received from the stock subscriptions constitute a deductible loss. The fact that the results of the services failed to reach the expectations of the petitioner is not material and does not alter the legal principles involved. The services performed were in connection with capital and the expenditures were capital expenditures. We see2757 no legal distinction between the payment of commissions for the sale of stock and the payment for services in selling stock or undertaking to sell it. In either case the payment is in connection with the acquisition of capital. The mere fact that the result sought was not obtained is not a basis for a deductible loss. A taxpayer might purchase a capital asset at an amount in excess of its actual value, but this does not give rise to a deductible loss in the acquisition. We are, therefore, of the opinion that no loss resulted from this transaction which is deductible from gross income either in 1922, 1923, or 1924. During the years 1922 and 1923 the hospital was in the course of construction and the petitioner expended $972.93 for stenographic hire, office supplies, etc., which related directly to the construction of the hospital or to the collection of stock subscriptions. The expenditures were for correspondence with contractors and architects, and other miscellaneous items which are an additional cost of the building. That portion of the expenditures which related to collection of stock subscriptions also deals with capital to the same extent as expenses incurred in the2758 sale of the stock, and is not a deductible item of expense. We, therefore, are of the opinion that of the $1,200.47, $972.93 consisted of items which were not ordinary and necessary expenses or losses and, therefore, were not deductible in 1922 or 1923. The balance of $227.54 was expended for state, county and municipal taxes. We have held that taxes are deductible in the year when paid or accrued. ; . The only question then remaining is whether or not such expenditures resulted in net losses contemplated by section 206(e) and (f) of the Revenue Act of 1924 as computed under the Revenue Act of 1921. Section 204(a) of the Revenue Act of 1921 provides: That as used in this section the term "net loss" means only net losses resulting from the operation of any trade or business regularly carried on by the taxpayer. Section 206(d)(1) of the Revenue Act of 1924 provides: As used in this section the term "net loss" means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations: 1018 (1) Deductions2759 otherwise allowed by law not attributable to the operations of a trade or business regularly carried on by the taxpayer shall be allowed only to the extent of the amount of the gross income not derived from such trade or business. From the above provisions of the Revenue Acts of 1921 and 1924 it is clear that the loss must result from the "operation of a trade or business regularly carried on by the taxpayer." The petitioner during the years 1922 and 1923 was not actually engaged in carrying on a trade or business. It was merely making preparations to carry on its business and was in the process of erecting a hospital for that purpose. Under these conditions in our opinion the petitioner does not come within the provisions of section 206(e) and (f) of the Revenue Act of 1924 and may not deduct in the year 1924 any amounts expended during the years 1922 and 1923 for taxes which may have been deductible from income in those years under the Revenue Act of 1921. Accordingly, the action of the Commissioner in refusing to permit the petitioner to deduct as a net loss from income during the year 1924 either $3,332.90, or $1,200.47, or any part thereof is approved. Reviewed by the*2760 Board. Judgment will be entered under Rule 50.PHILLIPS AND MILLIKEN dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623409/	John P. Quinn v. Commissioner.Quinn v. CommissionerDocket No. 1484-69SC.United States Tax CourtT.C. Memo 1970-8; 1970 Tax Ct. Memo LEXIS 349; 29 T.C.M. (CCH) 16; T.C.M. (RIA) 70008; January 14, 1970, Filed. John P. Quinn, pro se, 45 Pines Lane, Chappaqua, N. Y., MarwinA. Batt, for the respondent. FORRESTERMemorandum Opinion FORRESTER, Judge: Respondent has determined a deficiency of $227.12 in petitioner's 1966 income tax solely upon the ground that petitioner did not qualify as the head of a household under section 1(b)(2) of the Internal Revenue Code of 1954, since "[he was] not legally separated from [his] wife under a decree of divorce or of separate maintenance." All of the facts are stipulated and they are so found. The stipulation and attached exhibits350 are incorporated herein by this reference. 17 When the petition herein was filed petitioner's legal residence was Chappaqua, New York. Petitioner's individual income tax return for the year in issue was prepared upon the basis of "Unmarried Head of Household (separated)" with the district director, New York, New York. Petitioner and his wife, Barbara, entered into a written separation agreement on September 23, 1964, but neither of them has ever obtained a decree of divorce or of separate maintenance from any court. During the year in issue petitioner provided over one-half of the support of his and Barbara's two minor children, both of whom resided with him during such year. Petitioner admits that under the plain language of section 1(b)(2) and (3)(B), Internal Revenue Code of 19541 he is not entitled to head of household rates but argues that this is because of an oversight on the part of Congress which this Court should now correct. 351 Petitioner points to the language of the report of the Committee on Finance, U.S. Senate, 83d Cong., 2d Sess. (Rept. No. 1622) which provides in pertinent part: VI. SPECIAL INCLUSIONS IN GROSS INCOME A. Alimony and Separate Maintenance Payments (sec. 71) (1) House changes accepted by committee Present law taxes to a recipient and allows the payor a deduction for periodic alimony or separate maintenance payments if the payments are a legal obligation imposed by a court decree or by a written agreement incident to a decree. Attention has been called to the fact that the present treatment discriminates against husbands and wives who have separated although not under a court decree. For this reason both the House bill and your committee's bill extend the tax treatment described above to periodic payments made by a husband to his wife under a written separation agreement even though they are not separated under a court decree if they are living apart and have not filed a joint return for the taxable year. and argues that this clearly discloses the intent of Congress which it, through oversight, failed to fully implement by making requisite changes to section 1(b), supra. 352 Petitioner is asking us to legislate and this we cannot do. Congress considered and changed the provisions of section 71 regarding alimony and separate maintenance payments but it did not change the statutory provisions regarding entitlement to use of head of household rates. Cf. Hans P. Wesemann 35 T.C. 1164">35 T.C. 1164, affirmed per curiam 298 F. 2d 527 (C.A. 2, 1962). Decision will be entered for the respondent. Footnotes1. SEC. 1. TAX IMPOSED. * * (b) Rates of Tax on Heads of Households - (2) Definition of head of household. - For purposes of this subtitle, an individual shall be considered a head of household if, and only if, such individual is not married at the close of his taxable year, * * * * * * (3) Determination of status. - For purposes of this subsection - * * * (B) an individual who is legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married;↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4476087/	OPINION. Hill, Judge: The petitioners in 1947 and again in 1948 transferred certain real property in trust for the benefit of their six children and ten grandchildren, thus creating 16 separate trusts; one for each beneficiary. Each trust provided for the payment of its net income to the beneficiary for life until February 21, 1967, when the trust was to terminate and the corpus was to be distributed to the income beneficiary unless the trust had been previously terminated pursuant to an exercise of the unlimited discretion to accelerate distribution of the corpus given to the trustees. The gifts of corpus are gifts of future interests with respect to which exclusions are not allowable.1 Enjoyment of the corpus is deferred by the terms of the instrument until either February 21, 1967, or such time as the trustees in the exercise of their discretion determine to accelerate enjoyment. Since this is true, the gifts of corpus did not create a right in the donees to immediate enjoyment. United States v. Pelzer, 312 U. S. 399. The fact that these interests vested at their creation does not constitute them present interests. Andrew Geller, 9 T. C. 484. The petitioners recognize the rule set forth by the statute and cases and admit that the gifts of corpus made by them would ordinarily be future interests. However, they argue that the gifts of corpus to the ten minor grandchildren constitute present interests because the minors received as of the date of such gifts as much of the use, possession, and enjoyment of every interest or estate which they could possibly have received under the laws of New Jersey. To support their contention, they rely upon the fact that a minor, under the laws of the State of New Jersey, may not be entrusted with the custody or control of property, and any use or enjoyment of the emoluments thereof must be realized through a guardian or trustee. Thus, the petitioners argue, in order to make an effective gift of realty of which the minors could have the use, possession, and enjoyment, the device of guardianship or trusteeship must be used. It appears at once that the petitioners have neglected to distinguish between the purposes which may legally be accomplished by the use of trusts or guardianship. See Scott on Trusts, vol. 1, sec. T, pp. 60-61. In the case at bar, ownership of the property was not given to the minors with actual control in the guardian until the owners became of age; rather trusts were created to last in all but one instance far beyond the coming of age of each minor beneficiary. Thus, the interests created were future interests. In support of their argument on this point, petitioners rely upon Kieckhefer v. Commissioner, 189 F. 2d 118, and Commissioner v. Sharp, 153 F. 2d 163. Neither of these cases sustains the petitioners’ argument here. No right was given to the minor beneficiaries herein to acquire the property free of the trusts before the termination date set forth in the instrument. The court in the Kieclchefer case pointed out that were it not for the minor beneficiary’s power to require the trustee to distribute income and corpus to him, the interests there would have been future interests. As the court in the Kieckhefer case pointed out, the minority of the beneficiary can not convert what would otherwise be a present interest into a future interest. By the same token the minority of the beneficiariés herein can not convert what are otherwise future interests into present interests. The instant case is in no way like Commissioner v. Sharp, supra. The issue there was whether the gift of trust income to a minor beneficiary was a gift of a present interest. The petitioners also rely on Strekalovsky v. Delaney, 78 F. Supp. 556. In that case the trusts provided that upon the demand of a legally appointed guardian of any of the beneficiaries the entire share was to be paid to the guardian. The trusts also provided that during the beneficiary’s minority the trustee should pay any part of the beneficiary’s share for the beneficiary’s benefit as if the interest of the beneficiary were held by the trustee as guardian and as if the trustee were making payment and distributions in that capacity. Concerning this the court said: * * * the second use and purpose above quoted could not set out more clearly that it was the intent of the donor to make an absolute gift for the present use and benefit of each of her children. This is clearly brought out in the last three lines wherein she specified that the trustee was to hold as though he were a guardian. * * * It is not necessary for us to go into the arguments made by the District Court in deciding the Strekalovsky case. It is sufficient to state that the facts of the instant case do not fall within the facts relied upon by the District Court in laying down its opinion. The petitioners’ instrument in no way indicates an intention that the trustees hold as guardian for the minor beneficiaries. If in fact it was the intention of the petitioners to give to the minor beneficiaries herein as great an interest in the ownership, possession and enjoyment of the trust corpus as was permitted by the laws of New Jersey, and we can not find that this was in fact the case, the device chosen by them falls far short of their purpose. The petitioners are bound by the plain terms of their own instrument. The gifts to the minor children of the corpus were gifts of future interests and by the terms of. the statute no exclusion is permissible as to them. Two of the petitioners’ children are trustees of all the trusts. In their own trusts they are both trustee and beneficiary. As pointed out in our findings of fact, under paragraph 2 (b) of the trust agreement the trustees had the power in their sole, absolute, and unlimited discretion to accelerate the distribution of corpus to any of the beneficiaries of the trusts, including themselves. From this the petitioners argue that the gifts of corpus to the two trustee-beneficiaries constitute present gifts for the reason that their dominion and control over their respective trust corpus was for all practical purposes outright ownership. An examination of the trust provision on which the petitioners rely to support their argument on this point indicates that the trustees’ discretion to accelerate was one which must be exercised jointly. Neither could accelerate the enjoyment of the corpus of his trust without the consent of the other. Thus, the rights of each trustee fall far short of the ownership claimed by the petitioners. We, therefore, hold that the gifts of corpus to the two trustee-beneficiaries were future interests for which no exclusion is permissible. It has long been held that a transfer of property in trust may create a present interest in the income and a future interest in the corpus. Sensenbrenner v. Commissioner, 134 F. 2d 883; Fisher v. Commissioner, 132 F. 2d 383. Were it not for paragraph 2 (b) of the instrument here in question, the petitioners would be entitled to the exclusions for which they argue with respect to the gifts of income to each of the sixteen beneficiaries. Paragraph 2 (b) of the instrument provides as follows: 2. (b) Notwithstanding anything to the contrary hereinbefore provided, the Trustees may, in their sole, absolute and unlimited discretion, distribute, pay over and transfer to any of the beneficiaries hereinabove named, the corpus of any of their respective trusts, prior to the date of distribution set forth in each such respective trust; and the Trustees shall not be subject to any test of reasonableness in the exercise of such discretion. It appears at once that the gifts of income are present interests which can not be valued because the trustees could, pursuant to the discretion granted in the above-quoted paragraph, destroy the income interests at any time by an exercise of their unlimited discretion to distribute the corpus. Since the present interests of income can not be valued, no exclusion may be allowed with respect to them and we so hold. Sylvia H. Evans, 17 T. C. 206, affd. 198 F. 2d 435. In the Evans case the taxpayer created separate trusts for the benefit of her six children. Article 1 of the trust deed provided: 1. (a) During the lifetime of each such child Trustees shall pay the net income in quarterly or other convenient installments to him or her, even though a minor, and in addition such sum or sums from principal as in the uncontrolled discretion of the corporate trustee shall be necessary for the education, comfort and support of such child, or of the spouse or children of such child. Thus, the corpus of each trust was entirely exhaustible at the trustee’s discretion. In denying the exclusions, we followed our opinion in William Harry Kniep, 9 T. C. 943, affd. 172 F. 2d 755, in which it was held that gifts of trust income “were capable of valuation, and therefore subject to the statutory exclusion, only to the extent to which they were not exhaustible by the exercise of the right of the trustee to encroach upon the trust corpus.” Here, as in the Evans case, the corpus of each trust involved is entirely exhaustible by the trustees in their uncontrolled discretion. The gifts of income are therefore incapable of valuation and no exclusion is permissible. While the gifts of income are gifts of present interests, the gifts of the corpus are separate and distinct gifts of future interests, which can not be considered in any evaluation of the present interests. This Court, therefore, is unable to place a value upon the beneficiaries’ interests in the income. The petitioners were the masters of their deed of gift; they specifically divided the rights of each beneficiary into those of the present and those of future enjoyment and must accordingly accept the tax consequences of that division. Decisions will be entered wnder Hyle 50, Section 1003 (b) (3) of the Internal Revenue Code: SEC. 1003. NET GIFTS. (b) Exclusions from Gifts.— (3) Gifts after 1942. — In the case of gifts (other’than gifts of future interests in property) made to any person by the donor during the calendar year 1943 and subsequent calendar years, the first $3,000 of such gifts to such person shall not, for the purposes of subsection (a), be included in the total amount of gifts made during such year.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623410/	CHAP BRYANT, DECEASED, AND MARY BRYANT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBryant v. CommissionerDocket No. 13784-90United States Tax CourtT.C. Memo 1992-427; 1992 Tax Ct. Memo LEXIS 451; 64 T.C.M. (CCH) 291; July 28, 1992, Filed 451 Decision will be entered under Rule 155. For Petitioners: Fred K. PersonsFor Respondent: Patricia A. Evans. COLVINCOLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: Respondent determined deficiencies in income taxes and additions to tax for petitioners as follows: Additions to TaxSec.Sec.Sec.YearDeficiency6653(b)(1)(A)6653(b)(1)(B)66611986$ 999.17$ 749.381-- 198717,872.6913,404.521$ 4,468.17Petitioners booked bets for customers through an illegal gambling house in the years at issue. After concessions, the issues for decision are: 1. Whether respondent's determination that petitioners had unreported gambling activity income of $ 3,443.69 for 1986 and $ 53,337.54 for 1987 should be sustained. We hold that it should. 2. Whether petitioners are liable for additions to tax for fraud in 1986 and 1987 under section 6653(b)(1)(A) and (B), and452 for substantial understatement of tax in 1987 under section 6661. We hold that they are. The Court has also filed Williams v. Commissioner, T.C. Memo. 1992-428, and Webster v. Commissioner, T.C. Memo. 1992-220, which involved other taxpayers who were associated with the illegal gambling business at issue in this case. Section references are to the Internal Revenue Code in effect for the years at issue. Rule references are to the Tax Court Rules of Practice and Procedure, and, where noted, the Federal Rules of Evidence. FINDINGS OF FACT 1. PetitionersPetitioners were married and resided in Flint, Michigan, when they filed their petition. Mr. Bryant died on January 23, 1991, before the trial in this case was held. During the years at issue, petitioners owned and operated Fish King of Flint, a fish market and restaurant. 2. Gambling Activitiesa. Mertis Washington's Gambling HouseIn 1986 and 1987, petitioners took bets from customers and placed them with an illegal gambling house operated by Mertis Washington (Washington) in Flint, Michigan. Petitioners received money from bettors, gave 75 percent of the money453 to the gambling house, and kept 25 percent as a commission. Petitioners failed to report any income from this activity. Washington received money from people betting on a particular three- or four-digit number. Some people placed bets through "runners" who transported bet slips and money to the house for tabulation. Others placed them through telephone calls ("call-ins"). Each person who placed bets with Washington was identified by a code name or a "book number". Washington kept records of the bets he received,including the number selected by the bettor, the amount of the bet, and the book number of the person who placed the bet. At the end of each week, the gross amount of the bets (the "tops") for each book number was totaled. Then, 75 percent of this amount was calculated to determine what each book number owed Washington (the "bottoms"). Washington's records did not differentiate between bets for which the person making the bet received a commission, and bets for which that person did not receive a commisison (including personal bets), if any. Washington used the Michigan and Illinois lotteries to determine the winning numbers. When there was a winner, Washington's454 employees referred to a spiral notebook (labeled "PHONE BOOK"). The phone book contained the book numbers, names, and telephone numbers of people who booked bets with Washington. After locating the book number of the person who placed the winning bet, the employee called the phone number listed and asked for the name appearing next to the book number. Washington and his employees also used the notebook when calling people to let them know how much they owed Washington. Paulette Guice (Guice) was one of Washington's employees who kept the books and records for the gambling business. Guice worked 6 days a week. Washington testified in United States v. Croffe, No. 88-50031-20 (E.D. Mich., July 18, 1988), about his gambling activities. He died on September 10, 1991, before the trial in this case. b. Petitioners' InvolvementPetitioners were involved with Washington's numbers business for approximately 1 year beginning in 1986. They each had their own book number: Mrs. Bryant's number was 527 and Mr. Bryant's number was 4800. Petitioners took bets at the Fish King restaurant. Someone picked up the bet slips at the restaurant and brought them to Washington. Petitioners455 owed Washington 75 percent of the total amount of bets placed on their book numbers. Petitioners sometimes "hit" on the numbers they bet. Washington paid petitioners cash for their winnings if they did not owe him anything; otherwise, he subtracted the winning amount from their running account with him. Petitioners did not keep copies of betting slips or other records of their betting activities. In 1988, petitioners were indicted and pled guilty to the charge of conducting an illegal gambling business. They were placed on probation for this offense. In July 1988, Mr. Bryant testified in United States v. Croffe, supra, about his involvement in gambling activities. Petitioners did not report any income from their gambling activities on their income tax returns for 1986 or 1987. OPINION 1. Evidentiary MattersWe first consider three evidentiary issues raised by petitioners concerning the admissibility of certain evidence. a. Former testimony of Mertis WashingtonRespondent offered Mertis Washington's testimony in United States v. Croffe, supra, into evidence. Petitioners argue that Washington's testimony is inadmissible hearsay. They point out456 that their attorney did not have a chance to cross-examine Washington and assert that Maple Croffe, the defendant in that case, is not a predecessor in interest to petitioners. Rule 804(b) of the Federal Rules of Evidence provides several exceptions to the hearsay rule if the declarant is unavailable, which Washington indisputably was. Under rule 804(b)(1) of the Federal Rules of Evidence, former testimony of a declarant is admissible if the party against whom it is now offered, or a predecessor in interest, had an opportunity and similar motive to develop the declarant's testimony. Ms. Croffe and petitioners were indicted for their alleged involvement in illegal gambling activities. Washington testified about the gambling activities at Ms. Croffe's trial. We believe that Ms. Croffe, thought her attorney at the Croffe trial, had an opportunity and similar motive to petitioners' to cross-examine Washington at the Croffe trial. Clay v. Johns-Manville Sales Corp., 722 F.2d 1289">722 F.2d 1289, 1294-1295 (6th Cir. 1983). Accordingly, Washington's testimony is admissible under rule 804 (b)(1) of the Federal Rules of Evidence.b. Former Testimony of Chap Bryant457 Respondent offered Mr. Bryant's testimony at the Croffe trial. Petitioners argue that it should not be admitted because their attorney did not have the opportunity to cross-examine him about how his statements relate to this case. A statement is not hearsay if it is "offered against a party and [it] is * * the party's own statement in either an individual or a representative capacity." Fed. R. Evid. 801(d)(2)(A). A statement under rule 801(d)(2)(A) of the Federal Rules of Evidence is admissible even when the party is deceased at the time of trial. Savarese v. Agriss, 883 F.2d 1194">883 F.2d 1194, 1200-1201 (3d Cir. 1989); Pollack v. Metropolitan Life Ins. Co., 138 F.2d 123">138 F.2d 123, 125 (3d Cir. 1943). We believe Mr. Bryant is a party for purposes of rule 801(d)(2)(A) of the Federal Rules of Evidence and, thus, we admit his former testimony into evidence. c. Testimony of Paulette GuiceRespondent examined Guice about the operations of Washington's gambling house, and records she used while employed there. Petitioners dispute both Guice's qualifications to testify about Washington's business records and whether the records are admissible as business458 records under rule 803(6) of the Federal Rules of Evidence. We believe Guice was sufficiently familiar with Washington's business and its records to be qualified to testify about them pursuant to rule 803(6) of the Federal Rules of Evidence.United States v. Colyer, 571 F.2d 941">571 F.2d 941, 947 (5th Cir. 1978); Fernandez v. Chios Shipping Co., 542 F.2d 145">542 F.2d 145, 154 (2d Cir. 1976). We also believe that the records are admissible as business records under rule 803(6) of the Federal Rules of Evidence.2. Unreported IncomeThe next issue for decision is whether petitioners had unreported gambling activity income of $ 3,443.69 for 1986 and $ 53,337.54 for 1987. Gross income includes "all income from whatever source derived," including illegal sources. Sec. 61; Rutkin v. United States, 343 U.S. 130">343 U.S. 130, 137 (1952). Respondent's determination is presumed to be correct. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). Petitioners claim that they placed personal bets (i.e., their own bets), as well as bets for others, with Washington, but they have no records to corroborate the extent, if any, of such bets. 459 Petitioners would have had income on their personal bets to the extent of their net winnings. Mrs. Bryant testified at the Croffe trial that she was paid 20 to 25 percent for placing nonpersonal bets. She testified at the trial in this case, however, that the nonpersonal bets she placed were for her employees and that she did not receive a commission for any of these bets. Mr. Bryant testified at the Croffe trial that he received 25-percent profit for writing bet slips for others. We do not find credible Mrs. Bryant's testimony in this case that she did not receive a profit from her participation in the gambling business. Petitioners did not call any witnesses or otherwise corroborate Mrs. Bryant's testimony, and they failed to explain why Mrs. Bryant's testimony in this case conflicts with her testimony in Croffe. Petitioners did not keep records of their gambling activities. They have not offered any evidence to show to what extent they placed personal bets or other bets for which they did not receive a commission. Petitioners say they sometimes won on bets they placed on their own behalf, but they failed to produce any records of these purported winnings, and460 they did not report any winnings on their income tax returns for the years at issue. Washington's records show the amount of bets placed under each of petitioners' book numbers for the years at issue. Respondent determined that the total amount of bets under petitioners' book numbers in Washington's records was $ 13,774 in 1986 and $ 213,352 in 1987. Respondent determined that petitioners' 25-percent share of those bets was $ 3,443.69 in 1986 and $ 53,337.54 in 1987. Washington's records provide a credible basis for determining petitioners' income from booking bets in 1986 and 1987. Because petitioners have offered no credible evidence to dispute respondent's determinations, and because they kept no records of their gambling activities from which we can decide their income from gambling activities, we sustain respondent's determinations. Accordingly, we conclude that petitioners had gambling activity income in the amount of $ 3,443.69 for 1986 and $ 53,337.54 for 1987. 3. FraudThe next issue for decision is whether petitioners are liable for additions to tax for fraud in 1986 and 1987 under section 6653(b)(1)(A) and (B). For purposes of section 6653(b), fraud means461 "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 of 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; McGee v. Commissioner, 61 T.C. 249">61 T.C. 249, 256 (1973), affd. 519 F.2d 1121">519 F.2d 1121 (5th Cir. 1975). Fraud "does not include negligence, carelessness, misunderstanding or unintentional understatement of income." United States v. Pechenik, 236 F.2d 844">236 F.2d 844, 846 (3d Cir. 1956). Respondent has the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Castillo v. Commissioner, 84 T.C. 405">84 T.C. 405, 408 (1985); Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 220 (1971). Respondent must establish: (1) That petitioner has underpaid taxes for each year, and (2) that some part of the underpayment was due to fraud. Sec. 6653(c); Hebrank v. Commissioner, 81 T.C. 640">81 T.C. 640, 642 (1983). Fraud must be established462 by affirmative evidence. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970). Fraud, however, may be inferred from any conduct, the effect of which would be to mislead or conceal, Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943), or otherwise prevent the collection of taxes, Korecky v. Commissioner, 781 F.2d 1566">781 F.2d 1566, 1568 (11th Cir. 1986), affg. T.C. Memo. 1985-63; or where an entire course of conduct establishes the necessary intent, Patton v. Commissioner, 799 F.2d 166">799 F.2d 166, 171 (5th Cir. 1986), affg. T.C. Memo. 1985-148; Kotmair v. Commissioner, 86 T.C. 1253">86 T.C. 1253, 1260 (1986); Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111, 1123 (1983); Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 224 (1971). The courts have developed a number of objective indicators, or "badges", which tend to establish fraud, including: understatement of income; inadequate records; implausible or inconsistent explanations of behavior; engaging in illegal activities; and attempting to conceal illegal activities. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303, 307-308 (9th Cir. 1986),463 affg. T.C. Memo. 1984-601; Recklitis v. Commissioner, 91 T.C. 874">91 T.C. 874, 910 (1988). Petitioners have exhibited each of these badges of fraud. They did not report the income from their gambling activities on their 1986 or 1987 returns. They did not keep copies of the betting slips or any other records from these activities. At trial, Mrs. Bryant gave testimony about whether she received a commission for placing bets which was inconsistent with statements she made at the Croffe trial. Petitioners each were indicted and pled guilty to conducting an illegal gambling business. Finally, petitioners' failure to report income from their gambling activities indicates that they tried to conceal the illegal activities. We conclude that petitioners' conduct clearly and convincingly shows that they have committed fraud. Accordingly, they are liable for additions to tax under section 6653(b)(1)(A) and (B) for 1986 and 1987. 3. Section 6661The final issue for decision is whether petitioners are liable for an addition to tax for substantial understatement of tax under section 6661 for 1987. Section 6661(a) imposes an addition to tax of 25 percent464 on any underpayment attributable to a substantial understatement of income tax in any taxable year. A substantial understatement exists if in any year the amount of the understatement exceeds the greater of $ 5,000 or 10 percent of the amount required to be shown on the return. Sec. 6661(b)(1). An understatement, for purposes of this addition to tax, is the amount by which the amount required to be shown on the return exceeds the amount actually shown on the return. Sec. 6661(b)(2); Tweeddale v. Commissioner, 92 T.C. 501">92 T.C. 501, 505 (1989); Woods v. Commissioner, 91 T.C. 88">91 T.C. 88, 94 (1988). If the taxpayer has substantial authority for his tax treatment of any item on the return, the understatement is reduced the the amount attributable thereto. Sec. 6661(b)(2)(B)(i). Similarly, the amount of the understatement is reduced for any item adequately disclosed either on the taxpayer's return or in a statement attached to the return. Sec. 6661(b)(2)(B)(ii); sec. 1.6661-4(b) and (c), Income Tax Regs.Petitioners have not argued that either of the reductions to this addition to tax applies to them. Petitioners have not sustained their burden of proving465 that they are not liable for additions to tax under section 6661. Accordingly, if, after respondent's determination, the amount of the understatement for 1987 exceeds the greater of $ 5,000 or 10 percent of the amount required to be shown on the return, petitioners are liable for the section 6661 addition to tax for that year. Accordingly, Decision will be entered under Rule 155. Footnotes1. Fifty percent of the interest due on the portion of the underpayment attributable to fraud.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623413/	WILLIAM C. BOOHER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBooher v. CommissionerDocket No. 30170-81.United States Tax CourtT.C. Memo 1983-193; 1983 Tax Ct. Memo LEXIS 587; 45 T.C.M. (CCH) 1246; T.C.M. (RIA) 83193; April 11, 1983. 587 Held: The petition in this case was received within the time period prescribed by I.R.C. sec. 6213(a) since the private postmark date qualifies under I.R.C. sec. 7502(b) as the date of filing. John E. O'Brien, for the petitioner. Dennis R. Onnen, for the respondent. WHITAKERMEMORANDUM OPINION WHITAKER, Judge: This case is before the Court on respondent's motion to dismiss for lack of jurisdiction. The sole issue for decision is whether the petition in this case was filed within the 90-day period prescribed by section 6213(a). 1588 On September 11, 1981, respondent mailed to petitioner at his last known address, in Houston, Texas, by certified mail, the statutory notice of deficiency upon which this case is based. On December 15, 1981, this Court received the petition in this case. The petition lists petitioner's residence as Houston Texas. Under section 6213(a), the Court does not have jurisdiction over a case unless the petition is filed within 90 days after the mailing of the notice of deficiency, not counting Saturday, Sunday or a legal holiday as the last day. Normally, the date of filing is the date the petition is received by the Court. Section 7502 provides an exception, however, so that the date of the mailing of the petition is treated as the date of its filing if certain conditions are satisfied. In this case, the 90-day period prescribed by section 6213(a) expired on Thursday, December 10, 1981. Although the petition was not received by the Court until the following Tuesday, December 15, 1981, the envelope in which the petition was mailed bore the privately post metered date of December 10, 1981. We must determine whether the timely mailing-timely filing rule of section 7502 applies589 so that this post metered date will be treated as the date of filing. 2Under section 7502(b) the Secretary of the Treasury is authorized to prescribe regulations dictating how the timely mailing-timely filing rule will apply to privately postmarked mail. The pertinent regulation is section 301.7502-1(c)(1)(iii)(B), Proced. and Admin. Regs., which sets forth two alternative sets of requirements to be satisfied by taxpayers relying on privately post metered dates. Under the first alternative, a private postmark date that is on or before the last date prescribed for filing the petition will be treated as the date of filing if the petition is received by the Court within the time in which a properly addressed envelope sent by the same class of mail would ordinarily be received. In paragraph 3 of his answer to motion to dismiss for lack of590 jurisdiction, petitioner stated that: 3. A petition properly addressed, mailed in Houston and postmarked by the United States Post Office on Thursday, December 10, 1981 and [sic] would have normally reached the Tax Court in Washington, D.C. prior to Tuesday, December 15, 1981 but was delayed because of the Christmas mail rush. Respondent claims that this represents a concession by petitioner that the petition in this case was not delivered within the time that properly addressed mail postmarked in Houston, Texas, by the U.S. Postal Service would ordinarily be received by the Tax Court. At the hearing and in his trial memorandum petitioner has consistently argued that the delivery of the petition was within the ordinary time period for delivery of mail, given the increased mail volume due to the Christmas season. We believe it is clear that petitioner has not conceded that the petition was not received until after the expiration of the ordinary time period for delivery, but that he is contending that due to the Postal Service's increased work load during the Christmas season, the ordinary delivery period during that season was longer than at other time of the year. Whether591 the petition was received by the Tax Court within the time that a document mailed on the 90th day would have ordinarily been received is purely a factual question. Stotter v. Commissioner,69 T.C. 896">69 T.C. 896, 898 (1978). Frequently, testimony of Postal Service employees has been relied upon to establish the ordinary delivery time for mail. E.g., Stotter v. Commissioner,supra; Guerra v. Commissioner,T.C. Memo. 1983-21; McCurry v. Commissioner,T.C. Memo. 1981-68. Here, neither party introduced testimony from Postal Service employees. Nor was any other testimony presented on this point. Rather, petitioner has simply pointed out that the petition was mailed during the middle of the Christmas card rush season, and that a weekend intervened between the mailing of the petition on Thursday, December 10, 1981, and its receipt by the Court on Tuesday, December 15, 1981. Though the petitioners have thge burden of proving that the petition was received by the Court within the ordinary time period, we will not lightly dismiss a petition and thereby deprive petitioners of their opportunity to litigate a deficiency in this592 Court. Stotter v. Commissioner,supra. Furthermore, as the trier of fact we must evaluate the evidence in light of our own experience. It is common knowledge that the delivery of the mails is significantly slowed during the Christmas season and that the ordinary time period for delivery of the mail during the pre-Christmas rush is noticeably longer than at other times during the year. Given that the five days between the mailing of the petition and its receipt by this Court spanned a weekend, we find that the petition was received within the time that a properly addressed document of the same class of mail, mailed and postmarked by the U.S. Postal Service in Houston, Texas, on December 10, 1981, would have been received by this Court. Thus, petitioner has satisfied the requirements of section 301.7502-1(c)(1)(iii)(B), Proced. and Admin. Regs. Accordingly, December 10, 1981, the date of the mailing of the petition, should be treated as the date the petition was filed in this case. Since Decemer 10, 1981, was the 90th day following the mailing of the notice of deficiency, the petition was filed within the time period prescribed in section 6213(a). We therefore*593 deny respondent's motion to dismiss. An appropriate order will be entered.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩2. The petition was mailed to the Court by certified mail. However, this does not afford petitioner any relief, since the regulation dealing with certified mail, sec. 301.7502-1(c)(2), Proced. and Admin. Regs., applies only if the taxpayer has an employee of the U.S. Postal Service postmark the sender's receipt, which was not done here.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623417/	Daniel Lifter and Helene Lifter, Petitioners v. Commissioner of Internal Revenue, RespondentLifter v. CommissionerDocket No. 5765-72United States Tax Court59 T.C. 818; 1973 U.S. Tax Ct. LEXIS 161; 59 T.C. No. 79; March 12, 1973, Filed 161 Petitioners' motion to dismiss will be denied. A notice of deficiency for the year 1968 was sent to the petitioners by certified mail at the business address given on their Federal income tax return for such year. Since mail previously sent to such business address was returned undelivered, a copy of the deficiency notice was sent by ordinary mail to the petitioners' attorney, appointed to handle their Federal income tax matters for earlier years, and the petitioners actually learned of the notice before the running of the statute of limitations and in ample time to file a timely petition with this Court. Held, the notice of deficiency was valid and suspended the running of the statute of limitations. Richard B. Wallace and Harold Tannen, for the petitioners.Vernon J.163 Owens and Marlene Gross, for the respondent. Simpson, Judge. SIMPSON818 The respondent determined a deficiency of $ 100,069.20 in the petitioners' Federal income tax for the year 1968. This proceeding arises from a motion by the petitioners to dismiss for lack of jurisdiction on the ground that no proper statutory notice of deficiency was issued. At trial, the petitioners' motion was amended to request a ruling that, because no proper statutory notice was given within the 3-year statute of limitations, assessment and collection of a deficiency for the year 1968 is barred.FINDINGS OF FACTOn June 13, 1969, the petitioners, Daniel Lifter and Helene Lifter, timely filed their Federal income tax return for the year 1968 under an extension granted by the respondent. The address given on the return was 822 Northeast 125th Street, North Miami, Fla. (the 125th Street address), the location of an office of a corporation with which Mr. Lifter was connected. Since 1966, the petitioners have resided at 5151 Collins Avenue, Miami Beach, Fla. (the Collins Avenue address).The office at the 125th Street address was rented by the corporation from September 1968 to September 164 1969. On the petitioners' return for 1969, they gave 17880 Northwest Second Avenue, Miami, as their address, the place to which the corporation moved, and indicated that on their return for the preceding year, they had given the 125th Street address.Between 1967 and 1969, the petitioners' returns for the taxable years 1964 through 1967 were being audited by a revenue agent and a special agent. The petitioners gave different addresses on their returns for the years then under audit; therefore, the agents decided to use the petitioners' residence on Collins Avenue as their mailing address, and 819 the agents' reports set forth such address as the address of the petitioners. The report of the revenue agent was completed prior to October 1969 and was submitted for inclusion in an administrative file of the respondent. The report of the special agent was completed in the early part of 1971.On March 7, 1969, the petitioners executed a power of attorney designating Richard B. Wallace as their attorney in fact for purposes of Federal income tax matters covering the years 1964 through 1967. On this document, the petitioners gave their residence on Collins Avenue as their address. 165 The audit for 1968 was conducted by C. W. Charlesworth, another of the respondent's agents. He requested that the petitioners agree to extend until June 30, 1973, the period for assessing deficiencies in tax for the years 1965 and 1968. Such request was sent to the petitioners at the 125th Street address but was returned undelivered. On March 28, 1972, a letter containing a similar request was addressed to the petitioners in care of Mr. Wallace, their attorney for the years 1964 through 1967, at his address. The consent forms and the accompanying transmittal letter recited that the address of the petitioners was in care of Mr. Wallace. He responded on behalf of the petitioners and advised that he recommended against the execution of the consents. In his response, he made no reference to the fact that he was not at that time appointed as the attorney for the petitioners' 1968 Federal income tax matters and gave no address for the petitioners other than in care of his office.A statutory notice of deficiency with respect to the taxable year 1968 was prepared by Agent Charlesworth and was sent on April 13, 1972, to the petitioners by certified mail at the 125th Street address. 166 He sent the notice to such address because it was given by the petitioners on their return for 1968 and because the respondent had not been advised that he should use a different address to contact the petitioners with respect to their 1968 return. When he sent the notice, Agent Charlesworth was aware of the audit of the petitioners' returns for 1964 through 1967, and he knew that the petitioners then resided on Collins Avenue, and that the agents were using the Collins Avenue address as the petitioners' address for purposes of that audit.To ensure that notice of the deficiency determined by the respondent was actually communicated to the petitioners, a copy of the notice of deficiency was sent to Mr. Wallace. Such copy was mailed approximately at the same time as the original and was received by Mr. Wallace prior to May 13, 1972. Upon receiving a copy of the notice, Mr. Wallace arranged to inform the petitioners of it, and on May 13, 1972, they appointed him to handle their Federal income tax matters for 820 the year 1968. On July 11, 1972, a petition was filed with the Court requesting redetermination of the deficiency for 1968.OPINIONThe petitioners' motion to dismiss167 involves section 6212 of the Internal Revenue Code of 19541 and other related sections. Section 6212(a) provides that when the Secretary or his delegate determines there is a deficiency in income tax, he is "authorized" to send notice of such deficiency by certified or registered mail. Section 6212(b)(1) provides that a notice of deficiency in respect of an income tax shall be sufficient "if mailed to the taxpayer at his last known address." Section 6213(a) provides that within 90 days after the mailing of the notice of deficiency the taxpayer may file with the Tax Court a petition for redetermination of the deficiency; it also provides that no assessment shall be made within the 90-day period nor, if a petition is filed with the Tax Court, until the decision of the Tax Court becomes final. Section 6501(a) provides that the amount of any tax imposed shall be assessed within 3 years after the return was filed; but section 6503(a) (1) provides that the running of the period of limitations provided in section 6501 for making assessments of income tax shall (after the mailing of a notice under section 6212(a)) be suspended for the period during which the respondent is prohibited 168 from making an assessment and for 60 days thereafter.We are asked by the petitioners to declare the notice of deficiency to be invalid and to hold that we therefore lack jurisdiction of the matter. In addition, the petitioners assert that since a proper notice of deficiency was not issued, the running of the statute of limitations on assessment of a deficiency has not been suspended, and accordingly, they asked us to hold that the statute of limitations on the assessment of any deficiency for 1968 has now run.The petitioners contend that the notice of deficiency is invalid because it was sent to the wrong address. The purpose of sections 6212 and 6213 is to establish a procedure under which the respondent, if he determines that there is a deficiency in tax, notifies the taxpayer of such determination and under which the taxpayer is given an opportunity to litigate the issue before the Tax Court without first paying the claimed deficiency. Berger v. Commissioner, 404 F. 2d 668169 (C.A. 3, 1968), affirming 48 T.C. 848">48 T.C. 848 (1967), certiorari denied 395 U.S. 905">395 U.S. 905 (1969); DeWelles v. United States, 378 F. 2d 37 (C.A. 9, 1967). The respondent is "authorized" to notify the taxpayer of his determination by use of certified or registered mail. Berger v. Commissioner, supra.If he sends the notice of deficiency to the taxpayer's 821 "last known address," the notice is effective irrespective of whether it is in fact received by the taxpayer. DeWelles v. United States, supra.A taxpayer's last known address may be the address given on his return, if he has not clearly notified the respondent that he has moved and directs the respondent to use a different address. Floyd R. Clodfelter, 57 T.C. 102">57 T.C. 102, 106 (1971); Harvey L. McCormick, 55 T.C. 138 (1970); Langdon P. Marvin, Jr., 40 T.C. 982">40 T.C. 982 (1963). If the taxpayer directs the respondent to send a notice of deficiency to his attorney, then the attorney's address becomes the170 taxpayer's "last known address." Commissioner v. Stewart, 186 F. 2d 239 (C.A. 6, 1951), reversing a Memorandum Opinion of this Court. A taxpayer's last known address may be his office rather than his residence. Welch v. Schweitzer, 106 F. 2d 885 (C.A. 9, 1939); Abraham Goldstein, 22 T.C. 1233 (1954). In other words, for purposes of section 6212(b)(1), a taxpayer's last known address must be determined by a consideration of all relevant circumstances; it is the address which, in the light of such circumstances, the respondent reasonably believes the taxpayer wishes to have the respondent use in sending mail to him. Clark's Estate v. Commissioner, 173 F. 2d 13 (C.A. 2, 1949); see also Sorrentino v. Ross, 425, F. 2d 213, 215 (C.A. 5, 1970).Because the petitioners used a variety of addresses, they created confusion as to what address should be used to reach them. Since they used the 125th Street address on their 1968 return, Mr. Charlesworth initially was certainly justified in understanding that they wished to have any correspondence with171 them regarding the 1968 return sent to that address. Although they were then residing on Collins Avenue, they did not set forth the address of their residence on their return, and therefore, even though Mr. Charlesworth was then aware of the address of their residence, he was not required to direct mail to that address. In fact, since the petitioners had set forth the 125th Street address on their return, Mr. Charlesworth could reasonably infer that they were directing him not to contact them at their residence but at that business address.When Mr. Charlesworth sent the letter requesting that the petitioners agree to extend the time for assessing a deficiency for 1965 and 1968 to the 125th Street address, and it was returned, he had cause to reconsider what address should be used to reach the petitioners. He was aware of the audit of their returns for 1964 through 1967 and that the petitioners' residence on Collins Avenue was being used to reach them in connection with that audit. In light of such information, it would have been reasonable for him to write to the petitioners at their residence in connection with the 1968 return. However, he was also aware that Mr. Wallace was172 representing the petitioners with regard to the audit of their returns for 1964 through 1967, and 822 the requested extension related to one of those years. Accordingly, it was also reasonable for him to direct his second letter regarding the extension to Mr. Wallace. Mr. Wallace responded to that letter and undertook to represent the petitioners with respect to 1968 as well as 1965.Since the requested extensions were not approved by the petitioners, Mr. Charlesworth was then confronted with the necessity of preparing the notice of deficiency and deciding how it should be sent to the petitioners. Other than the address given on their return for 1968, he received no instructions from the petitioners as to how they should be reached regarding an audit of that return. Clearly, the addresses set forth in their subsequent returns did not constitute a direction as to the address to be used to reach them regarding the 1968 return. Culver M. Budlong, 58 T.C. 850">58 T.C. 850 (1972); Joseph Marcus, 1071">12 T.C. 1071 (1949). Since the petitioners had given the 125th Street address on their return and given no directions as to what address173 should be used in connection with such return, he chose to send the original of the notice of deficiency to them at that address. Because of the recognized possibility that such document might not reach them, he sent a copy to Mr. Wallace, who was known to represent them regarding earlier years, and who had undertaken to speak for them regarding 1968. When all of these circumstances are considered, one surely cannot say that Mr. Charlesworth acted negligently. See Arlington Corp. v. Commissioner, 183 F. 2d 448 (C.A. 5, 1950). It might have been reasonable for him to adopt a different course -- for example, to send the notice to the petitioners at their residence on Collins Avenue, but surely it must be recognized that there was reason for the course that he adopted.Moreover, it is clear that the petitioners were not injured by the course adopted by Mr. Charlesworth. The notice of deficiency was dated April 13, 1972, and the petitioners learned of it prior to the following May 13, when they formally authorized Mr. Wallace to represent them regarding the matter. Thus, they learned of the notice of deficiency prior to the expiration of the statute174 of limitations on assessment of a deficiency for 1968, and they had ample opportunity to prepare and file a petition with this Court. The courts have generally held that even though there may be a technical objection to the manner of delivery of a notice of deficiency, the notice is valid if the taxpayer is not substantially injured as a result of the technical shortcoming. See Floyd R. Clodfelter, 57 T.C. at 107, and the cases cited therein.Under section 6212, the respondent is to notify a taxpayer of a deficiency. Ordinarily, he will use the mail to give such notice, and if he follows the procedure set forth in that section, his position is 823 protected, irrespective of whether the taxpayer does in fact receive the notice of deficiency. Delman v. Commissioner, 384 F. 2d 929, 933, 934 (C.A. 3, 1967), affirming a Memorandum Opinion of this Court, certiorari denied 390 U.S. 952">390 U.S. 952 (1968); DeWelles v. United States, 378 F. 2d 37 (C.A. 9, 1967); Luhring v. Glotzbach, 304 F. 2d 556, 558 (C.A. 4, 1962); Jack D. Houghton, 48 T.C. 656">48 T.C. 656, 660 (1967).175 When, as here, the taxpayers received actual notice of the deficiency at such time and in such manner that their interests were fully protected, the purpose of section 6212 is accomplished, and there is no reason to invalidate the notice because of alleged technical imperfections in the manner chosen for delivery of it. In Berger v. Commissioner, 404 F. 2d 668 (C.A. 3, 1968), the taxpayers directed the respondent to send any notices of deficiency to their attorney; although the respondent sent the notice to the taxpayers with a copy to their attorney, the court held that the notice was valid because the taxpayers had received adequate actual notice. Similarly, in Delman v. Commissioner, supra, the court upheld a notice of deficiency when it found that the respondent had reason for choosing the address used by him and that the taxpayers received actual notice in due time; the original of the notice was sent to the taxpayers in care of their accountant, the address given on the return, and a copy to their attorney, although the respondent was aware that the taxpayers had moved their residence. Tenzer v. Commissioner, 285 F. 2d 956176 (C.A. 9, 1960), reversing an Order of this Court, and Boren v. Riddell, 241 F. 2d 670 (C.A. 9, 1957), held that a notice of deficiency was effective when the taxpayer received actual notice of it; in Tenzer, the notice was personally delivered to the taxpayer, and in Boren, it was sent to him by ordinary mail. In Commissioner v. Stewart, 186 F. 2d 239 (C.A. 6, 1951), the court sustained a notice of deficiency sent to the attorney of the taxpayer, not the taxpayer, because the purpose of the statute had been accomplished in that the taxpayer received actual notice of the deficiency. The court, in Whitmer v. Lucas, 53 F. 2d 1006 (C.A. 7, 1931), found that the taxpayer was not harmed because the notice of deficiency was delivered to him, even though it was incorrectly addressed, and accordingly, held that the notice was effective. In Clement Brzezinski, 23 T.C. 192 (1954), the Tax Court also held that a notice of deficiency mailed to the taxpayer and received by him was effective, even though it was sent to the wrong address. In a number 177 of cases, it has been said that a taxpayer waived any defects in the notice of deficiency when he filed a timely petition with the Tax Court, but in these cases, it is apparent that the taxpayer received actual notice of the deficiency in sufficient time to file a petition with the Court. See, e.g., Commissioner v. Rosenheim, 824 132 F. 2d 677 (C.A. 3, 1942), reversing 45 B.T.A. 1018">45 B.T.A. 1018 (1941); Commissioner v. New York Trust Co., 54 F. 2d 463 (C.A. 2, 1931), reversing 20 B.T.A. 162">20 B.T.A. 162 (1930), certiorari denied 285 U.S. 556">285 U.S. 556 (1932); Bankers Trust Co., Trustee, 24 B.T.A. 10">24 B.T.A. 10, 12 (1931); Kay Manufacturing Co., 18 B.T.A. 753">18 B.T.A. 753 (1930), affirmed per curiam 53 F. 2d 1083 (C.A. 2, 1931); United States v. Prince, 120 F. Supp. 563">120 F. Supp. 563, 566 (S.D.N.Y. 1954); compare Marjorie F. Birnie, 16 T.C. 861">16 T.C. 861 (1951); Gennaro A. Carbone, 8 T.C. 207 (1947).The petitioners contend that178 if a notice of deficiency is not mailed to the taxpayer's last known address, the notice is invalid. They urge us to adopt a strict interpretation of section 6212 and would have us ignore their receipt of adequate actual notice. In Arlington Corp. v. Commissioner, 183 F. 2d 448 (C.A. 5, 1950), the court found that the respondent's agents had been negligent in addressing the notice of deficiency, but nevertheless, the notice was not held invalid -- the court merely extended the time for filing a petition with this Court. In many of the cases relied upon for the proposition that a deficiency notice is invalid unless mailed to the last known address, the statement of such proposition is dictum because the court has found the deficiency notice was actually sent to the last known address. See, e.g., DeWelles v. United States, 37">378 F. 2d 37 (C.A. 9, 1967); Cohen v. United States, 297 F. 2d 760 (C.A. 9, 1962), certiorari denied 369 U.S. 865">369 U.S. 865 (1962); Frances Lois Stewart, 55 T.C. 238">55 T.C. 238 (1970); Draper Allen, 29 T.C. 113">29 T.C. 113 (1957);179 Bert D. Parker, 12 T.C. 1079">12 T.C. 1079 (1949); Estate of George F. Hurd, 9 T.C. 681 (1947). In some of the cases where the courts have held the notice to be invalid because it was not sent to the last known address, it is not clear whether the taxpayers received actual notice of the deficiency prior to the running of the statute of limitations and within ample time to file a timely petition with this Court; in other of such cases, the courts did not consider what effect should be given to receipt of actual notice. See D'Andrea v. Commissioner, 263 F. 2d 904 (C.A.D.C. 1959), reversing an order of this Court; John W. Heaberlin, 34 T.C. 58 (1960). Accordingly, such cases are inapposite. Floyd R. Clodfelter, 57 T.C. 102">57 T.C. 102 (1971).In summary, we find that the respondent had reason for mailing the notice of deficiency to the petitioners in the manner chosen by him, and that the purposes of section 6212 have been fully accomplished in that the petitioners received actual notice of the deficiency before the running of the statute of limitations180 and within sufficient time to prepare and file a petition with this Court. Under such circumstances, there is no cause to strike down the notice of deficiency. Thus, sound reason and the overwhelming weight of judicial authority require us to conclude that the notice of deficiency sent to the petitioners should *825 be sustained, and that this Court has jurisdiction to redetermine such deficiency. In view of that conclusion, it is clear that the statute of limitations has not run on the assessment of a deficiency for 1968.Petitioners' motion to dismiss will be denied. 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/4623419/	W. O. Pope and Essie N. Pope v. Commissioner.Pope v. CommissionerDocket No. 90234.United States Tax CourtT.C. Memo 1962-279; 1962 Tax Ct. Memo LEXIS 30; 21 T.C.M. (CCH) 1477; T.C.M. (RIA) 62279; November 26, 1962George M. Mott, Esq., 632 Illinois Bldg., Indianapolis, 31 Ind., for the petitioners. Ferd J. Lotz, Esq., for the respondent. FORRESTERMemorandum Findings of Fact and Opinion FORRESTER, Judge: Respondent has determined a deficiency in income tax of the petitioners for the taxable year 1955 in the amount of $2,698.24. The only issue presented for our consideration is whether petitioners are entitled to deduct the amount of $10,274.58 paid by petitioner W. O. Pope during 1955 on a judgment against him. Some of the facts have been stipulated and are so found. W. O. Pope and Essie N. Pope are husband and wife residing in Greenfield, Indiana. They filed their joint 1955 income tax return with the district director of internal revenue at Indianapolis, Indiana. Petitioner Essie N. Pope is involved solely by virtue of having filed a joint return, and W. O. Pope will hereinafter be referred to as petitioner. Prior to July 1, 1952, petitioner operated the Hancock Developing and Supply Company as a sole proprietorship business. On July 1, 1952, the business was duly incorporated under the laws of the State of Indiana. Between July 1950 and August 1951, petitioner purchased approximately 41 acres of land in Greenfield, Indiana, 32 for the purpose of establishing a housing project of approximately 300 houses. Shortly thereafter, an engineer was hired and eventually an acceptable plot plan was submitted to the Federal Housing Administration. The first house in this project was sold in October 1951. Eventually the proprietorship and the successor corporation built and sold 41 houses, and thereafter sold the remaining land in lots. On April 14, 1950, Corflor, Inc., was incorporated for the purpose of manufacturing pre-stressed, steel reinforced concrete beams which were called "Corflor," were formed with a hollow center about 5 inches in diameter, and were used as sub-flooring for houses. The hollow centers were designed for incorporation into a central heating system, thus furnishing both radiant and perimeter heat. The stockholders of the corporation as of December 30, 1950, were as follows: NumberStockholderof SharesC. C. Irving100Albert Irving100Irving Brothers100Josephine Irving80George Nagle20Ardis Miller10W. H. Sorrell10Total420When Corflor, Inc., was incorporated, $100,000 in no par stock, computed at $100 per share, was authorized. The incorporators33 had paid in approximately $42,000 for their stock interest and held $100,000 in purported capital notes payable of the corporation. On March 1, 1951, Albert Irving owned 100 shares of stock of Corflor, Inc., and held a purported capital note of the corporation payable to him in the amount of $21,000. The form used for this note provided in part: SIX PER CENT THREE YEAR CAPITAL NOTE … For value received, hereby promises to pay… or order, on the * * day of * * , 19 . (unless this capital note shall have been sooner redeemed),… Dollars in legal currency of the United States of America, and to pay interest thereon from date capital note was executed, at the rate of 6 per cent per annum, such interest to be payable annually in legal currency on the… day of… in each year. Both the principal and interest on this capital note shall be payable at the office of the Corporation. The indebtedness evidenced by this certificate will be junior in case of liquidation or insolvency of this corporation to bank indebtedness and operating indebtedness of the corporation. The right is hereby reserved to the Corporation at any time upon giving thirty (30) days' notice in writing34 of its intention to do so, to redeem any or all of said…% Capital Note at such time outstanding by the payment of the par value thereof plus accrued interest to the date of such redemption. This capital Note is transferable only on the books of the Corporation in person or by duly authorized attorney upon surrender of this Capital Note properly endorsed. Petitioner desired to use Corflor in his houses because of its heating uses and also because it would make the houses more fireproof and would eliminate squeaking floors. Petitioner was informed on or about March 1, 1951, that Corflor, Inc., would have difficulty in furnishing Corflor to him for use in his houses. Albert Irving was managing Corflor, Inc., at that time. His uncle, C. C. Irving, felt that Albert was incapable of managing it properly but that there was no one else available to run the business. C. C. Irving therefore suggested to petitioner that if he, petitioner, would buy Albert out, then petitioner could personally manage the business and assure himself a supply of Corflor. Thereafter, on March 8, 1951, petitioner purchased from Albert Irving his 100 shares of stock of Corflor, Inc., for $10,000. At the same35 time, petitioner gave his 90-day note to Albert Irving in the amount of $21,000, which note read as follows: $21,000.00 March 8, 1951 90 days after date I promise to pay to the order of A. R. Irving Twenty-One Thousand and 00/100 Dollars. Negotiable and payable at Lincoln National Bank, Ft. Wayne, Ind.With interest at the rate of 6% per annum and attorney's fees. Value received. Without any relief whatever from Valuation or Appraisement Law. The drawers and endorsers severally waive presentation for payment, protest, or notice of protest, and non-payment of this note. (signed) Wm. O. Pope (ON BACK) 12-1-51 to apply on interest$945.002-1-51 to apply on interest andprincipal500.00 After petitioner acquired Albert Irving's stock of Corflor, Inc., the latter ceased to be connected with the management of that corporation. Sometime thereafter, but no later than February 18, 1954, petitioner became treasurer of Corflor, Inc. On September 30, 1951, the corporation issued a purported capital note payable to petitioner in the amount of $21,000. On October 15 and November 3, 1952, petitioner purchased, respectively, 114 and 22 shares of stock of Corflor, 36 Inc. As of November 3, 1952, petitioner owned 236 shares of stock out of a total number of 470 then outstanding. During the April 1952 term of that court, Albert Irving brought suit in the Circuit Court of Hancock County, Indiana, against petitioner on the latter's note dated March 8, 1951. The suit was subsequently transferred to the Circuit Court of Madison County, Indiana, which latter court on November 13, 1952, rendered judgment in favor of Albert Irving and against petitioner in the amount of $22,907.44. During the taxable year 1955, petitioner made a final payment under the aforementioned judgment in the total amount of $10,616.36, which included interest in the amount of $341.78. After petitioner acquired his interest in Corflor, Inc., he learned that its entire operation was in an experimental stage. Nevertheless, during the period that the petitioner was engaged in the construction of the aforementioned subdivision project, he, operating as a single proprietorship and later, Hancock Developing and Supply, Inc., purchased Corflor from Corflor, Inc., for use in the project in the total amount of $32,378.76. Petitioner's housing project used Corflor in 31 of the 41 houses37 built by him. Corflor was a satisfactory product, and its use was discontinued only because the plant of Corflor, Inc., became unable to produce any further quantities. As of March 31, 1951, Corflor, Inc.'s balance sheet was as follows: CORFLOR, INC - FORT WAYNE, INDIANABalance Sheet, March 31, 1951ASSETSCURRENT ASSETS: Cash on hand and in bank$ 123.36Inventories: Materials$42,807.36Finished goods3,354.50Jobs in process2,756.5548,918.41Prepaid expense1,149.90Total Current Assets$ 50,191.67PROPERTY, PLANT AND EQUIPMENT: Land$ 500.00Building14,029.48Equipment94,497.08Total Property, Plant and Equipment109,026.56DEFERRED CHARGES: Organization expense$ 133.95Deferred operating expenses4,267.36Experimental expense3,045.00Total Deferred Charges7,446.31TOTAL ASSETS$166,664.54LIABILITIES AND CAPITALCURRENT LIABILITIES: Notes payable - Bank - Unsecured$ 9,500.00Notes payable - Stockholders and employees - Unsecured11,900.00Customer deposits10,530.00Accounts Payable: Building and equipment$22,453.45Trade11,817.86Withholding taxes942.2235,213.53Accrued Expenses: Interest$ 2,200.00Taxes321.012,521.01Total Current Liabilities$ 69,664.54LONG-TERM LIABILITIES: Notes payable - Officers and stockholders - Unsecured55,000.00CAPITAL: Common capital stock, no par value - authorized 1,000 shares; outstanding 420shares42,000.00TOTAL LIABILITIES AND CAPITAL$166,664.5438 On February 18, 1954, Corflor, Inc., filed a petition in bankruptcy in the United States District Court for the Northern District of Indiana, Fort Wayne Division. The only claim filed by petitioner related to an indebtedness other than the $21,000 capital note. As of December 31, 1961, the bankruptcy proceeding was still pending, and no final distribution had been made. Petitioner deducted on his 1955 income tax return the amount of $10,616.36 paid to Albert Irving in 1955 as a business bad debt. He attached an explanation thereto which appears in the margin. 1 Respondent allowed a deduction of $341.78, representing interest, but disallowed the remaining $10,274.58. 39 Petitioner deducted the amount in question as a business bad debt pursuant to section 166(a) of the Internal Revenue Code of 1954. 2 He apparently also contends that the amount is deductible as a business expense under section 162 3 or as a loss under section 165. 4 Respondent argues in opposition to a fourth alternative, section 166(f), 5 but that section applies only to guarantors of noncorporate obligations, and is therefore inapplicable to any obligation of Corflor, Inc. 40 Respondent disallowed the entire deduction, and therefore argues (1) that there was no bad debt, business or nonbusiness, because the "capital note" was not debt but a capital investment, (2) that the payment of Albert's judgment was not an ordinary and necessary business expense of petitioner, and (3) that no loss within the definition of section 165(c) was incurred. Basically, respondent contends that the issuance of petitioner's personal note to Albert was not necessary to petitioner's business but was a capital investment. In substance, petitioner bought Albert Irving's interest in Corflor, Inc. This interest consisted of 100 shares of stock, and the corporation's so-called capital note for $21,000. This capital note was, by its own terms, subordinated to the rights of general creditors, and was transferable only on the corporate books. Petitioner paid Albert $10,000 cash for his 100 shares of stock and gave him his personal, 90-day note for the so-called capital note. The record is unclear as to what happened to Albert's capital note of the corporation, but Albert did transfer his stock to petitioner. More than 6 months later Corflor, Inc., issued a $21,000 note to petitioner41 which was identical in form to the one previously held by Albert. Having weighed the facts, we are unable to accept respondent's argument that petitioner "invested" in Corflor, Inc. Instead, we find that his purchase of Albert's stock and issuance of his personal note to Albert were made solely to assist in securing a supply of Corflor for the Greenfield housing project. Therefore, the assets acquired are not capital assets. Electrical Fittings Corporation, 33 T.C. 1026">33 T.C. 1026 (1960); McMillan Mortgage Co., 36 T.C. 924">36 T.C. 924 (1961); Tulane Hardwood Lumber Co., 24 T.C. 1146">24 T.C. 1146 (1955). However, although petitioner's expenditures were proximately related to his business, we cannot sustain his deduction for the year 1955. If the entire transaction were but one capital investment in the corporation, the deductions would be proper when the stock and capital note became worthless, and 1955 has not been shown to be the proper year. Tulane Hardwood Lumber Co., supra. If the transaction were divisible, then petitioner purchased stock for $10,000 and gave a note for $21,000. In return for the cash, he received stock; in return for the note, he received42 a corporate capital note in the identical amount. 6 Assuming that the capital note was worth its face when issued (and nothing to the contrary has been proven) petitioner incurred no expense or loss in 1951 - he incurred a $21,000 liability given in consideration for a $21,000 receivable. His bad debt would occur when his receivable - the capital note - became worthless, not when he happened to pay off his personal note. The fact that petitioner gave his own promissory note (rather than cash or something else of value) for the capital note, does not alter the time of occurrence of the loss or deductibility of the bad debt. Petitioner's citations of authority support the deduction of the cost of the stock in 1954 when the corporation was adjudicated bankrupt. That claim is not before us. Similarly, the deduction for the worthlessness of the capital note43 would also appear to be available in that year which is not before us; and this is so whether the true character of said note is equity or debt, business or nonbusiness. For the sake of completeness, we add that the payment in question was not an ordinary and necessary business expense under section 162(a) for it would necessarily be used "in determining the gain or loss basis of [taxpayer's] plant, equipment, or other property" (here, the $21,000 capital note). See section 1.162-1, Income Tax Regs.; York Water Co., 36 T.C. 1111">36 T.C. 1111; KWTX Broadcasting Co., 31 T.C. 952">31 T.C. 952, affirmed per curiam 272 F. 2d 406; Eagle Pass & Piedras Negras Bridge Co., 23 B.T.A. 1338">23 B.T.A. 1338. We hold that petitioner has not proven that the capital note of Corflor, Inc., became worthless during 1955, or that he incurred any "expense" or "loss" during that year. Decision will be entered for the respondent. Footnotes1. W. O. Pope and Essie N. Pope Form 1040 - U.S. Individual Income Tax Return - 1955 Explanation of Bad Debt Deduction In 1951, W. O. Pope was personally engaged in developing a real estate project in Greenfield, Indiana, and constructing houses in such project. There was used in the construction of these homes precast reinforced concrete beams manufactured by Corflor, Inc. in Fort Wayne, Indiana. That corporation was in financial difficulty and, to improve its position and to insure a supply of concrete beams, Mr. Pope advanced various sums of money to it. One of the stockholders of Corflor, Inc. was Albert Irving who held $21,000 of notes of Corflor, Inc. and he was pressing for collection of these notes. To relieve the financial position of Corflor, Inc., Mr. Pope purchased Mr. Irving's stock and, in addition, he gave Mr. Irving his personal note of $21,000 and took in return the $21,000 of notes of Corflor, Inc. held by Mr. Irving. In 1952, Mr. Irving brought suit against Mr. Pope and secured a judgment against him for $21,000. Mr. Pope has been paying this judgment off at the rate of $500 per month plus interest. During the year 1955, he paid $10,616.36 against the judgment and the interest accrued thereon. In the year 1953, Corflor, Inc. was thrown into bankruptcy and is hopelessly insolvent, which means he will be unable to realize any recovery on the notes he received from that corporation. Inasmuch as this obligation was incurred by Mr. Pope in connection with his business of home construction and real estate development, the entire amount paid during the year is entirely deductible.↩2. All further statutory references are to the Internal Revenue Code of 1954. SEC. 166. BAD DEBTS. (a) General Rule. - (1) Wholly Worthless Debts. - There shall be allowed as a deduction any debt which becomes worthless within the taxable year. (2) Partially Worthless Debts. - When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. ↩3. 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, * * ↩4. SEC. 165. LOSSES. (a) General Rule. - There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. * * (c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to - (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. * * ↩5. SEC. 166. BAD DEBTS. (f) Guarantor of Certain Noncorporate Obligations. - A payment by the taxpayer (other than a corporation) in discharge of part or all of his obligation as a guarantor, endorser, or indemnitor of a noncorporate obligation the proceeds of which were used in the trade or business of the borrower shall be treated as a debt becoming worthless within such taxable year for purposes of this section (except that subsection (d) shall not apply), but only if the obligation of the borrower to the person to whom such payment was made was worthless (without regard to such guaranty, endorsement, or indemnity) at the time of such payment.↩6. The record does not definitely indicate whether Albert assigned his capital note to petitioner or whether it was surrendered to the corporation and a new note issued. The latter seems more likely, as it was stipulated that the corporation issued its note to petitioner more than 6 months after the transaction with Albert.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623421/	Anderson Brothers Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentAnderson Bros. Corp. v. CommissionerDocket No. 61238United States Tax Court34 T.C. 199; 1960 U.S. Tax Ct. LEXIS 155; May 16, 1960, Filed 155 Decision will be entered for the respondent. Expenditures for "Work in Process" under long-term contracts pursuant to which petitioner had billed its customers for progress payments, held, not includible in "assets," except as to excess over billings, for computation of excess profits credit under section 445, I.R.C. 1939. Clyde L. Wilson, Jr., Esq., for the petitioner.Robert L. Liken, Esq., for the respondent. Opper, Judge. OPPER199 OPINION.Respondent determined a deficiency in income and excess profits tax for petitioner's year ended June 30, 1951, in the amount of $ 49,685.88. The sole issue is whether a balance carried on petitioner's 156 books in an account entitled "Work in Progress" is properly included in petitioner's total assets at June 30, 1950, for purposes of computing its excess profits credit.All of the facts, having been stipulated, are hereby found accordingly. They are, in part, as follows:Petitioner, a corporation organized under the laws of Texas on July 1, 1946, had its principal place of business during its fiscal years ended June 30, 1950, 1951, and 1952 in Houston, Texas, and filed its income tax returns for those years with the collector (director) of internal revenue, Austin, Texas.During the fiscal years ended June 30, 1950, June 30, 1951, and June 30, 1952, Petitioner's primary business activity was that of a pipe line contractor. It maintained its books and filed its United States income and excess profits tax returns for such fiscal years and prior years on the completed contract basis.In the construction of pipe lines during the fiscal years ended June 30, 1950, June 30, 1951, and June 30, 1952, the pipe line customers provided the rights of way and furnished the pipe. Petitioner furnished labor, equipment, and other materials and supplies. The customary contract entered into by Petitioner157 and its customers during these fiscal years provided for a contract price which was based upon specified unit prices for the various phases or classes of work to be performed by the Petitioner pursuant to the contract. The customary contract provided further that either monthly or semi-monthly, Petitioner would be paid a fixed percentage, usually 80 per cent or 90 per cent, of the estimated amount payable for work done by Petitioner during the preceding period as a partial payment on the total contract price, the remaining 10 per cent or 20 per cent being payable by the customer after the completion of the contract upon its final acceptance of the work performed by Petitioner.In accounting for pipe line construction contracts in progress during the 200 fiscal years ended June 30, 1950, June 30, 1951, and June 30, 1952, and all prior years, Petitioner accumulated all costs with respect to a particular contract in an asset account styled "Work in Progress" until the job was completed. All amounts billed the customer prior to completion of the contract were credited on the books of Petitioner to a deferred income account styled "Deferred Income -- Job Contracts", and accounts158 receivable were debited. When payments were received, the accounts receivable were credited and the cash account was debited. Upon completion of the job and the acceptance by the customer, the charges in the "Work in Progress" account and the credits in the "Deferred Income -- Job Contracts" account with respect to the job were transferred to profit and loss. At the end of the fiscal years ended June 30, 1950, June 30, 1951, and June 30, 1952, the books of Petitioner reflected balances in the "Work in Progress" account of $ 4,289,740.13, $ 6,778,401.57, and $ 10,659,490.26, respectively, and balances in the "Deferred Income -- Job Contracts" account of $ 4,903,512.31, $ 8,394,242.18, and $ 12,447,241.16, respectively.Attached to the return filed by petitioner on October 16, 1950, for the fiscal year beginning July 1, 1949, and ending June 30, 1950, was a comparative consolidated balance sheet which is, in pertinent part, as follows:AssetsJune 30, 1950Cash on hand and in banks$ 22,238.71Net receivables1,677,217.69Inventory of repair parts82,396.71Prepaid insurance5,729.20Construction equipment$ 2,362,424.39Shop machinery13,169.37Furniture and fixtures28,969.92Tower furnishings2,391.69Real estate and buildings188,645.83Total2,595,601.20Less: reserves for depreciation1,390,083.681,205,517.52Deposits5,767.00Carl C. Anderson29,249.783,028,116.61Liabilities and CapitalJune 30, 1950Accounts and vouchers payable$ 926,353.84Overdraft -- Bank703,720.55Notes payable30,815.00Bonuses payable10,000.00Accrued payroll taxes73,240.95Income tax withheld123,443.84Provision for Federal income tax101,137.77Deferred income from job contracts613,772.18Capital stock10,000.00Paid-in surplus67,147.11Earned surplus368,476.17Other items9.203,028,116.61159 201 A comparison of the balance sheets filed by petitioner with its return for the fiscal year ended June 30, 1950, with the balance sheet filed with its return for the fiscal year ended June 30, 1951, discloses, in pertinent part, the same total assets at June 30, 1950, save for the following:(a) In the balance sheet attached to petitioner's return for the fiscal year ended June 30, 1951, total assets are shown in the amount of $ 7,317,856.74, rather than $ 3,028,116.61 as shown on the balance sheet included with petitioner's return for the fiscal year ended June 30, 1950.(b) This increase in total assets in the amount of $ 4,289,740.13 is due entirely to the addition of an item entitled "Advance Costs on Work-in-Progress" in like amount.A comparison of the balance sheets filed by petitioner with its returns for the fiscal years ended June 30, 1950, and June 30, 1951, each purporting to show petitioner's financial condition at June 30, 1950, discloses identical items and amounts on the liabilities and capital side of the respective balance sheets, save for the following:(a) On the balance sheet attached to petitioner's return for the fiscal year ended June 30, 1950, appears160 an item entitled "Deferred Income From Job Contracts" in the amount of $ 613,772.18. However, on the balance sheet attached to petitioner's return for the fiscal year ended June 30, 1951, the item entitled "Deferred Income From Job Contracts" has been deleted and a new item, entitled "Reserve for Advance Billings on Work-in-Progress" has been added in the amount of $ 4,903,512.31 at June 30, 1950.(b) The amount of $ 613,772.18 is the difference between $ 4,903,512.31, shown as "Reserve for Advance Billings on Work-in-Progress," and $ 4,289,740.13, listed as the amount of "Advance Costs on Work-in-Progress."A balance sheet filed by petitioner with its return for the fiscal year ended June 30, 1950, showing the various assets, liabilities, and capital of petitioner at the end of the fiscal year ended June 30, 1949, contains an item entitled "Deferred Income From Job Contracts" but does not contain items entitled "Advance Costs on Work-in-Progress" or "Reserve for Advance Billings on Work-in-Progress." "All assets held by Petitioner were held in good faith for purposes of its business."The question presented, which is said to be of first impression, involves an interpretation of 161 the 1950 (Korean war) Excess Profits Tax Act with respect to the computation of petitioner's excess profits credit based upon income. Not all of the steps involved are described by the parties, but as we reconstruct them, they are as follows.202 Petitioner is concededly a "new corporation" as defined by section 445(a), I.R.C. 1939. 1162 As such it is entitled to compute its average base period net income "[by] multiplying the amount of [its] * * * total assets for such taxable year (determined under subsection (c)) * * * by the base period rate of return, proclaimed by the Secretary * * * for the taxpayer's industry classification." 2 The determination under subsection (c) of the total assets is made by adding to the net capital addition for such taxable year "the total assets (as defined in section 442(f)) for the last day of the taxpayer's taxable year" preceding its first excess profits taxable year. The net capital reduction is then subtracted. Finally, in arriving at the income so computed under section 445(b), there is deducted under section 445(b)(1)(B) the interest paid or incurred by the taxpayer for the 12 months ending with such taxable year.Section 442(f), which is looked to for the definition of total assets, is set forth in the margin. 3163 The present controversy involves the correct amount of the total assets which petitioner is entitled to employ as the multiplicand for purposes of determining its excess profits credit based on income. Specifically, the problem has to do only with uncompleted contracts in the performance of which petitioner had made considerable expenditures and had received as periodic contract payments even greater sums from its customers. Petitioner contends that the total amounts paid out for performance of the contracts constitute an asset undiminished by any payments on account received from customers. 203 Respondent, on the other hand, insists that under the statute and accepted accounting principles only the net amount of excess work performed, over customers' payments received, can be treated as an asset and that as the facts are constituted in the present instance, since there is no excess of expenses over payments, the item is not an asset to any extent but is, in fact, a pro tanto liability.Rather than treating the present problem as primarily one of accounting practice, 4165 it seems to us our obligation is to attempt to ascertain what meaning Congress intended to attribute164 to the relevant sections as applied to the facts which we have here. We note in this connection petitioner's explanation of the practice of intermediate payments, on account, by customers before work is completed. It is, according to petitioner, a method by which the completion of the contract can be financed without funds borrowed for that purpose. 5 This means, of course, the elimination of the offset to excess profits credit envisioned by section 445(b)(1)(B), consisting of interest, which is presumably intended to measure the effect of borrowed capital on petitioner's income.It may be well to initiate the discussion by statements as to which apparently both parties agree: "Petitioner admits that a payment received from a customer represents a reduction of an account receivable; * * * Petitioner emphasizes that the account receivable which is reduced by such payment arose from the billing made to the customer by Petitioner under the terms of the contract." (Petitioner's brief.) On the other hand, "[there] is no question but what costs of work in progress, to the extent they exceed related billings, constitute an asset. * * * When a payment is made, the account receivable is166 reduced to that extent." (Respondent's reply brief.)204 The parties also agree that "the word 'payment' has a specified and clear meaning which is that a claim has been paid. 'Payment' is clearly distinguishable from loans and advances." (Respondent's brief.) "Petitioner agrees that the word 'payment' has the specified and clear meaning that a claim has been paid, but the claim of Petitioner arose from its right to bill its customer under the terms of the contract, and not from the fact that it had expended specific funds." (Petitioner's reply brief.)When the work was being done and the expenses incurred were carried in an asset account, the total might or might not, of course, equal or exceed the billing that was authorized by the contract. But it seems to us that at least as soon as a bill was sent to the customer based under the contract on the work already performed, an account receivable was thereby created. 6168 This account receivable would presumably also be included in "Notes and Accounts Receivable," an asset account, and would represent in whole or in large part the same asset created by the expenditures for the work done. To some extent, while the bill to the167 customer remained unpaid, there would thus be a duplication of assets, 7 in order to avoid which, and not to overstate total assets, it would seem to be necessary in some manner to replace as an asset the expenditure item with the billing item upon the creation of the account receivable by the billing. 8169 Petitioner insists that "[respondent] has not shown how any such alleged duplication of assets exists; in fact, it is clearly inferable from the balance sheet of Petitioner at June 30, 1950, that there is no such duplication in assets. The date of June 30, 1950, is the only relevant date." 9 But any absence of duplication on that date would be purely accidental. It would arise from the fact that presumably all billings had then been paid. Otherwise, the progress expenditures must have 205 been represented in "Notes and Accounts Receivable," as well as in "Advance Costs on Work-in-Progress." If this is correct, only the excess of amounts expended over corresponding billings should remain as a separate asset, 10 and in this case no such asset existed.170 Of course, regarding the asset as an account receivable, at least when the billing takes place, and combining it with petitioner's statement that "a payment received from a customer represents a reduction of an account receivable * * which * * * arose from the billing," means that where, as in this case, all of the billings apparently have been paid, no account receivable and therefore no asset remains in that respect either. One could obviously go further and assume that any payments made by a customer would show up in cash on hand. The difficulty, naturally, is that the cash may have been spent, either for some other asset, or in reduction of some liability, in which event the item would not appear as an asset at all.If we are correct so far, it will be evident that respondent's determination must be sustained. The legislative purpose seems to us to preclude the recognition as an asset of items which tend to be merely duplication of other assets. And there is nothing in petitioner's long-continued method of accounting which indicates the contrary. In fact, until it became advantageous to do so for tax purposes, petitioner apparently did not regard work-in-progress expenditures171 as an asset at all, at least, when, as appears here, billings had exceeded costs.Petitioner has conceded the statute of limitations issue originally raised.Decision will be entered for the respondent. Footnotes1. All sections referred to are those of the 1939 Code which were added as such by the 1950 Act and subsequently amended to some extent with retroactive effect by the Revenue Act of 1951.↩2. SEC. 445. AVERAGE BASE PERIOD NET INCOME -- NEW CORPORATION.(b) Average Base Period Net Income. -- The average base period net income of a new corporation determined under this section shall be computed as follows: (1) For the purpose of determining the excess profits credit for any of the taxpayer's first three taxable years which is a taxable year under this subchapter -- (A) By multiplying the amount of the total assets for such taxable year (determined under subsection (c)), held by the taxpayer in good faith for the purposes of the business, by the base period rate of return, proclaimed by the Secretary under section 447, for the taxpayer's industry classification.(B) By subtracting from the amount ascertained under subparagraph (A) the total interest paid or incurred by the taxpayer for the 12 months ending with the last day of such taxable year.↩3. SEC. 442. AVERAGE BASE PERIOD NET INCOME -- ABNORMALITIES DURING BASE PERIOD.(f) Total Assets. -- For the purposes of this section, the taxpayer's total assets for any day shall be determined as of the end of such day and shall be an amount equal to the excess of -- (1) the sum of the cash and the property (other than cash, inadmissible assets, and loans to members of a controlled group as defined in section 435(f)(4)) held by the taxpayer in good faith for the purposes of the business, over(2) the amount of any indebtedness (other than borrowed capital as defined in section 439(b)(1)) to a member of a controlled group (as defined in section 435(g) (6)) which includes the taxpayer.↩Such property shall be included in an amount equal to its adjusted basis for determining gain upon sale or exchange, determined under the rules provided in section 441.4. This does not mean that there is anything in the accounting authorities cited to us by petitioner which conflicts to any degree with the conclusion we reach. Quite the contrary. E.g.:"The billing for the completed work would be so recorded as to bring into the books under receivables only the amount matured as a cause of action, although the deferred portion of the completed work may be recognized as a noncurrent item, as follows:Accounts receivable$ 45,000Deferred portion of current billings5,000Completed portion of contract in process; or partialbillings on contracts in process$ 50,000 * * " * * the debit account, 'Contract in process,' does not by any stretch of the imagination represent an asset of the contractor except as an indication that he has done work and thus has a right to recover money from the obligor -- usually a different sum of money. This right to recover money is a receivable and is commonly represented in the balance-sheet as such * * ." (Myron M. Strain, "Some Specialized Phases of Accounting Practice," pp. 4, 5, 6 (The Pacioli Press -- 1947).)↩5. " * * this method of progress billings is customary in the construction industry for the purpose of providing a convenient means of financing the costs of contractors. * * " * * This practice has developed over the years as a method by which a contractor can more efficiently and expediently perform his obligations under the contract through the financing by the customer, instead of being required to finance his costs through a bank or outside lending institution." (Petitioner's briefs.)↩6. Petitioner appears to agree that this is so. "The contractor's account receivable from the customer arises only at the date when it is entitled to and does render a billing in accordance with the terms of the contract." (Petitioner's reply brief.)↩7. Petitioner contends that there is no reason for assuming that Congress was unwilling to permit the computation of excess profits credits on duplicating assets. But this would be so inequitable that we are unwilling to accept it as part of the congressional purpose.↩8. It is not clear to what extent petitioner's books actually reflected the elimination of any such duplication. Apparently when the bill was sent, "[this] was the date on which Petitioner debited accounts receivable on its books and credited a deferred income amount [account ?] styled 'Deferred Income -- Job Contracts'. (Stip. par. 11)."The stipulation already quoted above continues: "* * * Petitioner accumulated [debited ?] all costs with respect to a particular contract in an asset account styled 'Work in Progress' until the job was completed. All amounts billed the customer prior to completion of the contract were credited on the books of Petitioner to a deferred income account styled 'Deferred Income -- Job Contracts', and accounts receivable were debited. When payments were received, the accounts receivable were credited and the cash account was debited. Upon completion of the job * * * the charges in the 'Work in Progress' account and the credits in the 'Deferred Income -- Job Contracts' account * * * were transferred to profit and loss."↩9. The burden of proof, of course, is not on the respondent but on the petitioner.↩10. See American Institute of Accountants (270 Madison Ave., New York 16, New York) "Long-term Construction-type Contracts," Accounting Research Bulletin (Oct. 1955) No. 45:"When the completed-contract method is used, an excess of accumulated costs over related billings should be shown in the balance sheet as a current asset, and an excess of accumulated billings over related costs should be shown among the liabilities, in most cases as a current liability. If costs exceed billings on some contracts, and billings exceed costs on others, the contracts should ordinarily be segregated so that the figures on the asset side include only those contracts on which costs exceed billings, and those on the liability side include only those on which billings exceed costs. It is suggested that the asset item be described as 'costs of uncompleted contracts in excess of related billings' rather than as 'inventory' or 'work in process,' and that the item on the liability side be described as 'billings on uncompleted contracts in excess of related costs.'"↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623426/	Marvin E. Hinson and Pauline Hinson v. Commissioner. Marvin E. Hinson v. Commissioner.Hinson v. CommissionerDocket Nos. 4108-64, 4109-64.United States Tax CourtT.C. Memo 1967-15; 1967 Tax Ct. Memo LEXIS 247; 26 T.C.M. (CCH) 95; T.C.M. (RIA) 67015; January 30, 1967247 Held: Petitioners' substantial understatement of their adjusted gross income on their Federal income tax returns for 5 years was due to fraud with intent to evade tax. Robert B. Lloyd, Jr., and H. Thomas Greene, for the petitioners. Charles B. Sklar, for the respondent. SIMPSONMemorandum Findings of Fact and Opinion SIMPSON, Judge: In docket No. 4109-64, respondent determined a deficiency in Marvin E. Hinson's Federal income tax for the year 1956 in the amount of $2,728.45 and an addition to the tax pursuant to section 6653(b) of the Internal Revenue Code of248 19541 in the amount of $1,364.22. In docket No. 4108-64, respondent determined deficiencies in Marvin E. Hinson's and Pauline Hinson's Federal income tax and additions to the tax pursuant to section 6653(b) as follows: AdditionYearDeficiencyto Tax1957$12,209.33$ 6,104.6619587,055.103,527.551960543.08271.5419611,566.161,102.17The issues presented are the correctness of the respondent's determination, based on a net worth computation, that petitioners understated their income on their Federal income tax returns for the years 1956, 1957, 1958, 1960, and 1961, and the determination that such understatements were due to fraud with intent to evade tax. The parties agree that the deficiencies for the years 1956 and 1957 are barred by the statute of limitations unless fraudulent understatements of income are found for those years. Findings of Fact Some of the facts were stipulated, and those facts are so found. During the taxable years 1956 through 1961, Marvin E. Hinson and Pauline Hinson were married. During these years they were both residents of Wilmington, 249 North Carolina, but were not living together as husband and wife. For the taxable year 1956, Marvin E. Hinson filed a separate Federal income tax return with the district director of internal revenue at Greensboro, North Carolina. For the years 1957 through 1961, Marvin E. Hinson and Pauline Hinson filed joint income tax returns with the district director of internal revenue at Greensboro, North Carolina. During the years 1956 through 1958, two of petitioner's children resided with Pauline Hinson. During 1959, only one child resided with Pauline Hinson. Since Pauline Hinson is a party in docket No. 4108-64 solely because petitioners filed joint returns for some of the years in question, "petitioner", in the singular, will be used to refer to Marvin E. Hinson. Petitioner was born February 27, 1915, near Staley, North Carolina. He attended Randolph County public schools and completed his formal education with the fifth grade. Soon after leaving school, petitioner was employed by his grandfather in sawmilling and general farming. This employment was in 1929 or the early 1930's. After leaving employment with his grandfather, petitioner operated a produce truck for a while and then worked250 for Cape Fear Transport Company and Sing Oil Company as a truck driver. In 1942, petitioner purchased a gasoline transport truck from Sing Oil Company for $3,000 and started operating his own transportation business, later to be known as Hinson Transport Company. Hinson Transport Company was operated as a sole proprietorship from 1942 until 1961, and over these years was expanded into a multitruck operation hauling many different types of commodities. Petitioner organized another sole proprietorship in 1948, Hinson Oil Company, which was engaged in selling gasoline and other petroleum products at retail through the operation of a service station and at wholesale to other service stations. Although Hinson Oil Company was not affiliated with any major oil company, it has purchased petroleum products from them. Hinson Transport Company transported petroleum products for Hinson Oil Company. Hinson Oil Company is still in operation. In 1957, petitioner organized another sole proprietorship, Hinson Truck Sales and Service, which was an International Harvester truck dealership selling trucks and trailers and maintaining a stock of truck parts and doing truck maintenance. Petitioner251 was also engaged during the years 1956 through 1961 in the operation of Continental Construction Company. This business was initially operated as a partnership by petitioner and S. E. Cooper, but in September of 1955, the business was incorporated, and petitioner and Cooper transferred their partnership interests to the newly-formed corporation in exchange for its stock. Jack Scruggs, Jr., then obtained an equal interest in the corporation by giving the corporation his note in exchange for stock, but the note was never paid and his stock was cancelled in 1957. Continental Construction Company engaged in various types of construction using heavy earthmoving and roadway equipment. Most of its work was under various government contracts. In 1961, petitioner purchased S. E. Cooper's stock and became the sole stockholder of Continental Construction Company. During the taxable years 1956 through 1961, petitioner did not understand detailed principles of accounting and tax law, but he was successful in handling business transactions. He has been able to maintain control over the operation of his service station and has made spot checks on his bookkeepers and employees handling cash. His252 service station maintains an adequate daily sales and cash report record with which the amount of cash in the cash register is reconciled. Petitioner has been able to review and analyze these reports to ascertain whether, for a particular day's operations, there has been a cash overage or shortage. Petitioner did not participate in the accounting or bookkeeping of his businesses. He hired bookkeepers and accountants, who were adequate and competent in ability, to keep the books of three proprietorships, and he did not make deposits or write checks for his businesses. Petitioner did have problems with several of his bookkeepers, partly because of alleged dishonesty. Anytime that petitioner suspected improper conduct on the part of any of his bookkeepers, he hired an accountant or detective to investigate the bookkeeper's work and activities. Petitioner also relied on others to handle the bookkeeping activities of Continental Construction Company. While they were with the corporation, the other two stockholders of Continental Construction Company, S. E. Cooper and Jack Scruggs, Jr., with the assistance of the certified public accounting firm of Cherry, Bekaert & Holland, supervised253 the bookkeepers. The books and records of petitioner were audited by the Internal Revenue Service for the years 1948 through 1951, and petitioner paid certain deficiencies for those years. These deficiencies were determined by use of the net worth method. The respondent determined that petitioner's adjusted gross income shown on his returns should be increased by $15,000.69 for 1948, $2,638.82 for 1949, $5,733.34 for 1950, and $7,388.20 for 1951. At that time, petitioner was advised by a revenue agent to obtain the services of a public accountant so that adequate books and records could be established as a foundation for the preparation of accurate income tax returns. Petitioner followed this advice and sometime during 1956 engaged the firm of Cherry, Bekaert & Holland to prepare income tax returns and financial statements for the year ended December 31, 1955, and to install a double entry accounting system that would record the income and expenses of Hinson Oil Company and Hinson Transport Company as separate units, thereby permitting the two businesses to maintain their records separately. The financial statements were to be prepared without audit of petitioner's original books254 of entry. Cherry, Bekaert & Holland was also retained to set up the books of Hinson Truck Sales and Service in 1957 and to prepare profit and loss statements for that proprietorship from 1957 through 1961. The firm also rendered accounting services to Continental Construction Company during a portion of the years 1956 through 1961. In addition, Cherry, Bekaert & Holland assisted petitioner in the hiring of new bookkeepers for his businesses and prepared petitioner's income tax returns for the years 1956 through 1961. Petitioner paid a total of between $8,000 and $11,000 in fees to Cherry, Bekaert & Holland for their services. Cherry, Bekaert & Holland prepared petitioner's returns by working from a trial balance taken from petitioner's general ledgers. The firm did not examine petitioner's journal except as needed to refer to a particular item. Petitioner filed no income tax returns for the years 1930 through 1946. For the years 1948 through 1955, petitioner's adjusted gross income, computed in audit examinations by the Internal Revenue Service for 1948 through 1951 and taken from petitioner's income tax returns for 1952 through 1955, was $19,000.68 for 1948, $9,983.76 for 1949, 255 $9,733.33 for 1950, $11,388.19 for 1951, $5,099.64 for 1952, $4,261.21 for 1953, $7,630.66 for 1954, and $6,719.17 for 1955. During the years 1948 through 1952, petitioner's family consisted of himself, his wife, and their four children, and he was entitled to six personal exemptions. He was entitled to four personal exemptions for 1954 through 1958, three exemptions for 1959, and two exemptions for 1960 and 1961. Petitioner has maintained a modest standard of living throughout his life. During the years 1956 through 1961, petitioner and his wife were not on the best of terms. Petitioner has for several years suffered from a stomach ailment that required treatment by a doctor. During the years 1956 through 1961, petitioner did not have a personal checking account. Many of his personal expenses were paid by his businesses and charged to his drawing accounts. For the purpose of obtaining credit, petitioner in his own name or in the name of Hinson Transport Company, submitted financial statements to Security National Bank and Morris Plan Bank of Wilmington. Petitioner's cash on hand and in banks, as shown by such statements, was $15,900 on October 30, 1947, $5,317.04 on November 30, 1948, $7,000256 on April 29, 1949, and $4,375 on May 31, 1949. From June 30, 1950, through May 23, 1952, petitioner, on behalf of Hinson Transport Company, obtained a number of new loans from the Bank of Wilmington, Wilmington, North Carolina (now North Carolina National Bank). These loans were all based on approximately 30-day promissory notes, all bearing interest at 6 percent, and secured by chattel mortgages on truck tractors and trailers. These notes were each renewed a number of times so that some amount of principal was always outstanding during this period. At one point the amount petitioner owed on these notes totaled $10,400. On May 29, 1951, petitioner borrowed $3,500 from Security National Bank, Wilmington, North Carolina, on a 90-day note bearing interest at 6 percent and secured by a deed of trust on a parcel of petitioner's real property. After several renewals, this note was repaid in full on November 28, 1952. Security National Bank made this $3,500 loan to petitioner after investigating his financial status. The investigation included a complete financial statement as of May 22, 1951. On this financial statement, petitioner stated that his cash on hand was $200 and his cash257 in banks was $2,100. Security National Bank's investigation also indicated that in 1951 the real property pledged as security for the $3,500 loan had a valuation of $3,550 but was subject to liens for unpaid taxes due New Hanover County, North Carolina, in the amount of $46.10 for 1949 and $41.00 plus 3 percent interest for 1950. The Bank of Wilmington also made loans to petitioner. In October of 1953, petitioner borrowed $4,000 from the Bank of Wilmington. This loan was to be repaid in 12 monthly installments of $334 each. In December of 1955, petitioner borrowed $3,182 from the Bank of Wilmington to purchase a new 1956 Lincoln automobile. The loan was to be repaid in 12 monthly installments of approximately $265 each. In January of 1956 petitioner borrowed $4,200 from the Bank of Wilmington to purchase a new 1956 White tractor. The loan was to be repaid in 12 monthly installments of $350 each. Petitioner was required to file Intangible Personal Property Tax returns with the State of North Carolina, setting forth certain assets owned as of December 31 of each year. The returns required the reporting of money on hand or on deposit other than in North Carolina banks. Petitioner258 did not file such a return for the year 1954. Petitioner filed returns reporting total money on hand or on deposit other than in North Carolina banks of $1,279.30 for the year 1955, $1,500.00 for 1956, and $1,426.32 for 1957. Agreed audit deficiencies, including applicable penalties and interest, for petitioner's taxable years 1948 through 1951 were assessed on January 15, 1953. A first notice of assessment was sent to petitioner on January 23, 1953, followed by a second notice on March 6, 1953. When assessments remained unpaid, a delinquent account notice was issued on March 31, 1953, and notices of Federal tax liens were filed on April 16, 1953, no part of the tax having been paid prior to that date. Petitioner paid the agreed deficiencies over the next 7 months, and the Federal tax liens were released on November 16, 1953. On January 28, 1957, petitioner opened a savings account of $10,000 at Security National Bank in his own name and a savings account of $10,000 in trust for his daughter, Shirley Jean Sullivan. In April of 1957, petitioner borrowed $10,000 from Security National Bank and put the proceeds into Hinson Truck Sales and Service as an initial capital investment. 259 Soon after this, petitioner borrowed a second $10,000 from Security National Bank and invested the proceeds in Hinson Truck Sales and Service. The loans were each secured by one of the two savings accounts mentioned above. About June 30, 1958, petitioner withdrew $10,000 from the savings account in trust for his daughter and paid off one of the loans from Security National Bank. About December 31, 1958, petitioner withdrew $10,000 from the savings account in his own name and paid in full the other loan from Security National Bank. Interest was credited by the bank to these accounts in the amount of $512.10 for the year 1957, $471.93 for 1958, $30.36 for 1959, $27.67 for 1960, and $31.56 for 1961. Such interest was not reported on petitioner's income tax returns for any of the years 1957 through 1961. In 1956, petitioner received at least $4,965.75 income from rental of a bulldozer to Continental Construction Company during April, May, and June of 1956 at a fixed rate of $10 per hour. Only $2,950.45 of this amount was reported as income on petitioner's return for that year. In 1957, petitioner rented a D-7 Caterpillar tractor and accessories to Continental Construction Company260 for which he received $3,000 in rental income. This rental income was not reported by petitioner on his 1957 income tax return. On October 24, 1957, petitioner sold a D-7 Caterpillar tractor to Continental Construction Company for $8,032.50. This sale was not reported on petitioner's 1957 income tax return. On January 24, 1957, petitioner purchased 250 shares of stock of the Canadian Limited Company at a cost of $4,656.25. Petitioner sold these shares on June 7, 1957, for $7,266.25. This purchase and sale was not disclosed to Cherry, Bekaert & Holland and was not reported on petitioner's 1957 income tax return. During 1958, Continental Construction Company sold a one-third interest in a joint venture, Stream Clearing Construction Company, to the other members of the joint venture for a total price of $20,000, which was to be paid on an installment basis as work progressed on the joint venture's project. Petitioner and S. E. Cooper bypassed the corporation and received directly $6,116.72 during 1958 from this sale, which they divided equally. Petitioner then loaned $3,000 of this sum back to the joint venture to help finance completion of the project. After this transaction, petitioner261 received no further money from the joint venture, not even his $3,000. These transactions were not reported on petitioner's 1958 income tax return. In 1959, petitioner sold a Ford truck to Continental Construction Company for $700. This sale was not reported on petitioner's 1959 income tax return. Information on petitioner's income tax returns that was not related to his three businesses was supplied to Cherry, Bekaert & Holland by either petitioner or his bookkeepers. In May of 1962, one of petitioner's bookkeepers asked Cherry, Bekaert & Holland if $10,000 received from the sale of motor carrier rights of Hinson Transport Company had been reported on petitioner's 1961 income tax return. This sale had not been reported on petitioner's return, and an amended return for petitioner was therefore filed for the year 1961. On March 15, 1955, petitioner rented a safe deposit box at Security National Bank. Petitioner entered the safe deposit box on April 19, 1955, and January 28, 1957. Because of the method employed by the bank in keeping safe deposit box access tickets, any entry into petitioner's box other than [by] those two would be improbable, although not impossible because262 of the movement of bank records in a merger after the above dates of entry. The following schedule correctly reflects petitioner's net worth and adjusted gross income at December 31 for each of the years 1955 through 1961: Description12/31/5512/31/5612/31/5712/31/58Net Worth per Books: Hinson Oil Company$60,468.45$65,101.47$ 70,947.50$ 66,841.57Hinson Transport Company(4,604.39)Hinson Truck and Sales10,758.3638,015.30Assets not Recorded onBooks: Cash24,000.0024,000.004,000.000Notes Receivable1,800.001,800.009,082.75Corporate Stock2,766.68Fruehauf Trailers386.504,817.707,069.97Accounts Receivable8,500.00Investment in CapitalStock - IndustrialProper-ties, Inc.1,000.001,000.00Savings Account -Security National Bank,Wil-mington, North Carolina20,491.941,000.92Real Estate2,995.002,995.002,995.002,595.00Total Net Worth$87,463.45$94,282.97$116,810.50$132,267.80Net Worth Increase$ 6,819.52$ 22,527.53$ 15,457.30Add: Personal Property Removedfrom Net WorthPersonal Living Expenses5,235.535,244.265,281.42Federal and State Income1,286.41253.775,748.46TaxesFines and Penalties PaidLess: Non-taxable Capital Gains(350.00)Dividend Exclusion(50.00)Corrected Adjusted Gross$13,341.46$ 28,025.56$ 26,087.18IncomeAdjusted Gross Income as3,297.1223,028.686,494.80ReportedIncrease (Decrease) in$10,044.34$ 4,996.88$ 19,592.38Adjusted Gross Income263 Description12/31/5912/31/6012/31/61Net Worth per Books: Hinson Oil Company$ 75,797.99$ 78,820.90$ 87,638.00Hinson Transport Company(17,326.45)(24,068.98)(29,486.71)Hinson Truck and Sales49,290.2052,948.3443,114.34Assets not Recorded onBooks: Cash006,250.00Notes Receivable5,706.557,175.007,175.00Corporate Stock2,766.682,766.686,516.68Fruehauf Trailers6,909.263,368.093,472.00Accounts Receivable1,000.004,100.007,802.00Investment in CapitalStock - IndustrialProper-ties, Inc.1,000.001,000.001,000.00Savings Account -Security National Bank,Wil-mington, North Carolina1,030.271,057.131,077.62Real Estate2,595.002,595.002,595.00Total Net Worth$128,769.50$129,762.16$137,153.93Net Worth Increase[ 3,498.30)$ 992.66$ 7,391.77Add: Personal Property Removed1,500.002,500.00from Net WorthPersonal Living Expenses5,345.546,894.126,358.13Federal and State Income1,108.131,071.051,759.13TaxesFines and Penalties Paid571.0526.00Less: Non-taxable Capital Gains(5,000.00)Dividend Exclusion(50.00)(50.00)(50.00)Corrected Adjusted Gross$ 4,405.37$ 9,478.88$ 12,985.03IncomeAdjusted Gross Income as5,433.367,403.518,453.93ReportedIncrease (Decrease) in$ (1,027.99)$ 2,075.37$ 4,531.10Adjusted Gross Income264 The amounts and percentages of petitioner's corrected adjusted gross income, adjusted gross income reported, and understatement of adjusted gross income for each of the taxable years 1956 through 1961 are as follows: ADJUSTED GROSS INCOMEUnderstatementor Over-YearCorrected%Reported%statement %1956$13,341.46100$ 3,297.1224.71$10,044.3475.29195728,025.5610023,028.6882.174,996.8817.83195826,087.181006,494.8024.8919,592.3875.1119594,405.371005,433.36123.331,027.99 23.33 19609,478.881007,403.5178.112,075.3721.89196112,985.031008,453.9365.114,531.1034.89Totals$94,323.48100$54,111.4057.37$40,212.0842.63Ultimate Findings of Fact On December 31, 1955, petitioner had in his safe at Hinson Oil Company $24,000 in cash. Petitioner transferred $20,000 of this cash from his safe to his safe deposit box at Security National Bank sometime in 1956. Early in 1957, petitioner then removed this cash from his safe deposit box and with it opened two savings accounts at Security National Bank. The remaining $4,000 in petitioner's265 safe was retained by him and ultimately expended during 1958 on behalf of Hinson Truck Sales and Service. Opinion Respondent determined petitioners' income for the years 1956 through 1961 under the net worth method of income reconstruction. Petitioner contends that the net worth method may not be used in this case since his books and records were accurate, adequate, and complete. In support of this contention, petitioner makes a detailed argument based on Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954), that if a taxpayer's books are accurate, the net worth method may not be used. Petitioner then argues that proof of inaccurate books is a condition precedent to the use of the net worth method. We do not agree with petitioner's reading of the Holland case. It seems clear to us that the net worth method may be used to test the accuracy and adequacy of a taxpayer's books regardless of whether such books are on their face accurate or inaccurate. This view appears to have the clear support of the cases that have dealt with this problem since the Holland decision. See, e.g., Schwarzkopf v. Commissioner, 246 F. 2d 731 (C.A. 3, 1957), affg. a Memorandum Opinion266 of this Court; Davis v. Commissioner, 239 F. 2d 187 (C.A. 7, 1956), affg. a Memorandum Opinion of this Court, cert. denied 353 U.S. 984">353 U.S. 984 (1957); Vloutis v. United States, 219 F. 2d 782 (C.A. 5, 1955); Kite v. Commissioner, 217 F. 2d 585 (C.A. 5, 1955), affg. in part a Memorandum Opinion of this Court; Morris Lipsitz, 21 T.C. 917">21 T.C. 917 (1954), affd. 220 F. 2d 871 (C.A. 4, 1955), cert. denied 350 U.S. 845">350 U.S. 845 (1955). Moreover, petitioner's books were not accurate. We have detailed in our Findings of Fact a number of income items specifically omitted by petitioner from his books and the income tax returns he filed for the years in question. We therefore see no merit in petitioner's contention and are fully satisfied that respondent was justified in his use of the net worth method. The parties have stipulated in this case to the correctness of all items appearing in the net worth computation of respondent with two exceptions: the amount of petitioner's cash on hand as of the beginning of 1956, the first tax year in question, and the amount of petitioner's personal expenses during all of the years in question. 267 As to these items, the petitioner has the burden of proof. Clark v. Commissioner, 253 F. 2d 745 (C.A. 3, 1958), affg. in part and revg. in part a Memorandum Opinion of this Court; Joseph B. Moriarty, 18 T.C. 327">18 T.C. 327 (1952), affd. per curiam 208 F. 2d 43 (C.A.D.C. 1953). Petitioner maintains that on December 31, 1955, he had in his safe at Hinson Oil Company $24,000 or $25,000 in cash. Petitioner claims that respondent erred in not including this amount in calculating petitioner's opening net worth for the years in question. Petitioner's claim is a common one in cases of this type. The Supreme Court in the Holland case referred to the claim of opening cash on hand as a "favorite defense" (348 U.S. 127">348 U.S. 127). However, the Supreme Court recognized in Holland that "the correctness of the result depends entirely upon the inclusion in * * * (opening net worth) of assets on hand at the outset" (348 U.S. 132">348 U.S. 132). We must therefore never take lightly a taxpayer's contentions as to an opening cash accumulation. We have found that petitioner did have $24,000 in cash at the beginning of 1956. Although there is a great deal of conflicting268 evidence in this case as to the existence of petitioner's cash hoard, we will summarize the arguments and evidence that have led us to our conclusion. Not only did petitioner testify as to the existence of his cash hoard, but two witnesses - one a close friend of petitioner's and one a former business associate of petitioner's - also testified that they saw counted, or themselves counted, approximately $25,000 cash in petitioner's safe in the fall of 1955. One of these two witnesses testified that he saw this cash again in the early spring of 1956. The testimony of petitioner and the two witnesses was substantially consistent in view of the time that has passed since these events. Although the two witnesses do have close connections with petitioner and the testimony of one witness was somewhat inconsistent with a prior written statement of his made to respondent during the investigation of this case, we have no substantial reason for doubting the truthfulness of the witnesses, and, as direct testimony, their assertions are entitled to great weight. Respondent argues that petitioner filed no returns prior to 1947 and that this is evidence that his income during those years was269 insufficient to require them. Respondent further argues that petitioner's income from 1948 through 1955 as shown by his returns and a prior net worth computation for the years 1948 through 1951 was not sufficient to allow accumulation of any substantial amount of cash. Respondent also points out that petitioner made no claim of a cash hoard in respondent's prior examination of petitioner's returns for the years 1948 through 1951. These arguments are persuasive, but there exists the possibility that the cash hoard could have been accumulated from income not reported on petitioner's income tax returns for years prior to 1956. In addition, petitioner's standard of living was modest, and in 1942 he purchased his first truck for $3,000 cash that he had accumulated between 1930 and 1942. Furthermore, if it were possible for him to accumulate $3,000 cash during his low income years of 1930 to 1942, it might have been possible for him to accumulate $25,000 cash during his higher income years of 1942 through 1955 - an accumulation of slightly less than $2,000 per year. From 1950 through 1956, petitioner borrowed money at interest on a number of occasions and renewed a number of such loans. 270 In 1955, petitioner borrowed money to buy a luxury automobile. In 1953, it was necessary to assert Federal tax liens to collect petitioner's earlier deficiency in income taxes. As of May 1951, real property taxes due Hanover County, North Carolina, for the years 1949 and 1950 had not been paid by petitioner. Petitioner's North Carolina intangible tax returns for the years 1955, 1956, and 1957 showed no substantial cash. All of these facts tend to indicate that the petitioner lacked any substantial cash hoard. However, some people borrow money, or defer paying their obligations, even though they have cash on hand. Finally, the respondent attempts to impeach the testimony of the witnesses who claim to have counted, or seen counted, the cash hoard by showing that the petitioner could not have transferred the hoard from his safe in Hinson Oil Company to his safe deposit box at the time he claims to have done so. Petitioner testified that he had approximately $24,000 cash in December of 1955. On March 15, 1955, petitioner rented a safe deposit box at Security National Bank. Petitioner testified that in March or April of 1956, he took $20,000 of this cash from his safe at Hinson Oil Company271 and placed it in his safe deposit box. Then, petitioner testified that on January 28, 1957, he entered his safe deposit box, removed the $20,000 in cash, and opened two savings accounts at Security National Bank, each in the amount of $10,000. Respondent has argued that Security National Bank's records show only two entries into petitioner's safe deposit box - on April 19, 1955, and January 28, 1957. An official from the bank testified that it would be improbable that any other entries into petitioner's safe deposit box were made; but such officer also testified that there was a subsequent merger of the bank in which the bank's records were moved, and that therefore other unrecorded entries were possible. Respondent then points out that if petitioner entered his safe deposit box only in the spring of 1955, the testimony of the two witnesses who allegedly saw the cash in the fall of 1955 must be false. Respondent argues that petitioner could not have put the cash in his safe deposit box on January 28, 1957, since that is the day that petitioner testified he removed the cash. Respondent's argument is very persuasive. Nevertheless, if we refuse to believe petitioner's testimony in272 regard to his cash hoard, we can find no probable source for the $20,000 deposited by petitioner in the two savings accounts. The existence of this cash hoard in early 1957 is, in our view, the decisive consideration when combined with the testimony of petitioner and two witnesses. Petitioner had to have cash approximating $20,000 at the beginning of 1956, or he had to accumulate in 1956 whatever amount of the $20,000 cash hoard he lacked at the beginning of the year. If petitioner had accumulated this amount during 1956, his income for that year would have been $20,000 greater than even respondent computed on his statement of petitioner's net worth. It seems unlikely that the petitioner could have accumulated most of such cash hoard during 1956; it seems more likely that he had the cash hoard at the beginning of the year. In summary, we concluded that the most likely account of what happened is that the petitioner had a cash hoard of about $24,000 at the beginning of 1956. We are influenced by the testimony of the witnesses who claim to have seen the money and by the existence of a large cash hoard in early 1957. Although the respondent did succeed in establishing that there was273 no recorded entry into the safe deposit box in the spring of 1956, as the petitioner claimed, we think that the course of events recounted by the petitioner can be reconciled by the assumption that there must have been some other entry into the safe deposit box - the record of which is now lost. The second item in respondent's net worth computations that is in dispute is the amount of petitioner's personal living expenses during the years 1956 through 1961. Respondent determined petitioner's personal living expenses to be $5,235.53 in 1956, $5,244.26 in 1957, $5,281.42 in 1958, $5,345.4 in 1959, $6,894.12 in 1960, and $6,358.13 in 1961. Petitioner disputes $2,600 each year of respondent's determination of personal expenses. In other words, petitioner maintains that his personal expenses for these years amounted to $2,635.53 in 1956, $2,644.26 in 1957, $2,681.42 in 1958, $2,745.54 in 1959, $4,294.12 in 1960, and $3,758.13 in 1961. Petitioner and his wife were separated during the years 1956 through 1961, and in each of these years, petitioner contributed to his wife's support in the amount of $2,208. In computing petitioner's personal expenses for these years, respondent added to274 these support payments petitioner's life insurance payments made by check, his medical expenses paid by check, his property taxes paid by check, and personal withdrawals by petitioner from his business. Respondent's calculations appear to us to be very reasonable. Petitioner would have us believe that in several of these years, his personal expenses, excluding the amounts paid for his wife's support, amounted to only $400 or $500 per year. We cannot accept petitioner's calculations, for petitioner has given us no evidence to support his position except for a few statements that his standard of living was modest and frugal. We have therefore accepted respondent's calculations as to petitioner's personal living expenses. Since the remaining items in respondent's net worth calculations were stipulated by the parties to be correct, we accept the net worth computation set out in our Findings of Fact as accurately reflecting petitioner's adjusted gross income for each of the years in question. We must now decide whether the understatement by petitioner of his adjusted gross income on his Federal tax returns for 5 out of the 6 years from 1956 through 1961 constitutes fraud. Respondent275 has the burden of proof with respect to fraud (section 7454(a)), and he must establish by clear and convincing evidence that at least some part of the deficiency for each year at issue is due to fraud with intent to evade tax. E. S. Iley, 19 T.C. 631">19 T.C. 631 (1952), acq. 2 C.B. 4">1953-2 C.B. 4; Arlette Coat Co., 14 T.C. 751">14 T.C. 751 (1950). It is well settled that the mere understatement of income alone is not proof of fraud, but consistent and substantial understatement of income is highly persuasive evidence of intent to defraud. Schwarzkopf v. Commissioner, supra; Davis v. Commissioner, supra. See also, Holland v. United States, supra.Such consistent understatements are even more convincing when supported by other circumstances pointing to an intent to evade tax. Gatling v. Commissioner, 286 F. 2d 139 (C.A. 4, 1961), affg. a Memorandum Opinion of this Court. The whole record must be searched for the intent to defraud. E. S. Iley, supra. In approximate figures, petitioner reported 25 percent of his adjusted gross income for the year 1956, 82 percent of his adjusted gross income for 1957, 25 percent276 for 1958, 123 percent for 1959, 78 percent for 1960, and 65 percent for 1961. The total understatement for these 6 years was $40,212.08, and for the 6 years as a wholey petitioner reported only 57.37 percent of his total adjusted gross income. We know that a part of this understatement was due to specific transactions set forth in our Findings of Fact. Petitioner attempts to explain his understatements of income by arguing that he was unable personally to keep complete and adequate records and, because of his lack of education, that he was unfamiliar with the Federal income tax laws. Consequently, petitioner argues that he was forced to rely on a firm of certified public accountants to prepare his tax returns, and these accountants should have been able to prepare correct returns. We cannot accept petitioner's explanations. Petitioner did testify that he discussed a number of the transactions not reported on his tax returns with his bookkeepers or accountants. However, we have not been able to find such as a fact. There was ample testimony in the record to the effect that petitioner's bookkeepers were adequate and competent in ability. The accountants from Cherry, Bekaert & Holland277 that worked on petitioner's books seemed very well qualified. We cannot believe that had petitioner informed his bookkeepers or accountants of these transactions, the transactions - substantial in number and amount - would have been omitted from petitioner's returns. We accordingly cannot find that petitioner furnished his bookkeepers and accountants all the information necessary to file accurate and complete income tax returns, and we cannot find that the specific omission of a number of transactions from the returns was due to the fault of petitioner's bookkeepers or accountants. Petitioner did not have to be familiar with income tax law or be able to keep a set of books to report his correct income on his tax returns. All he had to know was that when he received money, he should tell his bookkeepers. We cannot understand how petitioner can plead ignorance when in 1956 he rented a bulldozer to Continental Construction Company and received rents of $4,965.75, while only reporting $2,950.45. Furthermore, petitioner's income tax returns for the years 1948 to 1951 had been audited by respondent. Petitioner was told at that time that his books were inadequate, and respondent advised*278 that petitioner find competent accounting aid. Petitioner followed this advice, but we think that because of this audit examination and the resulting assessment, petitioner should have been very conscious that in any transaction in which he either received or disbursed money for business purposes, he should inform his bookkeepers to ensure that the transaction would be reported on his tax returns. We accordingly find that petitioner's failure to report all of his adjusted gross income on his Federal income tax returns for the years 1956, 1957, 1958, 1960, and 1961 was due to fraud with intent to evade tax. The respondent's assertion of fraud penalties under section 6653(b) is therefore proper, and, in accord with section 6501(c)(1), the statute of deficiencies in tax for the years 1956 and 1957. Decisions will be entered under Rule 50. 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/4623428/	Mayo Holbrook and Verna Holbrook, Petitioners v. Commissioner of Internal Revenue, RespondentHolbrook v. CommissionerDocket No. 1261-74United States Tax Court65 T.C. 415; 1975 U.S. Tax Ct. LEXIS 24; November 26, 1975, Filed 24 Decision will be entered for the respondent. Held, petitioners are not entitled to a percentage depletion deduction in 1970 with respect to income derived from coal mining under a nonexclusive and nontransferable license which was subject to termination without cause by giving the licensee 10 days' notice. William H. Beck, for the petitioners.Robert P. Ruwe, for the respondent. Featherston, Judge. FEATHERSTON415 Respondent determined a deficiency of $ 12,605.40 in petitioners' Federal income tax for 1970. The issues to be decided 25 are: (1) Whether petitioners are entitled to a percentage depletion deduction under sections 611 1 and 613, with respect to income derived from coal mining operations; and, if so, (2) whether petitioners' gross income as determined for 416 purposes of sections 611 and 613 must be reduced in the amount of certain transportation costs incurred during the year in issue.FINDINGS OF FACTPetitioners Mayo and Verna Holbrook, husband and wife, were legal residents of Whitesburg, Ky., when their petition was filed. Petitioners filed a joint Federal income tax return for 1970 with the District Director of Internal Revenue, Louisville, Ky.Petitioner Mayo Holbrook (hereinafter referred to as Holbrook) was engaged in the business of coal mining for a number of years. On March 23, 1967, his wife, petitioner Verna Holbrook (hereinafter Mrs. Holbrook), as licensee, executed a document entitled26 license No. 145 with the Kentucky River Coal Corp. (hereinafter Kentucky River), as licensor. That document provided in pertinent part:Witnesseth: That for and in consideration of the performance by the Licensee of the provisions hereinafter set forth, the Licensor hereby gives and grants to the Licensee the license, right, and permission, at the sole cost and expense of the Licensee, and subject to the provisions hereinafter set out, to mine coal from the No. Whitesburg seam of coal on the following tract of land, to wit:Lying and being in Letcher County, Kentucky, on the waters of Smoot Creek * ** * The terms of this license are as follows:1. Licensee will begin work immediately and will prosecute the mining of the coal hereunder with due diligence during the life of this license. * 4. Licensor will furnish at its cost all necessary mining engineering, but Licensor shall in no event be responsible for the conduct or manner of mining nor any of the other cost incident thereto, nor for the employing, hiring, firing, controlling or directing any of the employees of Licensee working in said mine or mines, nor any other activity connected with the mining and selling of the27 said coal.5. Licensee shall have the right to use so much of the surface and/or mining rights in and on said boundary for the mining of the coal covered hereby as may be vested in Licensor, but such rights shall not be exclusive and Licensor reserves the right to use or grant to others the joint use of said surface and/or mining rights.6. Licensee agrees to mine all of the mineable and merchantable coal covered hereby in a good and workmanlike manner, and according to the laws of Kentucky and the United States applicable to such mining.* * 8. Title to the coal covered hereby shall not pass until the same has been reduced to physical possession by Licensee.417 * * 10. This license shall continue in force until all of the mineable and merchantable coal covered hereby is mined and paid for unless the same is sooner revoked. This license is revocable at the pleasure of the Licensor, and may be revoked by Licensor at any time, with or without cause, by giving to the Licensee Ten Days written notice in person, or by mail, or by posting the same at any mine portal or opening on the premises. The Licensee may likewise surrender and terminate this license by giving Licensor28 Ten Days written notice, in person or by certified mail. And in the event of such revocation or termination, if Licensee shall not be in default of any payments hereunder or in default of any of the provisions or agreements herein contained, Licensee may remove within Thirty Days all of its equipment and property on said premises; but if in default, or at the expiration of said Thirty Days, all such equipment and property shall become the absolute property of Licensor without any accountability therefor.11. This license is personal to the Licensee and is in all respects nontransferrable.12. This license shall be strictly construed according to its terms and any and all rights not herein specifically given to the Licensee are excepted and reserved to the Licensor.The agreement also provided for payment of a royalty in the sum of 28 cents per ton of coal mined or a minimum monthly royalty of $ 300 per month. Pursuant to the terms of the license, Kentucky River provided engineering services for Holbrook's operations designed to ensure that petitioners' mining operations were conducted along a profitable direction. Kentucky River also reserved the right to, and in fact did, make29 periodic inspections of the mines described in license No. 145 for the purpose of measuring the amount of coal extracted and ensuring that Holbrook was mining in accordance with acceptable practices.Prior to conducting mining operations in mine No. 145, Holbrook was required by Federal safety laws to improve the roof support in the mines to prevent its collapse. Holbrook expended approximately $ 4,000 to $ 5,000 for this purpose, a process which took nearly 4 weeks to complete.From March 1967 through March 1971, Holbrook successfully mined the property covered by license No. 145. As permitted by the license, petitioner sold the coal to several different purchasers, obtaining the highest possible price. In 1970, Holbrook had gross receipts in the amount of $ 347,095.62 from these operations. Holbrook paid royalties to Kentucky River in the amount of $ 16,014.50 during that year. He never paid the minimum royalty because the amount of coal extracted 418 consistently produced a higher royalty. These payments averaged approximately $ 1,200 to $ 1,500 per month during 1970.Most of the improvements and equipment utilized in Holbrook's mining operations with respect to mine30 No. 145 were movable. Much of that equipment had been used in other mines and had been purchased prior to 1967. Some equipment used in this mine was later used in other mines. One machine utilized in this operation, a "joy" loader, was purchased in 1967 from the former operator of the mine at a cost to Holbrook of approximately $ 16,000. Holbrook also erected several buildings necessary for the mining operations on the area covered by license No. 145. Some of them were salvageable and others were not.Holbrook also incurred other deductible expenses in 1970 as a result of the mining operation. Among the items listed as deductions on petitioners' income tax return for that year is an expense for "Contract hauling" in the amount of $ 52,017.88.On their 1970 income tax return petitioners deducted $ 33,108.11 as a depletion allowance with respect to their mining operations under license No. 145. Respondent disallowed that deduction in its entirety. Respondent determined, alternatively, that if petitioners are entitled to a percentage depletion deduction, their gross income from mining should be reduced by the amount expended for contract hauling, $ 52,017.88. Respondent thus31 reduced the claimed depletion by $ 5,201.79. 2OPINIONSection 611(a) provides that in the case of mines there shall be permitted as a deduction in computing taxable income a reasonable allowance for depletion according to the peculiar conditions of each case. Section 613 provides that the depletion allowance in the case of coal shall be 10 percent of the gross income from the property (defined as the gross income from mining, sec. 613(c)), excluding amounts paid as royalties by the taxpayer in respect of the property. The theory of the deduction is that "extraction of minerals gradually exhausts the capital investment in the mineral deposit," and the allowance "is designed to permit a recoupment of the owner's capital investment in the minerals so that when the minerals are exhausted, the owner's capital is 419 unimpaired," Commissioner v. Southwest Expl. Co., 350 U.S. 308">350 U.S. 308, 312 (1956).32 See Parsons v. Smith, 359 U.S. 215">359 U.S. 215, 220 (1959).The touchstone for determining eligibility for the depletion allowance is the ownership of an "economic interest" in the minerals in place. The rule for determining who has an "economic interest" in the minerals in place has been crystallized in section 1.611-1(b)(1), Income Tax Regs., as follows:Annual depletion deductions are allowed only to the owner of an economic interest in mineral deposits * * . An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place * * and secures, by any form of legal relationship, income derived from the extraction of the mineral * * * to which he must look for a return of his capital. * * * A person who has no capital investment in the mineral deposit * * * does not possess an economic interest merely because through a contractual relation he possesses a mere economic or pecuniary advantage derived from production. * * This regulation boils down to two tests for identifying an economic interest: (1) A capital investment in the mineral in place, and (2) a return on the investment which is realized33 solely from the extraction of the mineral. There must exist some element of "ownership" in the mineral deposit "in place" and a right to share in the income from its production. The mineral deposit "in place" must be a reservoir of the taxpayer's capital investment, and that reservoir must be depleted through production. Lynch v. Alworth Stephens Co., 267 U.S. 364">267 U.S. 364, 370-371 (1925); Kohinoor Coal Co. v. Commissioner, 171 F.2d 880">171 F.2d 880, 883 (3d Cir. 1948), affg. a Memorandum Opinion of this Court, cert. denied 337 U.S. 924">337 U.S. 924 (1949). The application of these principles "depends upon the totality of the facts of each case." Ramey v. Commissioner, 398 F.2d 478">398 F.2d 478, 479 (6th Cir. 1968), affg. 47 T.C. 363">47 T.C. 363 (1967).We do not think petitioners "acquired by investment any interest in mineral in place" within the meaning of this regulation. The only right petitioners acquired was a nonexclusive and nontransferable license, terminable on 10 days' notice. Kentucky River did not give up any capital interest in the coal in place but, under the license, retained34 "the right to use or grant to others the joint use" of the "surface and/or mining rights." Kentucky River could terminate the license at its "pleasure" by "giving to the Licensee [i.e., petitioners] Ten Days 420 written notice in person, or by mail, or by posting the same at any mine portal or opening on the premises."Where a license, such as the one granted petitioners by Kentucky River, permitting a licensee to mine coal is nontransferable, is nonexclusive, and is terminable at will on short notice, the owner has given up none of his capital interest in the coal in place. The owner, without cause, can stop the licensee's operations at any time he wishes to do so. He can mine the coal himself. He can permit others to mine coal from the same property, with or without a termination of the licensee's mining rights. The owner thus retains complete control over, and ownership of, the coal in place and the price he will require others to pay for the privilege of mining it. Such a license does not convey "any interest" in the coal "in place" but, in the words of the regulation, transfers "a mere economic or pecuniary advantage" to be "derived from production." Whitmer v. Commissioner, 443 F.2d 170">443 F.2d 170, 172 (3d Cir. 1971),35 affg. a Memorandum Opinion of this Court; United States v. Wade, 381 F.2d 345">381 F.2d 345, 350-351 (5th Cir. 1967); United States v. Stallard, 273 F.2d 847">273 F.2d 847, 851 (4th Cir. 1959); Charles P. Mullins, 48 T.C. 571">48 T.C. 571, 582 (1967); see generally Paragon Coal Co. v. Commissioner, 380 U.S. 624">380 U.S. 624, 633-634 (1965); Parsons v. Smith, 359 U.S. 215">359 U.S. 215, 224 (1959).Moreover, petitioners did not make any "investment" in the minerals "in place." The only investment petitioners had in the mining operation was their equipment and roof supports and all, or nearly all, of these items were movable. 3 That investment was recoverable and was recovered through depreciation, and all the rest of petitioners' outlays were recovered through current expense deductions. See Paragon Coal Co. v. Commissioner, supra;Parsons v. Smith, supra;Lesta Ramey, 47 T.C. at 373-374. The nonexclusive character of the license and its terminability by either party on short notice without cause 421 refutes36 any contention that petitioners' obligations under the license constituted a capital investment for which an economic interest was acquired.37 It is true that the coal, after it was mined, belonged to petitioners and that they were free to sell it to others at any price they could negotiate. But they had no interest in the coal "in place." Until the coal was mined and reduced to petitioners' possession, it belonged to Kentucky River. For each ton they mined, petitioners paid Kentucky River an agreed price, referred to in the license agreement as a royalty, and to secure the payment of that price Kentucky River reserved a lien on all coal mined and not previously sold and upon all equipment and improvements placed upon the property. In no sense do these provisions confer on petitioners an economic interest in the coal in place.The facts in Winters Coal Co. v. Commissioner, 496 F.2d 995">496 F.2d 995 (5th Cir. 1974), revg. 57 T.C. 249">57 T.C. 249 (1971), relied upon by petitioners, are distinguishable. In that case, the court held that a lease of coal lands, which was terminable on 30 days' notice, conveyed an economic interest in the coal in place, but the lease required the lessee to obtain rights from the owner of the surface rights before the lease could become effective. Citing Commissioner v. Southwest Expl. Co., supra,*38 the court emphasized (496 F.2d at 998) that the surface-rights-ownership requirement was crucial to its holding. Indeed, the opinion indicates that, absent that requirement, the majority would have concluded that the taxpayer did not have an economic interest in the minerals in place because of the short term of the lease and the cancellation clause. 4 In the instant case, the "Licensor reserves the right to use or grant to others the joint use" of the surface rights.We conclude petitioners are not entitled to the disputed depletion allowance.Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the year in issue, unless otherwise noted.↩2. Since we have concluded that the claimed percentage depletion deduction is not allowable, we do not reach this alternative determination.↩3. On brief petitioners assert they paid $ 16,000 to a Mr. Proffit for the purchase of the Kentucky River license. However, Holbrook first testified that he paid the prior "owner" of the mine $ 16,000 for a "joy" loader, and on their joint income tax return for 1970 petitioners show two items acquired in 1967 (when they were granted license No. 145) in the respective amounts of $ 15,494.86 and $ 2,300. In response to later leading questions, Holbrook gave testimony which could be interpreted to mean that he paid $ 16,000 for the license, but at one point Holbrook interrupted a colloquy of counsel to say the payment was for the "lease and the loader both." No documentation of the transaction was introduced. The license here in issue was granted by Kentucky River to Verna T. Holbrook without any reference to a prior owner, and it expressly provides that it "is personal to the Licensee and is in all respects non-transferrable." We are not satisfied petitioners paid anything for the license as such.↩4. Also distinguishable on its facts is Bakertown Coal Co. v. United States, 202 Ct. Cl. 842">202 Ct. Cl. 842, 485 F.2d 633">485 F.2d 633↩ (1973), where the taxpayer had a valid mineral lease which, though subject to termination, granted the taxpayer exclusive rights which were fully effective until terminated.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623429/	Brownie Coldiron Logging Company v. Commissioner.Brownie Coldiron Logging Co. v. CommissionerDocket No. 83755.United States Tax CourtT.C. Memo 1961-145; 1961 Tax Ct. Memo LEXIS 207; 20 T.C.M. (CCH) 731; T.C.M. (RIA) 61145; May 19, 1961207 Frederick A. Jahnke, Esq., Executive Bldg., Portland, Ore. for petitioner. Walter I. Auran, Esq., for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: The respondent determined a deficiency of $17,494.79 in petitioner's income tax for the year 1957. The only issue remaining for decision is the correctness of respondent's determination that there should be included in petitioner's income the amount of $24,249.68 representing advances made to petitioner by the company for whom it was performing logging services under a contract. Findings of Fact The petitioner, Brownie Coldiron Logging Company, is a corporation organized under the laws of the State of Oregon, having its principal place of business at Gold Beach, Oregon. The petitioner's corporate Federal income tax return for the year 1957 was filed with the district director of internal revenue at Portland, Oregon. Petitioner employs an accrual method of accounting and files its income tax returns on a calendar year basis. The petitioner was incorporated on March 16, 1956, with authorized capital consisting of 1,000 shares of no par common stock. On June 30, 1956, 100 shares of petitioner's208 stock were issued to Howard Jesse Coldiron for $1,000 cash. On January 1, 1957, 125 additional shares of petitioner's stock were issued to Howard Jesse Coldiron in exchange for various assets and liabilities of the Howard Jesse Coldiron Logging Company, a sole proprietorship. The corporate petitioner had no operations prior to January 1, 1957. Since that date, petitioner has been engaged in contract logging operations in the Gold Beach, Oregon vicinity. On January 15, 1957, petitioner entered into a logging contract with Evans Products Company, a Delaware corporation (hereinafter referred to as Evans). The logging contract provided that petitioner would log, remove, transport, and deliver to Evans at designated points all logs that could be produced from a designated area "and for said purposes except and unless herein otherwise expressly provided, Logger agrees * * * to complete the logging and delivery thereof during the year 1957." The logging contract provided generally for the felling, bucking (sawing into lengths), yarding (collecting), loading, hauling, and delivery of all the merchantable peeler and mill grade logs that could be produced from the designated area and the209 cleaning up of the area. The logs being delivered to Evans were first to be scaled on truck by the Columbia River Log Scaling and Grading Bureau (hereinafter referred to as the Bureau). The scaling reports of the Bureau were to be used as the basis of determining the amounts owed to petitioner by Evans. Paragraphs 11, 21, and 24 of the contract provided as follows: 11. All trees felled will be bucked by Logger and the logs therefrom delivered within six (6) months from the date of falling. * 21. Logger will burn and dispose of slash resulting from his operations at the times and in the manner required by law and will obtain from the Forestry Department the release of each of the areas where slash is disposed of and will deliver the releases to Evans promptly on issuance. The Parties agree that from the sums herein provided to be paid to Logger, Evans may withhold the sum of One ($1.00) Dollar per thousand feet net log scale for all logs delivered from the said logging areas, which withheld sum shall be for the purpose of indemnifying Evans to the extent of the sums withheld against Logger's failure to dispose of slash and against loss, damage or expense resulting from210 Logger's failure to perform any other of his agreements herein. * * 24. In consideration of the agreements of Logger, Evans agrees to pay to Logger for all logs delivered hereunder at Evans' Euchre Creek Plant and scaled as herein provided, at the rate of Twenty-one ($21.00) Dollars per thousand feet net log scale; and for all logs delivered hereunder by Logger to Evans' Hunter Creek Plant, at the rate of Twenty-four ($24.00) Dollars per thousand feet net log scale. Payments at said rates less sums withheld under terms of this agreement will be made on the fifteenth (15th) day of each calendar month for all such logs delivered and scaled during the previous calendar month. Petitioner started logging operations pursuant to the contract on or shortly after January 15, 1957. The first work done in the logging operation was felling and bucking. After that logs were loaded, delivered, and scaled. Starting with the first operations and continuing through the rest of 1957, petitioner requested and received from Evans advances of various amounts of money to enable it to meet its payroll and trucking and similar expenses necessary in the performance of the contract. Such amounts211 were paid on or about the 10th and 25th of the months when petitioner had to meet its payroll. The amount of these payments usually varied between $20,000 and $40,000. The scaling reports made by the Bureau were sent to Evans and were the basis of settlement sheets made out by Evans showing the amount and price of the logs delivered. The advances made by Evans would be applied against the amount due petitioner upon delivery of the logs as shown by the scaling reports and any excess was treated on the books of Evans as an overadvance. There was usually a 2 to 3-month lag in the making of these settlement sheets from the time the logs were actually delivered and scaled. When a request was made by petitioner for an advance, Evans would determine the amount to be advanced by the volume of logs that had been delivered but not yet credited to petitioner, and by the number of logs felled and bucked in the woods but not yet delivered. Evans also, to some extent, relied on the good personal character of Howard Jesse Coldiron. In determining the quantity of logs felled and bucked but still remaining in the woods, Evans followed the practice of examining cutting reports, prepared by one of212 its foresters, covering areas being logged. It was the general policy of Evans not to advance amounts in excess of the value of the logs actually delivered plus the value of the logs felled and bucked but not yet delivered. At times petitioner received an advance of a greater sum than was requested and at other times a lesser amount was received. There was no discussion between petitioner and Evans concerning the manner in which the advances would be treated. The cutting report, prepared by Evans' forester on December 20, 1957, disclosed that at that time 5,100,000 board feet of logs were felled and bucked in the woods. Evans valued these logs at $5 per thousand for a total of approximately $25,000. As of December 31, 1957, the logging advance account on the books of Evans disclosed a balance of $44,504.35 representing the advances made to petitioner in excess of completed log deliveries. Of this amount petitioner included in income in 1957 $20,254.67 representing amounts withheld as slash deposits. On petitioner's income tax return for 1957 under the designation "Schedule L - Item 19 - Other Liabilities" was shown, among other items, the following: "Performance Liability - Logging213 Advances - $44,504.35." The settlement sheet showing the amount of advances from Evans to petitioner as of December 31, 1957, in excess of credits for log deliveries as of that date was not received by petitioner until over 2 months after the end of the year and it was not until receipt of this settlement sheet that petitioner knew the amount, if any, of the overadvance. The stipulated facts are found accordingly. Opinion Petitioner contends that the $24,249.68 received in excess of the amount due to it for logs delivered to Evans plus the withholding by Evans for indemnity against loss for failure to dispose of slash was in the nature of a general obligation or debt owed to Evans and, therefore, does not constitute income for 1957. Respondent takes the position that the entire $44,504.35 was an advance payment received by petitioner under a claim of right for services rendered or to be rendered and, hence, constituted income to petitioner when it was received. Petitioner states that Evans treated the $44,504.35 amount as an "overadvance" on its books and petitioner regarded the amount in the same fashion on its 1957 income tax return. Petitioner argues that there was no agreement214 or contract between the two parties respecting the year 1958; therefore, the subject amount could not, on December 31, 1957, constitute income for services to be rendered in the future. Petitioner's president testified that no contract, written or oral, had been entered into for the year 1958 as of December 31, 1957. Although the contract here involved provided that the logger (petitioner) agreed "to complete the logging and delivery thereof during the year 1957", it also provided that all trees felled would be bucked by petitioner and the logs therefrom delivered within 6 months from the date of felling. There was a substantial amount of trees felled as of December 20, 1957, from which the logs had not been delivered to Evans. Insofar as the evidence shows, this situation also prevailed on December 31, 1957. The clear implication from these facts is that petitioner was obligated to deliver logs to Evans during 1958. Petitioner further contends that inasmuch as the contract called for payment only when the logs were delivered and scaled, the $44,504.35 amount was not received by petitioner under a claim of right under the contract. It is clear to us that the parties amended their215 contract by an understanding and practice providing for payments by Evans in advance of the delivery of the logs by petitioner and the subsequent charging against such advances of amounts determined to be due for the logs delivered. There is no evidence in the record that petitioner during 1957 received payment under the contract in any other manner. Considering all the evidence, we hold that the amount of the advances was received under a claim of right for services to be rendered and thus constitutes income at the time of receipt. It has been clearly established that, under the "claim of right" doctrine, prepaid income must be reported as income in the year of receipt. , and cases there cited. Although petitioner requested and received the amounts to enable it to meet necessary expenses in the performance of the contract, there was no restriction placed by Evans upon the use to be made by petitioner of the money advanced. Thus, in the instant case, as in the Andrews case, the advances were received by petitioner free of any restrictions as to their use. The advances were, in fact, used by petitioner to its advantage, primarily216 in defraying expenses incurred in the performance of its contract. Petitioner cites ; , affd. (C.A. 7, 1952); and . Each of these cases is clearly distinguishable on its facts from the instant case. In the Summit Coal Co. case, the taxpayer had entered into an agreement whereby it was to receive advances of $150,000 to be used to pay its then outstanding indebtedness and to develop its mining properties. Notes were given for the money advanced. Repayment was to be made at the rate of $1 per ton of coal delivered with a final date for repayment set. On the basis of the facts therein the advances were held to constitute loans. The fact that one of the parties in the instant case treated the $44,504.35 amount on its books as "overadvances" and the other party considered the amount in somewhat the same light is not persuasive that the advances constituted a loan. These entries are as consistent with advance payment for services to be rendered as with the creation of a general indebtedness. 217 Furthermore, even if the bookkeeping entries could be said to show that the advances were treated as a loan, the entries would be merely evidence of the fact they purported to show and not conclusive. Cf. and cases there cited, affd. (C.A. 2, 1959). Petitioner did not give notes for the amounts advanced. It did not pay interest on the amounts advanced. There was no specified time for repayment. In fact, petitioner did not know that an overadvance existed until approximately 2 months after December 31, 1957. On the basis of the evidence, we hold that the advances in the instant case did not constitute loans. In the Bates case the petitioner charged the United States Government an excessive amount for freight services rendered, knowing that the charge was excessive and that part of the amount received would have to be returned. Under these circumstances the Court held that petitioner did not receive the excessive amounts under a claim of right. In the Veenstra & DeHaan Coal case, petitioner received advances or deposits from customers to be applied on the price of coal and coke to be charged by*218 petitioner when and if the coal and coke were sold and delivered to the customers. This Court stated that at the time the deposits were made it was impossible to determine what if any income (excess of sales price over cost) would be made on the eventual sale because at the time the deposits were made there was only an executory and contingent contract to sell unascertained goods at an unspecified price, which were to be acquired if possible, by petitioner at a cost unknown to it at the time the deposits were received. Consequently, this Court held the deposits did not represent income at the time of receipt. In the present case we do not have a deposit on an executory and contingent contract to sell goods but an advance on a contract to perform services. The $24,249.68 representing advances to petitioner is includible in its income in 1957. Certain issues raised in the pleadings have been conceded by each party. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623432/	ORVILLE B. and MARTHA J. SILVEY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSilvey v. CommissionerDocket No. 5607-75.United States Tax CourtT.C. Memo 1976-401; 1976 Tax Ct. Memo LEXIS 2; 35 T.C.M. (CCH) 1812; T.C.M. (RIA) 760401; December 30, 1976, Filed Orville B. and Martha J. Silvey, pro se. Thomas G. Schleier, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Chief Judge: This case was assigned to and heard by Special Trial Judge Murray H. Falk pursuant to the provisions of section 7456(c) of the Internal Revenue Code and4 Rules 180 through 182 of the Tax Court Rules of Practice and Procedure. The parties have filed no exceptions of law or fact to Special Trial Judge Falk's report. The Court agrees with and adopts his opinion which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE FALK, Special Trial Judge: This case was originally set for trial at Chicago, Illinois. Petitioners moved that it be consolidated for trial with another case, involving a deficiency in respect of their tax for 1973 (Dkt. No. 7629-75S), in which they had elected to proceed under our small tax case procedures, see sec. 7463, Internal Revenue Code of 1954; 1Rules 170-179, Tax Court Rules of Practice and Procedure, and had designated Springfield, Illinois, as the place for hearing, and urged that both matters be heard at Springfield. Petitioners' motion was granted and the case was heard at Springfield pursuant to the provisions of Rule 180, Tax Court Rules of Practice and Procedure. See sec. 7456(c). 5 Respondent determined deficiencies in petitioners' federal income taxes for 1971 and 1972 in the amounts of $776.26 and $773.13, respectively. At trial, petitioners expressly conceded respondent's adjustments relating to their medical expense deductions. At issue, then, are the allowable amounts of petitioners' deductions for charitable contributions for 1971 and for taxes, charitable contributions, and interest for 1972. Also at issue, in respect of both years, is petitioners' liability for self-employment taxes under section 1401. FINDINGS OF FACT Petitioners, husband and wife, resided in Palmyra, Illinois, at the time their petition in this case was filed. They filed their joint federal income tax returns for the taxable years 1971 and 1972 with the district director of internal revenue at Springfield, Illinois. Petitioner Orville B. Silvey is a minister. At trial, respondent conceded that petitioners are entitled to exclude $392.10 from their gross income for 1971 under section 107. 2 Petitioners had not claimed any such exclusion on their 1971 return. Respondent also allowed petitioners to exclude from gross income for 1972, under section 107, $1,103.46 of the6 $1,110.00 which they erroneously claimed as a miscellaneous deduction for utilities and maintenance of the parsonage on their 1972 return. The allowance of the parsonage exclusion for utilities and maintenance and the correct amounts thereof apparently were subjects which caused some consternation and controversy prior to the trial, but by the time these matters came on for hearing, the parties were in agreement. Petitioners claimed itemized deductions on their 1971 and 1972 income tax returns. In respect of 1971, respondent disallowed $573 of the $780 claimed by petitioners as a deduction for charitable contributions. For 1972, respondent disallowed the entire balance of petitioners' claimed itemized deductions 3 on the grounds that the amounts they substantiated in respect thereof did not exceed the allowable standard deduction, 4 and computed the tax from the tax tables7 prescribed pursuant to section 3. The only evidence offered as to petitioners' itemized deductions was their testimony regarding charitable contributions. Mr. Silvey served several congregations in southern and central Illinois and made cash contributions to each of them. He believes in8 tithing and makes a conscious effort to keep his contributions in the neighborhood of 10% of his gross income, making his contributions when he is paid.Mrs. Silvey contributed about $30 each year, in the aggregate, to the missionary societies of the churches her husband served. Petitioner Orville B. Silvey is not, on religious grounds or otherwise, opposed to the federal old-age and survivors insurance program. Indeed, he elected coverage under section 1402(e) as it was in effect before its amendment in 1967. He merely denies that he is self employed and questions why the self-employment tax provisions of the Code should apply to him, an employee of the churches he serves. In preliminary matters before this Court and at trial, petitioners complained that legal counsel was not appointed to represent them. However, petitioners took no steps to establish, with any particularity, definiteness or certainty, the facts as to their poverty. Petitioners also complain that they have been harassed by the Internal Revenue Service in that their returns for every year beginning with 1969 have been audited. Counsel for respondent claimed to have no idea why the Silveys were audited so9 frequently, but Mr. Silvey suspects that there is a connection to his activities in 1969 involving a welfare rights protest march in Washington. OPINION With regard to petitioners' allowable deductions, the issues are purely factual. Petitioners have the burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Barnes v. Commissioner,408 F.2d 65">408 F.2d 65, 68 (7th Cir.), cert. denied 396 U.S. 836">396 U.S. 836 (1969); Rule 142(a), Tax Court Rules of Practice and Procedure. We fully believe Mrs. Silvey's testimony, and we believe Mr. Silvey's testimony as to his intent to tithe and as to his general method of making contributions. Further, we have no doubts as to the feelings of generosity reposing in his heart. Nevertheless, we find it difficult to believe that he found it possible within the limitations of his rather meager income fully to carry out his intentions in this regard, and he did not directly say that he did. We have in mind, also, that, in making approximations in matters of this sort, where the proof lacks specificity and substantiation, it is not inappropriate to bear heavily upon the taxpayer, "whose inexactitute is of his10 own making." Cohan v. Commissioner,39 F.2d 540">39 F.2d 540 (2d Cir. 1930). On the whole, we find that in each of the years involved petitioners contributed a total of $375 to the various churches which Mr. Silvey served and their missionary societies.5Cohan,supra.The answer to petitioners' question as to why Mr. Silvey is taxed as a self-employed person when, in fact, he is an employee of the churches he serves is one as to which "a page of history is worth a volume of logic," New York Trust Co. v. Eisner,256 U.S. 345">256 U.S. 345, 349 (1921). "For so long as federal income taxes have had any potential impact on churches -- * * [over 80 years, now] -- religious organizations have been11 expressly exempt from the tax." Walz v. Tax Commission,397 U.S. 664">397 U.S. 664, 676 (1970). It seems understandable, then, that -- in the exercise of its "benevolent neutrality toward churches," Walz,supra -- Congress chose not to place the onus of participation in the old-age and survivors insurance program upon the churches, but to permit ministers to be covered on an individual election basis, as self employed, whether, in fact, they were employees or actually self employed. See S. Rept. No. 1987, 83d Cong., 2d Sess. (1954), 2 C.B. 695">1954-2 C.B. 695, 701; H. Rept. No. 2679, 83d Cong., 2d Sess. (1954), 2 C.B. 712">1954-2 C.B. 712, 714. Perhaps petitioner would wish us to substitute his judgment on this subject for Congress' mandate, but we cannot. "Any criticism provoked by it must be made to the lawmakers, not to the courts." Selected American Shares, Inc. v. United States,196 F.2d 473">196 F.2d 473, 476 (7th Cir. 1952). Petitioner does not appear to have any quarrel with respondent's calculations of the self-employment taxes, and our review of them discloses no error. Petitioners have no right to counsel in this, a civil case. 12 6Ehrlich v. Van Epps,428 F.2d 363">428 F.2d 363 (7th Cir. 1970); Peterson v. Nadler,452 F.2d 754">452 F.2d 754, 757 (8th Cir. 1971). Although "a federal district judge is given discretion to appoint counsel in civil cases pursuant to the salutary provisions of 28 U.S.C. § 1915(d)," SEC v. Alan F. Hughes, Inc.,481 F.2d 401">481 F.2d 401, 403 n.5 (2d Cir.), cert. denied 414 U.S. 1092">414 U.S. 1092 (1973); see Peterson v. Nadler,supra, this Court has no such power, see 28 U.S.C. sec. 451 (1970). Even if we did, this is not a case in which we can say we would have exercised it. See 28 U.S.C. sec. 1915(d); cf. Jordan v. Simon, an unreported case ( N.D. Ill. 1975, 36 AFTR 2d 75-6386, 75-2 USTC par. 9851). Finally, we must dispose of petitioners' contention that they have been harassed by the Internal Revenue Service, possibly for13 political motives. We had occasion to discuss somewhat similar allegations in Greenberg's Express, Inc.,62 T.C. 324">62 T.C. 324 (1974). As we said in our opinion in that case: [It] is conceivable that there may be situations where a taxpayer should be accorded some relief, if he were able to prove that he was selected for audit on a clearly unjustifiable criterion. [Cf. United States v. Falk,479 F.2d 616">479 F.2d 616 (7th Cir. 1973).] But we think that such situations will be extremely rare and we are satisfied that petitioners' allegations, even if true, would not be sufficient. 62 T.C. at 328. Here, as in Greenberg's Express, there were legitimate reasons for the government to conduct an audit. Petitioners do not argue that the deficiency notices were without foundation, i.e., that they owe no tax. 7 Assuming without deciding that a standard similar to that developed in cases concerning alleged selectivity in criminal prosecutions should be applied to civil tax litigation -- a large assumption, indeed -- petitioners have not presented facts sufficient to raise a reasonable belief that the Service's decision to audit was based on impermissible14 considerations. See United States v. Peskin,527 F.2d 71">527 F.2d 71 (7th Cir. 1975), petition for cert. filed (April 20, 1976). In any event, we believe that petitioners' right to a trial de novo in this Court, and their exercise of it, have sufficiently assured petitioners that the final determination of their tax liabilities was based fairly upon the facts eatablished, and was not the result of any prejudicial action by a government agency. See Greenberg's Express,supra.* * In accordance with the foregoing, and to reflect the concessions made by the parties, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. "The Code" refers to the Internal Revenue Code of 1954, as amended.↩2. Because of this reduction in petitioners' gross income, their allowable medical expense deduction in excess of the 1% and 3% of adjusted gross income limitations, see sec. 213(a) and (b), will increase slightly for 1971. We expect the parties to take this into account in their Rule 155 computation.↩3. In light of petitioners' concession as to the medical expense deduction and the parties' agreement relating to the allowance of an exclusion, rather than the deduction claimed by petitioners, for utilities and maintenance of the parsonage, and the amount thereof, of relevance here are the deductions which petitioners claimed for taxes ( $270), charitable contributions ( $701), and interest ($855.45), amounting to $1,826.45 in the aggregate. ↩4. The standard deduction is the larger of the percentage standard deduction computed under section 141(b) or the low income allowance provided in section 141(cn8. Sec. 141(a). Here, the larger of those amounts is the low income allowance; $1,300 for 1972. Of course, petitioners are also allowed the two personal exemptions ($1,500) which they claimed. The tax tables take the exemptions as well as the appropriate standard deduction into account.↩5. We are uninformed as to the extent to which respondent has not accepted petitioners' claimed deductions for taxes and interest in 1972. If less than $200, then the Rule 155 computation herein should be made on the basis of itemized deductions and not from the tax tables. If more than $200 of the amounts claimed as deductions for taxes and interest in 1972 were disapproved, then respondent's determination based upon the tax tables is sustained.↩6. The Sixth Amendment provides, in relevant part: Inallcriminalprosecutions,↩ the accused shall enjoy the right * * to have the assistance of counsel for his defense. [Emphasis supplied.]7. At the trial, Mr. Silvey stated: Really, the only reason I'm here, I'd have to say, is that I wanted my day in court, where it wasn't all Internal Revenue Service.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623433/	C. H. REINHOLDT & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.C. H. Reinholdt & Co. v. CommissionerDocket No. 13392.United States Board of Tax Appeals13 B.T.A. 905; 1928 BTA LEXIS 3157; October 10, 1928, Promulgated 3157 Proof held insufficient to overcome the presumption that the Commissioner's disallowance of certain deductions representing debts alleged to have been ascertained as worthless and charged off in the taxable year was correct. Harry C. Reinholdt, for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON 905 The respondent asserts a deficiency in income and profits tax for the year 1920 in the amount of $3,100.60. At the hearing it was agreed by the parties that all the issues except a claim for the deduction 906 of the amount of $3,924.16, alleged to represent debts ascertained to be worthless and charged off in the taxable year, had been settled and that the tax in controversy is $2,527.79. FINDINGS OF FACT. The petitioner is an Iowa corporation with its principal office at Manning, where it is engaged in the retail hardware business. In the taxable year the petitioner kept no books of account reflecting its true income and tax liability. Upon audit of its income and profits-tax return for such year the Commissioner determined taxable income and tax liability by an analysis of surplus at the beginning and end3158 of such year. At the end of the taxable year the petitioner owned book accounts and notes against its customers representing goods sold during many years prior thereto, in the amount of $3,924.16. Such debts were not deducted from its gross income for the taxable year in its income and profits-tax return for such year and were to some extent carried forward on its books as assets for the succeeding year. The accounts and notes that were considered worthless were marked with a "D" and when new books were opened, except in a very small number of instances, were not carried forward. The petitioner's debtors for the most part were farmers, farm laborers and the tenants of farms. Prior to the taxable year many had moved away, some had died, others had become insolvent. None of the notes or accounts were given to any attorney for collection and no suits to secure payment were instituted. Petitioner's officers tried to collect the accounts and notes by personal interviews and by correspondence, but received nothing. The 17 notes involved total the amount of $1,552.69, and in amount range from $26 to $260; the 107 accounts receivable total $1,741.47, and range in amount from*3159 40 cents to $131.95. In some instances the debts in question date back as far as 1909. OPINION. LANSDON: The petitioner seeks to deduct notes and accounts receivable in the amount of $3,294.16 from its gross income in the taxable year as debts ascertained to be worthless and charged off in such year. From the evidence we are left in much doubt as to whether all the debts were ascertained to be worthless in the taxable year, whether any of such notes and accounts were actually charged off in said year, and whether all reasonable and usual methods had been exhausted in attempts to collect from the several debtors. From the meager record we are unable to say that the petitioner has overcome the presumption that the determination of the Commissioner as to the alleged bad debts was correct. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623434/	Albert V. Moore, Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret T. Oden Trust, Wells Fargo Bank & Union Trust Co., Trustee and Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret T. Oden, Petitioner, v. Commissioner of Internal Revenue, RespondentMoore v. CommissionerDocket Nos. 7648, 7647, 7649United States Tax Court10 T.C. 393; 1948 U.S. Tax Ct. LEXIS 254; February 26, 1948, Promulgated 254 Decision will be entered under Rule 50. Albert V. Moore made certain cash payments to his wife and created a life insurance trust for her benefit pursuant to a decree of divorce which ratified and confirmed a separation agreement. Held, the transfer of property and cash by Moore in compliance with the decree of the court was for an adequate and full consideration in money or money's worth, and did not constitute taxable gifts, following Commissioner v. Converse, 163 Fed. (2d) 131, affirming 5 T.C. 1014">5 T. C. 1014. Truman H. Luhrman, Esq., for the petitioners.Ellyne E. Strickland, Esq., for the respondent. Arnold, Judge. ARNOLD 394 These consolidated proceedings involve gift tax deficiencies for 1938, 1939, 1940, and 1941. Deficiencies in the respective amounts of $ 2,295, $ 607.50, $ 8,699.19, and $ 67,937.30 have been determined against Albert V. Moore, as donor in Docket No. 7648. The statutory notice of deficiency to Moore states that only $ 123.76 of the 1940 deficiency is assessable against him, as donor, and that the balance of the deficiency determined against him has been made the subject of 255 statutory notices of deficiency to each of the petitioners in dockets numbered 7647 and 7649, because of their transferee liabilities as donee and trustee. An increase of $ 1,059.71 in the deficiency determined against the donor for 1940 is claimed by respondent in amended answers filed in the transferee cases.In determining the deficiencies the respondent made certain adjustments which petitioners alleged were erroneous. Respondent now concedes that Albert V. Moore's taxable gifts should not include $ 750 per month paid to his former wife during the taxable years, and that $ 15,000 of a payment of $ 27,500 made in 1938 to the former wife should not be included in his taxable gifts. The parties stipulated that shares of stock of Moore-McCormack Lines, Inc., which were transferred as gifts by Albert V. Moore in 1941 had a value of $ 12.25 per share, and not $ 13.50 per share, as determined by the respondent. Petitioners in Dockets 7647 and 7649 abandoned their allegation that they were not transferees within the meaning of the gift tax statute. Effect will be given to the above concessions and stipulations upon recomputation of the deficiencies under Rule 50.The remaining issues256 for decision are: (1) Whether respondent erred in determining that $ 12,500 of a $ 27,500 payment made by Albert V. Moore in 1938 to his former wife, Margaret T. Moore, pursuant to the terms of a separation agreement, constituted a taxable gift; and (2) whether the transfer in 1940 of certain paid-up life insurance policies by Albert V. Moore to a trustee for the benefit of his former wife, pursuant to the terms of a separation agreement, constituted a taxable gift at the date of the transfer to the extent of the replacement cost of the policies at the time of the transfer.FINDINGS OF FACT.Albert V. Moore, the petitioner in Docket No. 7648, is an individual residing in Forest Hills, Borough of Queens, City and State of New York. His gift tax returns for the years 1938, 1939, 1940, and 1941 were filed with the collector of internal revenue for the first district 395 of New York. His gift tax return for 1940 was filed under date of March 15, 1941, and an amended gift tax return for that year was filed on March 12, 1942.Petitioner Albert V. Moore and his former wife, Margaret T. Moore, now Margaret T. Oden, were married on February 1, 1912, and lived together until the summer257 of 1938. Albert V. Moore was born September 21, 1880; Margaret T. Moore was born February 22, 1888.In the fall of 1937 Margaret T. Moore consulted a New York attorney relative to instituting an action for divorce. Following an investigation, her attorney prepared a summons and complaint in an action for divorce in the Supreme Court of the State of New York and caused it to be served on Albert V. Moore on or about August 19, 1938. Albert V. Moore instructed his attorney to communicate with his wife's attorney, ascertain her demands, and see if a mutually satisfactory agreement could be reached in settlement of their marital problems.Several conferences were held by the two attorneys, at which each negotiated for the best interests of his client. As a result of these conferences and under date of September 2, 1938, Albert V. Moore and Margaret T. Moore entered into a separation agreement "so as to adjust their mutual relations and questions of property and support." The agreement effected a compromise of the demands of each party thereto.The separation agreement, after providing that the parties should continue to live separate and apart, free from the marital control and authority258 over each other, made the following provisions with respect to property settlement: Albert V. Moore agreed (1) to pay his wife $ 27,500 in cash at delivery of the separation agreement; (2) within 30 days of delivery of the separation agreement to deliver to his wife life insurance policies on his life, in her favor if she survived him, the proceeds of which would amount to $ 100,000. The policies were to be free of loans, all premiums thereon paid to date, and without power of revocation or borrowing thereon. Moore was to pay the premiums during his lifetime, and his wife was given the right to create a life insurance trust; (3) to pay his wife during her lifetime $ 750 per month during his lifetime.Margaret T. Moore agreed that upon delivery of the separation agreement she would convey to her husband or his nominee the property which she owned in Forest Hills, Long Island, New York, subject to existing mortgages. Certain other provisions regarding proceeds from a subsequent sale of this property are omitted as immaterial.Paragraph six of the separation agreement reads as follows:6. The execution and delivery of this agreement and any acts performed hereunder shall not be deemed259 to be a waiver of the right of Mrs. Moore to elect to 396 take against the Last Will and Testament of Mr. Moore, under the Statutes of Descent and Distribution of the State of New York, and Mr. Moore hereby confirms and vests in Mrs. Moore said right of election and all her rights, in the event of his decease, to share in his estate under the New York Statutes of Descent and Distribution, provided, however, that her share in his estate shall be reduced by the sum of Twelve thousand five hundred ($ 12,500) plus any insurance monies that she and/or her assigns may receive on the policies of insurance provided for in paragraph "4" hereof.Albert V. Moore's attorney objected strenuously to the inclusion of the above quoted paragraph in the separation agreement. Margaret T. Moore declined to surrender the rights reserved to her thereby and reservation of her rights to share in his estate upon his death was incorporated in the agreement as hereinabove set forth.Prior to November 18, 1938, Margaret T. Moore instituted divorce proceedings in the State of Nevada in which Albert V. Moore appeared by counsel. Under date of November 18, 1938, the Nevada court having jurisdiction of the260 proceeding entered a decree of absolute divorce dissolving the marriage existing between Albert V. and Margaret T. Moore. The decree of the court provided in part as follows:It Is Further Ordered, Adjudged and Decreed that the written agreement made and entered into by and between the parties on the 2nd day of September, 1938 [the separation agreement aforementioned], settling the property rights of the plaintiff and of the defendant, and all matters concerning the care, custody and support of Barbara Ann Moore, the said minor child of the parties, a true, full and correct copy of which said written agreement has been admitted in evidence in this action, and marked and designated as Exhibit "A" therein, be and the same hereby is, by this Court, ratified and confirmed, and declared to be fair, just and equitable to the plaintiff, to the defendant, and to said minor child.Following the rendition of the final decree of divorce in Nevada, the New York action was discontinued, Albert V. Moore paid Margaret T. Moore $ 27,500, and she deeded him the property in Forest Hills, New York. The payment of $ 27,500 to Margaret T. Moore was in consideration of her transfer of title to the property261 in Forest Hills, New York, plus $ 2,500 for counsel fees.On August 2, 1940, Albert V. Moore, pursuant to the separation agreement, transferred in trust, for the benefit of his former wife, Margaret T. Oden, paid-up life insurance policies on his life having the face value of $ 104,901. Wells Fargo Bank & Union Trust Co. was named trustee, and, as transferee, is the petitioner in Docket No. 7647. Margaret T. Oden acknowledged that the trust created for her benefit on August 2, 1940, was in compliance with the provisions of the separation agreement.397 The replacement costs of all policies transferred in trust by Albert V. Moore, based upon single premium ordinary life policies issued in 1940 for a person aged 60, would have amounted to $ 79,545.37. In determining the deficiencies herein respondent used a commuted value for said policies aggregating $ 60,577.70.In 1938 Albert V. Moore had assets of approximately $ 1,273,000. For the years 1934 to 1938, inclusive, his income tax returns showed net taxable income as follows:1934$ 58,555.45193558,939.61193667,633.87193730,092.60193822,284.23The payment of $ 27,500 by Albert V. Moore to Margaret T. Moore262 and the creation of a life insurance trust for her benefit, pursuant to the separation agreement and the decree of the Nevada court, did not constitute transfers of property by gift.OPINION.Respondent contends that, since property was transferred for less than an adequate and full consideration in money or money's worth, a gift resulted under section 1002 of the Internal Revenue Code. We see no point in laboring the question presented. A number of cases with similar facts have been decided by this and other courts against respondent's contentions, and distinguishing Merrill v. Fahs, 324 U.S. 308">324 U.S. 308; Commissioner v. Wemyss, 324 U.S. 303">324 U.S. 303; and Commissioner v. Bristol, 121 Fed. (2d) 129. See Herbert Jones, 1 T.C. 1207">1 T. C. 1207; Matthew Lahti, 6 T. C. 7; Commissioner v. Converse, 163 Fed. (2d) 131, affirming 5 T.C. 1014">5 T. C. 1014.Here, the separation agreement was ratified and confirmed by the Nevada court which dissolved the marriage, and the agreement was declared by that court263 to be fair, just, and equitable to the parties and to their minor child. The payments required of Albert V. Moore and the setting up of the insurance trust were made, therefore, pursuant to court decree and in discharge thereof. Had petitioner failed or refused to make the transfers, he could have been required to do so by court proceedings to enforce the terms of the decree. The discharge of the judgment was, under Commissioner v. Converse, supra, an adequate and full consideration in money or money's worth for the transfers. Upon the authority of the Jones, Lahti, and Converse cases, supra, we hold for the petitioners on the contested issues.This case is distinguishable from the Roland M. Hooker case, this day decided, in that here the divorce court's decree fixed the amount 398 of petitioner's marital obligation, whereas there the court's order of specific performance did not involve any question of the amount of a parent's obligation to support his minor child.In view of the stipulations of the parties, particularly with respect to the value of the stock of Moore-McCormack Lines, Inc., the deficiencies, if any, will264 be recomputed under Rule 50.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623435/	Clyde R. Royals, Sr. v. Commissioner.Royals v. CommissionerDocket No. 46957.United States Tax CourtT.C. Memo 1955-62; 1955 Tax Ct. Memo LEXIS 279; 14 T.C.M. (CCH) 199; T.C.M. (RIA) 55062; March 15, 1955279 From 1940 to 1947, inclusive, petitioner received income from a hauling and construction business, a motor service company, farms, and rental property. He diverted a part of the income from such sources into a personal bank account and did not report the income deposited therein on his income tax returns during the 8-year period. He conceded that he substantially understated his true taxable income each year as determined by respondent. In four of such years the amount of such understatement was from 147 per cent to 922 per cent of reported income. Held, petitioner's understatements of income for the years 1940 to 1947, inclusive, were due to fraud with intent to evade tax; and assessment and collection of the deficiencies are, therefore, not barred by the statute of limitation. Kenneth G. Cumming, Esq., and Richard T. Yates, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion This proceeding involves deficiencies in taxes and penalties under section 293(b) of the 1939 Code determined by respondent as follows: Section293(b)YearTaxDeficiencyPenalty1940Income$ 380.26$ 190.131941Income199.7899.891942Income10,094.175,047.091943Income andVictory10,984.515,492.261944Income3,007.211,503.611945Income2,446.101,223.051946Income16,423.688,211.841947Income8,864.374,432.19$52,400.08$26,200.06280 Petitioner conceded his liability for the deficiencies as determined by respondent if assessment and collection of such deficiencies are not barred by the statute of limitation. The issues are: (1) whether the deficiencies were due to fraud with intent to evade tax; and (2) if not, whether the amount of income which the petitioner failed to report for 1947 was in excess of 25 per cent of the amount of gross income stated on his return for that year. Some of the facts were stipulated. Findings of Fact The stipulated facts are so found and are incorporated herein by this reference. Petitioner was a resident of Hampton, Virginia, during the years in issue and filed individual tax returns for such years with the collector of internal revenue for the district of Virginia. On December 3, 1946, he filed an amended return for the taxable year 1945 with such collector. Petitioner had only a limited education and, prior to 1935, had worked in an automobile garage. In that year he began operating a motor repair service for himself. During the years in issue, he owned a trucking and construction business, a motor service company, farms, and rental real estate, from all of which he281 derived income. Petitioner maintained a double entry set of books for his various business ventures and employed competent bookkeepers to maintain such books during the years in issue. He supervised their work generally and any questions concerning the handling of specific items of income or expense were referred to him by the bookkeepers. Petitioner also maintained separate bank accounts for his various business ventures and, in addition, maintained a personal bank account. During the years in issue, petitioner caused to be deposited in such personal account a part of the proceeds received from his various businesses. The only records maintained on sums deposited in such account were check stubs, bank statements, and duplicate deposit slips. The record does not show by whom petitioner's return for the year 1940 was prepared. His bookkeeper prepared his return for 1941, and independent accountants prepared the returns for the remaining years in issue. Petitioner's bookkeepers collected and prepared the information which the accountants used in making such returns. The bookkeepers did not include in such information the amounts of income deposited in petitioner's personal bank account. 282 Petitioner inspected his returns for all of the years in issue and signed and filed them. Set forth below are the amounts of income reported by petitioner on his returns, the amounts of income which respondent determined petitioner received and which petitioner concedes he should have reported, the amounts of understatement, and the percentage of understatement: NetNet IncomePercentageIncomeDeterminedIncomeof Under-YearReportedBy RespondentNot Reportedstatement1940$ 6,584.02$11,770.46$ 5,186.447919415,592.227,292.321,700.1030194213,397.7933,043.5719,645.7814719432,833.1728,964.7326,131.569221944 3,045.2114,571.2311,526.0237819458,656.0415,600.846,944.8080194614,612.9345,020.9630,408.03208194728,555.2043,391.5114,836.3152Petitioner's returns for all the years in issue were fraudulently filed with intent to evade tax. Opinion RICE, Judge: As heretofore noted, petitioner conceded that he understated his income in the amounts determined by respondent. He protests the imposition of the fraud penalty, arguing that the283 understatements of income were due to his limited education and general ignorance of bookkeeping; his reliance on others to prepare his returns and to show thereon the true amount of his income; that he made no attempt to hide bank accounts or assets or keep false books; and that he never told anybody to conceal income or falsify his returns. The respondent has carried his burden of showing by clear and convincing evidence that petitioner's returns for all of the years in issue were fraudulently filed with intent to evade tax. We have carefully reviewed the entire record with particular consideration for petitioner's testimony that the large understatements of income were due to general ignorance and negligence. In the face of the large amounts of income understated each year throughout the entire 8-year period, we cannot believe that the deficiencies were due to petitioner's ignorance or neglect; we are satisfied that those large and consistent understatements were due to a purposely fraudulent intent to evade taxes. (C.A. 6, 1940). Although petitioner did not personally prepare his returns, he inspected and signed them. We284 are unable to believe that he did not know that such returns showed only a fraction of his true income. The fact that petitioner split business income between bank accounts maintained for his businesses and a personal account is not an inherently fraudulent practice. We are convinced, however, that petitioner's diversion of income to his personal account became the established plan by which he sought to understate his income and evade the taxes due thereon throughout all of the years in issue. Since we have found that the returns were fraudulently filed with intent to evade tax, we need not decide the second issue. Decision will be entered for the respondent. Footnotes. Adjusted Gross Income.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623437/	J. NOAH H. SLEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Slee v. CommissionerDocket Nos. 17306, 21233, 36603, 39727.United States Board of Tax Appeals15 B.T.A. 710; 1929 BTA LEXIS 2800; March 6, 1929, Promulgated 2800 Contributions to the American Birth Control League and the American Birth Control League, Inc., held not deductible. Newell W. Ellison, Esq., for the petitioner. Frank S. Easby-Smith, Esq., for the respondent. ARUNDELL710 These proceedings, which were consolidated for hearing and decision, involve income taxes as follows: Docket No.YearDeficiencies determinedAmount in controversy173061921$1,407.20$1,407.202123319222,879.532123319234,892.765,963.727,772.2919243,664.583660319253,685.357,349.933972719269,434.282,434.282,434.28There is only one issue in the several proceedings, and that is whether contributions to the American Birth Control League in 1921 and to the American Birth Control League, Inc., in the subsequent years are deductible from income. 711 FINDINGS OF FACT. Petitioner is a citizen of the United States and a resident of the State of New York. During the years 1921 to 1926, inclusive, he made the following contributions to the American Birth Control League and the American Birth Control League, Inc.: 1921. American Birth Control League$4,463.801922. American Birth Control League, Inc10,902.011923. American Birth Control League, Inc9,131.841924. American Birth Control League, Inc7,848.441925. American Birth Control League, Inc14,741.391926. American Birth Control League, Inc9,054.462801 Petitioner's income for these years, before deducting charitable contributions, was as follows: 1921$52,268.89192263,677.07192376,312.901924$121,415.851925143,118.101926106,655.28For each of the years involved petitioner, in computing net income, claimed as a deduction from gross income the amount contributed in the respective years to the American Birth Control League and the American Birth Control League, Inc. The American Birth Control League, hereinafter called the League, was organized as an unincorporated association in November, 1921, at a conference of a number of people interested in the birth control movement. Among those attending were many doctors of medicine and other professional men connected with large universities and hospitals. At the conference the following resolutions were presented and adopted: RESOLUTIONS to present to the meeting called to form the AMERICAN BIRTH CONTROL LEAGUE WHEREAS, there is an urgent need for a wider cooperation of groups and individuals in the interest of the Birth Control Movement; and WHEREAS the complex problems now confronting America as the result of the practice of reckless procreation2802 are fast threatening to grow beyond human control, THEREFORE BE IT RESOLVED that we proceed to organize an AMERICAN BIRTH CONTROL LEAGUE, the objects of which will be To establish a DEPARTMENT FOR RESEARCH AND INVESTIGATION HYGIENIC AND PHYSIOLOGICAL instruction by the medical profession to mothers and potential mothers through clinics A program of EDUCATION to the public at large To enlist the support and cooperation of Legal Advisors, Statesmen and Legislators 712 To send into the various States of the Union field workers to enlist the support and interest of the masses, and To establish a Department to cooperate with similar international organizations. BE IT FURTHER RESOLVED that the Chairman of this meeting be empowered to appoint a Committee of three to draft a Constitution and By-Laws, allowing a recess of twenty minutes to have them present this to the meeting. The American Birth Control League, Inc., hereinafter called the League, Inc., was incorporated under the laws of the State of New York in September, 1922, since which time it has operated under its corporate name. In the certificate of incorporation the objects of the League, Inc., are set2803 forth as follows: To collect, correlate, distribute and disseminate lawful information regarding the political, social and economic facts of uncontrolled procreation. To enlist the support and cooperation of legal advisors, statemen and legislators in effecting the lawful repeal and amendment of state and Federal statutes which deal with prevention of conception. In conjunction with these objects to publish an official organ, to be known as THE BIRTH CONTROL REVIEW, in which there shall be contained reports and studies of the relationship of controlled and uncontrolled population to national and world problems. Nothing herein set forth, however, shall be construed to authorise this corporation to do any act or thing forbidden by any Federal or state law. The constitution of the League, Inc., sets forth its objects in the same words as those in the certificate of incorporation. Both the League and the League, Inc., have operated along the same lines. A research department has been established in New York City, with a physician in charge, a medical director, and a clinical director. Since the establishment of this department approximately 10,000 women have applied2804 for advice. In each case a complete record is made of the applicant, listing names, addresses, nationality, occupation, finances, number of children, and other data of both social and sex character. The applicant is examined by the physician in charge and if a proper health reason is found, contraceptive advice is given by the clinical director. If no health reason is present the applicant is dismissed without advice. In more than half the cases, particularly those referred by welfare or social agencies, no charge is made for advice and materials. In cases where the applicant has some income a charge is made for supplies, and in some cases applicants make voluntary contributions. The research department keeps in touch, as far as possible, with applicants to whom advice is given and the history of each case is recorded. The information so obtained is placed at the disposal of the medical profession. Thousands of physicians have inquired of the research department as to its discoveries, many have visited it, and at the request of medical societies the medical director has spoken in each of the United States before such societies, hospital staffs, and other interested groups. 2805 713 These lectures were presentations of the data gathered in the 10,000 cases that have been handled. Largely as a result of the work of the League, Inc., some twenty clinics of a character similar to its research department have been established in various parts of the country. The League, Inc., and its research department prepare and distribute various publications. One is entitled "Report of the Clinical Research Department of the American Birth Control League for the year 1925." It contains a description of the clinic, the method of recording data, the number of patients advised, data as to the source of reference of patients, their religion, and social and economic status. Another publication is entitled "Some Reasons for the Popularity of the Birth Control Movement." This contains articles by the medical director of the research department on such subjects as population and food supply, child welfare, social status of women, and the director's replies to objections to birth control. Another published pamphlet is entitled, "What We Stand For. Principles and Aims of the American Birth Control League, Inc." Under the head of "Aims" is set forth the following: 2806 POLITICAL AND LEGISLATIVE: To enlist the support and cooperation of legal advisors, statesmen and legislators in effecting the removal of state and federal statutes which encourage dysgenic breeding, increase the sum total of disease, misery and poverty and prevent the establishment of a policy of national health and strength. Most of the legislative work of the League and the League, Inc., has been carried on in the eastern States. This work has consisted in part in directing interested groups in the several States how best to formulate their proposals for repeal of existing laws, and in the distribution of leaflets asking legislators, statesmen, and others interested in eugenic breeding to aid in securing changes in statutes. No part of the net earnings of the League or the League, Inc., inures to the benefit of any private stockholder or individual. In a letter to the League, Inc., dated November 25, 1925, the collector of internal revenue for the second district of New York quoted from a letter from the respondent holding that the League, Inc. was exempt under section 231(8) of the Revenue Acts of 1921 and 1924 as a civic league or organization not organized for profit, 2807 but operated exclusively for promotion of social welfare. OPINION. ARUNDELL: The petitioner contends that the League and the League, Inc., were organized and operated exclusively for charitable, scientific and educational purposes within the meaning of section 214 (a)(11) of the Revenue Act of 1921 and section 214(a)(10) of the Revenue Acts of 1924 and 1926, and hence his contributions, to the 714 extent that they do not exceed the 15 per cent limitation, are deductible from gross income. The respondent concedes that if contributions to the League, Inc., are deductible, then those made to the League may also be deducted. We will therefore refer to the two organizations indiscriminately as the League. The statutory provisions here involved allow deductions for amounts contributed to: (B) * * any corporation * * * organized and operated exclusively for religious, charitable, scientific, Literary, or educational purposes, * * * or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual. The above sections of the taxing Acts further allow deductions for contributions2808 to: (C) * * the special fund for vocational rehabilitation authorized by section 7 of the Vocational Rehabilitation Act. (Revenue Acts of 1921, 1924 and 1926.) and also to: (E) * * * a fraternal society, order, or association, operating under the lodge system * * . (Revenue Acts of 1924 and 1926.) The contributions under (E) are allowed if they are to be used for the purposes specified in paragraph (B). In the case of , the statutory tests that an organization of the claimed character of the League must meet are set out as follows: (A) It must be organized and operated for one or more of the specified purposes; (b) it must be organized and operated exclusively for such purposes; and (c) no part of its income must inure to the benefit of private stockholders or individuals. The evidence is that the League meets the last of the enumerated tests. As to the other two, we are of the opinion that the League does not come within them. The certificate of incorporation and the constitution specifically state that one of its objects was, To enlist the support and cooperation of legal advisors, statesmen and legislators in2809 effecting the lawful repeal and amendment of state and Federal statutes which deal with prevention of conception. The League did not abandon this avowed object of its formation, but continued to hold it as one of its aims as shown by the quotation in the findings of fact taken from one of its pamphlets. Moreover, the evidence shows that this aim was carried into operation through the direction of groups in various States and the distribution of literature seeking the repeal or amendment of statutes which the League felt hampered it in accomplishing its aims. In these matters we think the League stepped beyond whatever charitable, scientific, or educational character it might otherwise have had. Undoubtedly the definition given to the words "charitable," "scientific" and "educational" by such standard authorities as Webster's New International 715 Dictionary and the Century Dictionary are sufficiently broad that some phases of the League's activities may come within them. If it had been the intention of Congress, however, to give to the words of the statute the broad definition the petitioner contends for, it would have been unnecessary to have specifically provided in2810 the Act that contributions or gifts for the prevention of cruelty to children or animals might be deducted or to have provided that contributions might be deducted if made to the special fund for vocational rehabilitation, authorized by section 7 of the Vocational Rehabilitation Act. There can be no doubt that one of the objects of the League was to engage in the dissemination of controversial propaganda and that it did in fact carry out that purpose. The word "propaganda" is defined in Webster's New International Dictionary as "The scheme or plan for the propagation of a doctrine or system of principles." The dissemination of propaganda is usually thought of, not as a charitable, religious, or educational program, but primarily to accomplish the purpose of the person instigating it, which purpose here was a change or repeal of statutes. That the matters to which the propaganda of the League was directed are controversial is shown by the fact of the existence of statutes which the League felt should be amended or repealed. The Board has heretofore held that organizations engaged in such pursuits do not come within the provisions of the taxing act. See *2811 Such has also been the uniform interpretation of the Commissioner of Internal Revenue in all of his regulations, beginning with those promulgated April 17, 1919. See article 517 of Regulations 45, 62, 65, and 69. In our opinion the League was not organized and operated exclusively for the purposes specified in the statute and contributions to it are not deductible from gross income. Reviewed by the Board. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623438/	Harmony Dairy Company v. Commissioner.Harmony Dairy Co. v. CommissionerDocket Nos. 76486, 82566.United States Tax CourtT.C. Memo 1960-109; 1960 Tax Ct. Memo LEXIS 174; 19 T.C.M. (CCH) 582; T.C.M. (RIA) 60109; May 31, 1960Robert G. MacAlister, Esq., 3700 Grant Building, Pittsburgh, Pa., Albert Duff Brandon, Esq., and Frank E. Coho, Esq., for the petitioner. Gerald Backer, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: These consolidated proceedings involve deficiencies in income and excess profits taxes in the amounts and for the years as set forth below: DocketFiscal Year EndedNo.September 30Deficiency764861951$17,624.44195221,055.5519539,081.35195424,393.6119559,328.8582566195612,547.1519574,767.28The issues for decision are: (1) Whether payments made by petitioner to purchasers of its milk and milk products constituted rebates which may be used to reduce its gross sales in determining gross profit175 from sales; if not (2) whether these payments were deductible as ordinary and necessary business expenses; (3) whether the cost of milk and milk products delivered by petitioner free-of-charge to its officer-stockholders was deductible as an ordinary and necessary business expense. Findings of Fact The stipulated facts are so found and are incorporated herein by this reference. Harmony Dairy Company, petitioner herein, is a Pennsylvania corporation with offices in Pittsburgh. It kept its books and filed its Federal income tax returns on an accrual basis. Its return for the taxable year ended September 30, 1951 was filed with the collector of internal revenue for the twenty-third district of Pennsylvania. Returns for the other years in issue were filed with the district director of internal revenue at Pittsburgh. As a milk dealer licensed under the Pennsylvania Milk Control Law 1 petitioner engaged in the sale of fluid milk, milk products, and other products at both the wholesale and retail level. Insofar as material herein, section 807 of that law provided: "No method or device shall176 be lawful whereby milk is bought * * * sold or handled or delivered or made available on consignment or otherwise, * * * at a price less than the minimum price applicable to the particular transaction, whether by any discount, premium, rebate, free service, trading stamps, advertising allowance, or extension of credit, or by a combined price for such milk, together with another commodity or a service which is less, or is represented to be less, than the aggregate of the price of the milk and the price or value of such commodity or service when * * * sold or delivered or made available * * * separately or otherwise." Petitioner sold its products on both a cash and credit basis. Those products subject to price control under the Milk Control Law were sold at the minimum prices provided by that law. Other products were sold at market prices. On this basis its customers were charged and billed for the products purchased, and paid the amounts so billed. Pursuant to prior agreements with its wholesale customers, petitioner, after the close of each month, made cash payments to them based upon a specific percentage of the total amounts177 billed to and paid by the customer during the month for products purchased. The percentages varied from month to month, and as between customers. By virtue of this arrangement, the wholesale customer knew that the net charge for any controlled product would be less than the minimum price provided therefor by the Milk Control Law. These payments were motivated, in part, by an expectation that the customer would sell more of its products. If the sales potential expected did not materialize in a particular customer's area, the customer was notified that the payment arrangement was to be discontinued. In 1950, petitioner created Advance Advertisers. Though this company was owned and operated by and for the benefit of the petitioner, it was registered under the Pennsylvania Fictitious Names Act as a sole proprietorship conducted by an employee of petitioner to whom the task of running the concern had been assigned. While serving in this capacity, this employee remained on petitioner's payroll. Advance Advertisers was used to effect most of the cash payments made by petitioner to its customers. Each month, one of petitioner's officers prepared a list of customers who were to receive these178 payments, and the respective amounts to be paid. These lists were transmitted to Advance Advertisers, which drew checks on its own bank account in favor of the particular customers involved. The funds in this account were supplied by the petitioner. In some instances, checks were made payable to cash or to the order of the individual conducting Advance Advertisers' affairs, the monies then being transferred by him directly to the customer. In other instances, checks were made payable to an employee of the particular customer to whom payment was being made. Advance Advertisers kept no books, records, or analyses of the expenditures which it made. However it did retain its cancelled checks. In addition to customer payments made through the medium of Advance Advertisers, petitioner made certain payments directly to its customers during each of the years 1951, 1952, 1955, 1956 and 1957. Sometime in 1955, petitioner discontinued the use of Advance Advertisers as a means of handling its cash payments to customers. Thereafter, it made these payments directly to the customer, utilizing a bank account separate and distinct from that which it maintained for the greatest portion of its business179 transactions. On its books petitioner carried the disbursements which it made to Advance Advertisers under accounts variously labeled "Advertising", "Allowances and Returns", and "Contributions and Donations." The amounts expended by it on direct payments to its customers were carried under accounts designated "Allowances and Returns" and "Selling Expense." In addition to the payments made pursuant to its agreements with its wholesale customers, petitioner disbursed monies to various individuals, organizations and concerns which were not customers. These disbursements primarily were made through the medium of Advance Advertisers, and were classified either as an advertising or operational expense. The advertising expenditures included disbursements to various church organizations, parent-teacher associations, sports organizations, veteran groups, magazines, periodicals, and expenditures termed general good will. The operational expenditures included charges to Advance Advertisers for banking services, an expense allowance for its manager, the cost of flowers purchased for various occasions, and the cost of school lunch envelopes provided for school children. In addition, petitioner180 made certain direct payments to non-customers during the years in issue which are now in dispute. During its fiscal year ended September 30, 1952 it expended $650 on a display advertising its products which it installed at the Greater Pittsburgh Airport. During its fiscal year ended September 30, it disbursed $25 to a religious organization which it classified as an advertising expense, and $28.68 on what it termed operational expenses. The largest non-customer expenditure incurred directly by petitioner was the cost of milk and milk products which it delivered free-of-charge to its officer-stockholders during its fiscal years ended September 30, 1956 and 1957. Petitioner estimated the cost of the products so delivered at $1,200 for each of those years, and considered the expenditure to be in the nature of a fringe benefit. These amounts were reported by it as "Returns and Allowances" and utilized to reduce its gross sales. The recipients of these products included no amount with respect thereto in their personal income tax returns. During the years in issue petitioner's stock was held equally by Robert E., Howard L. and James A. Thompson, its president, vice-president and treasurer, 181 respectively. The amounts advanced by petitioner to the account of Advance Advertisers, the disbursements made by petitioner, either through that entity or directly for the items here in issue, and the manner in which those disbursements were returned by it during the years in issue were as set forth below: FISCAL YEAR ENDED SEPTEMBER 30195119521953To Advance Advertisers$28,300.00$23,100.00$14,050.00Disbursements: Advance AdvertisersCustomer payments26,673.7920,693.598,497.18Customer loan750.00Payments to non-customers385.201,406.622,713.37classified "Advertising"Payments to non-customers435.551,337.201,961.78classified "Operating Expense"Total$27,494.54$23,437.41$13,922.33PetitionerCustomer payments$ 1,940.36 1$1,908.88Payments to non-customersclassified "Advertising"Payments to non-customersclassified "Operating Expense"Cost of refrigerator placed incustomer's storeAdvertising Display650.00Products furnishedofficerstockholdersTotal$ 1,940.36$ 2,558.88Total Disbursements$29,434.90$25,996.29$13,922.33Returned As: Returns and Allowances 2$28,300.00$21,000.00$ 8,149.66Selling Expense1,940.361,908.88Advertising2,750.004,590.69Contributions and Donations318.60Other Deductions991.05 4Total 5$30,240.36$25,658.88$14,050.00182 FISCAL YEAR ENDED SEPTEMBER 301954195519561957To Advance Advertisers$12,550.00$ 63.68Disbursements: Advance AdvertisersCustomer payments9,087.6656.07Customer loanPayments to non-customers2,332.24classified "Advertising"Payments to non-customers1,808.247.61classified "Operating Expense"Total$13,228.14$ 63.68PetitionerCustomer payments$8,291.23$8,042.74$5,834.55Payments to non-customers25.00classified "Advertising"Payments to non-customers28.68classified "Operating Expense"Cost of refrigerator placed in211.50customer's storeAdvertising DisplayProducts furnished1,200.001,200.00officerstockholdersTotal$8,556.41$9,242.74$7,034.55Total Disbursements$13,228.14$8,620.09$9,242.74$7,034.55Returned As: Returns and Allowances 2$ 8,871.96$7,808.17$8,482.23 3$7,034.55Selling Expense811.92Advertising2,001.95Contributions and Donations1,676.09Other Deductions760.51Total 5$12,550.00$8,620.09$9,242.74$7,034.55183 The customer payments made by petitioner, either directly or through the medium of Advance Advertisers, during each of the years here in issue constituted rebates of purchase price made pursuant to agreements with those customers, and were intended to reduce the charges for the products sold below the specified gross price in an amount equal to the rebate. The rebates so made by petitioner for each of the years in issue were as set forth below: Fiscal Year EndedSeptember 30Rebate1951$28,614.15195222,602.4719538,497.1819549,087.6619558,347.3019568,042.7419575,834.55Opinion The principal issue in this proceeding concerns the customer payments made by petitioner during the years in issue, either directly or through the medium of its alter ego, Advance Advertisers. In the main, petitioner contends these payments did not constitute income to it upon their initial receipt, and thus are properly to be used to reduce Gross Sales in arriving at its Gross Profits from sales for Federal tax purposes, citing Pittsburgh Milk Co., 26 T.C. 707">26 T.C. 707 (1956). In the alternative, it contends these payments were deductible as ordinary and184 necessary business expenses. On the other hand, respondent argues the customer payments do not come within the ambit of Pittsburgh Milk, supra, and, if they do, that case was incorrectly decided. In answer to petitioner's alternative position, he argues the payments were made in direct violation of the public policy of the Commonwealth of Pennsylvania as defined in its Milk Control Law, and thus can not be held deductible as ordinary and necessary business expenses. Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30">356 U.S. 30 (1958). In Pittsburgh Milk, supra, we were confronted with the tax effect of rebates by the taxpayer to the purchasers of its milk in violation of the Milk Control Law of Pennsylvania. We concluded these rebates should be applied to reduce the taxpayer's gross sales on the theory that the product was in fact sold for an agreed net price, arrived at by reducing the minimum price provided for the product by the Milk Control Law by the amount of the agreed upon rebate. We therefore did not reach the question as to whether the rebates qualified as ordinary and necessary business expenses deductible from gross income. In the185 course of our discussion we said, beginning at page 716: "It does not follow, of course, that all allowances, discounts, and rebates made by a seller of property constitute adjustments to the selling prices. Terminology, alone, is not controlling; and each type of transaction must be analyzed with respect to its own facts and surrounding circumstances. Such examination may reveal that a particular allowance has been given for a separate consideration - as in the case of rebates made in consideration of additional purchases of specified quantity over a specified subsequent period; or as in the case of allowances made in consideration of prepayment of an account receivable, so as to be in effect a payment of interest. The test to be applied, as in the interpretation of most business transactions, is: What did the parties really intend, and for what purpose or consideration was the allowance actually made? Where, as here, the intention and purpose of the allowance was to provide a formula for adjusting a specified gross price to an agreed net price, and where the making of such adjustment was186 not contingent upon any subsequent performance or consideration from the purchaser, then, regardless of the time or manner of the adjustment, the net selling price agreed upon must be given recognition for income tax purposes." Applying the test so provided in Pittsburgh Milk to the facts now before us, we have concluded and have found as a fact that the payments made by petitioner to its customers during the years in issue constituted rebates of purchase price made pursuant to agreements with those customers, and were intended to reduce the charge for the product sold below the specified gross price in an amount equal to the rebate. No other conclusion would be warranted by this record. Respondent argues this case is distinguishable from Pittsburgh Milk inasmuch as the result there was predicated upon a stipulation that the customer allowances were made for the purpose of avoiding the Pennsylvania Milk Control Law pursuant to agreements with those customers. Contending that petitioner denies its payments violated the Milk Control Law, and further that it has failed to establish any informal agreements with its customers calling for the payments, respondent maintains reliance upon187 that case is misplaced. We do not agree. Our holding in Pittsburgh Milk was not based upon a finding that the particular payments were intended to circumvent the Milk Control Law, nor upon a finding that they did so violate the provisions of that law. Rather, it resulted from a recognition of the substance of what occurred; i.e., that notwithstanding the fact that the taxpayer received a gross amount upon the sale of its product, it rebated a porion thereof to the purchaser pursuant to prior agreement, the end result being the sale of the product at a specified net price. Consequently, the rebate was not received under any claim of right, but rather constituted a deposit to be returned by the seller, and therefore was not income to it. Further, there is sufficient evidence in this record to justify our finding that the payments were made pursuant to prior agreements between petitioner and its wholesale customers. We therefore see no distinction between that proceeding and the one presently before us. The lengths to which petitioner went in disguising its customer payments as advertising and other operational expenditures on its books might suggest wrong doing, but, as the Supreme188 Court said in Commissioner v. Wilcox, 327 U.S. 404">327 U.S. 404, "Moral turpitude is not a touchstone of taxability." Finally, respondent challenges the correctness of our holding in Pittsburgh Milk. We believe we were right, and now adhere to that result. Tri-State Beverage Distributors, Inc., 27 T.C. 1026">27 T.C. 1026 (1957). We therefore hold that the customer payments which petitioner made during each of the years in issue, in the amounts as set forth in our Findings, did not constitute income to it when received, and are properly to be used to reduce its gross sales in determining its gross profits from sales for Federal income tax purposes. Our Findings dispose of the amounts of these payments for each of the years in issue, however, a few comments with respect thereto might well be warranted. Petitioner has classified as a customer payment a loan to a customer during its fiscal year ended September 30, 1953, in the amount of $750. The record indicates this amount was subsequently repaid and taken into cash. Though the net effect of this is to take the $750 into income in the year of its recovery, we are of the opinion that the original loan cannot be classified as a customer189 payment. Further, we note the total amounts returned by petitioner during each of the years in issue, whether as adjustments to gross receipts or as deductible expenses, were computed by adding to the amounts advanced to Advance Advertisers the amounts expended directly by petitioner. The record reveals that in at least two of the years in issue Advance Advertisers expended less than the amounts advanced it, and that in at least two other years its expenditures were in excess of the advances. Therefore, in arriving at the amounts properly to be considered as customer payments we have considered only those amounts actually expended either by Advance Advertisers or directly by the petitioner. This leaves for our consideration the payments which were made by petitioner to non-customers, exclusive of the free delivery of products to its officers, set forth in our Findings as disbursed for: Advertising$6,862.43Operating Expenses5,579.06Advertising Display650.00Refrigerator Supplied Customer211.50 Petitioner has conceded the refrigerator expense item, agreeing with respondent that it represented a capital expenditure. The remaining items clearly were not customer190 payments, and thus respondent's contention that they are not deductible business expenses because they violate the provisions of the Milk Control Law relating to rebates is beside the point. We do not understand respondent to contend that the operating expenses incurred by Advance Advertisers per se violated the public policy of the Commonwealth of Pennsylvania, but only that they did so if they constituted customer payments. However, assuming without deciding that the "business" of Advance Advertisers, i.e., the making of rebates, was directly contrary to the public policy of Pennsylvania as expressed in its Milk Control Law, we cannot say the expenses incidental thereto, which were not illegal in themselves, may not be deducted. See Commissioner v. Sullivan, 356 U.S. 27">356 U.S. 27 (1958) where certain business expenses, incident to activities made illegal by State law, were held deductible. Apparently respondent's only other concern is whether or not the amounts were actually expended for the purposes claimed. We are satisfied from the record that they were. As evidence of its various transactions, petitioner introduced a schedule of cancelled checks issued by Advance Advertisers191 on which is set forth the date of the check's issuance, its number, the payee, and the purpose for which it was issued; i.e., a customer allowance, advertising expense, or operational expense. Also introduced in evidence were cancelled checks relating to other transactions which were appended to a similar schedule setting forth the particulars of their issuance. These schedules were prepared by petitioner's chief accounting officer shortly before trial of this proceeding from an examination of the checks themselves. In making this analysis he relied upon his familiarity with the specific accounts involved, plus knowledge of some of the particular transactions. While the various transactions numbered in the thousands, and there is a possibility for error, we are of the opinion that petitioner, by virtue of the evidence presented, has at least overcome the presumptive correctness of the notice of deficiency, and thus shifted the burden of going forward to the respondent. On the other hand, we cannot say that respondent has met his burden simply by suggesting the possibility of error. Respondent submits the $650 expended in 1951 for an advertising display was not disallowed, and therefore192 is not in issue. His argument is that this amount was deducted by petitioner as an advertising expense on its return, and that there was no disallowance of an advertising deduction in the notice of deficiency for the fiscal year ended September 30, 1952. If this be true, it applies equally to $2,100 advance to Advance Advertisers during that taxable period which was also deducted on the return as an advertising expenditure. The parties have stipulated petitioner advanced to Advance Advertisers $23,100 during its fiscal year ended September 30, 1952, of which $21,000 was returned as "Returns and Allowances" and used to reduce gross sales; the remaining $2,100 being deducted as an advertising expense. They have further stipulated that $1,908.88 in customer payments was deducted as a "Selling Expense." These items total $25,008.88, whereas the total disallowance set forth in the statement attached to the notice of deficiency was: (a) Returns and Allowances$23,750.00(b) Selling expense1,908.88$25,658.88 It would thus appear that the difference, $650, was the amount expended by petitioner on the advertising display. It would also appear that the $2,100 advance193 to Advance Advertisers which was deducted as an advertising expense was included in the $23,750 disallowance of "Returns and Allowances." In any event, we are persuaded by the record that petitioner is entitled for its fiscal year ended September 30, 1952, to: an adjustment to gross sales for customer allowances of $22,602.47; and advertising expense deduction of $650 for the airport display; and miscellaneous expense deductions in the respective amounts of $1,406.62 and $1,337.20. The final issue is whether the cost of milk products delivered free-of-charge to its officer-stockholders, during its fiscal years ended September 30, 1956 and 1957, was deductible by petitioner as an ordinary and necessary business expense. Petitioner's primary position is that the free delivery of these products was in the nature of a fringe benefit. It further contends that it expected the recipients would provide a means whereby it could check the quality of its various products. Under either theory, it claims the estimated cost of these products was a deductible business expense. Respondent, on the other hand, argues that the value of these products constituted either a distribution of earnings194 and profits to petitioner's stockholders, or the payment by it of personal living expenses of its officer-stockholders. We believe the record to be inconclusive insofar as petitioner's contention that its officer-stockholders performed a quality check service for it in return for the free delivery of its milk products. The only evidence bearing on this point appears in the testimony of petitioner's vice-president on direct examination, where he said: "We have allowed all our employees a discount on their milk. That has been our practice over the years. As far as the officers, that is the reason my father started in the milk business, so he could get milk cheaper for his family. I don't know - that has been the practice of people who work in the place, and certainly they can drink their own products. It gives us a chance of our own to judge the quality, know what - That has been a practice as far as I can remember. I have never before been questioned on it." Clearly this testimony is not a sufficient basis upon which to make a finding that petitioner expected its officer-shareholders to make a quality check on its products, and that in consideration therefor the products were*195 delivered to them free-of-charge. Thus, we are left with petitioner's claim that these free products were in the nature of fringe benefits. So far as this record is concerned, the only individuals receiving such products were officer-stockholders. Further, the stipulation indicates that petitioner's stock was closely held by Robert E., Howard L. and James A. Thompson who were respectively, its president, vice-president and treasurer. Therefore, our immediate concern is whether the products were received free-of-charge because of the recipient's executive position, or because of his status of stockholder. In case of the latter, respondent well may be correct in contending the value of these products constituted a distribution of earnings and profits. The record fails to disclose which of the two relationships engendered the free products. Thus, we cannot say that respondent's disallowance of these items was erroneous. Decisions will be entered under Rule 50. Footnotes1. Purdon's Pa Stat. Ann., title 31, sec. 700j↩.1. Of total disbursements of $3,704.47 only $1,940.36 was disallowed by respondent. ↩2. Used to reduce Gross Sales. ↩4. Includes $750 loan subsequently repaid and taken into cash at an undisclosed time. ↩5. Amount disallowed in Deficiency Notice.↩3. Erroneously set forth in Deficiency Notice as $8,582.23. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623440/	Lilian Bond Smith, Petitioner, v. Commissioner of Internal Revenue, RespondentSmith v. CommissionerDocket No. 42454United States Tax Court21 T.C. 353; 1953 U.S. Tax Ct. LEXIS 15; December 8, 1953, Promulgated 15 Decision will be entered under Rule 50. Petitioner and her husband executed a separation agreement in 1937, providing, inter alia, for monthly support payments to petitioner, and requiring her husband to pay the premiums on a policy of insurance on his life of which petitioner is the primary beneficiary. In 1940, the husband failed to pay the insurance premiums and petitioner instituted an action against him for specific performance of the separation agreement. The litigation was settled by a stipulation of the parties and the entry of a consent judgment by the court in accordance therewith in 1940. The stipulation of the parties and the consent judgment of the court also embraced the support payments. Thereafter, in 1944, petitioner's husband obtained a decree of divorce in which the separation agreement was incorporated. Held, the obligation to make support payments was imposed upon or incurred by the husband by a decree of divorce and the support payments are includible in the petitioner's gross income, as alimony, under section 22 (k), Internal Revenue Code. Held, further, the premiums paid on the policy of insurance are not includible in petitioner's gross16 income, as alimony, under section 22 (k), Internal Revenue Code, since petitioner had only a contingent interest in the policy, and it was not for her sole benefit. Walter E. Bennett, Esq., for the petitioner.John J. Burke, Esq., for the respondent. Harron, Judge. HARRON 353 The Commissioner has determined deficiencies in income tax for the years 1945 and 1946 in the amounts of $ 439.85 and $ 285.73, respectively. Petitioner does not contest part of the deficiency for 1945. Two questions are presented: (1) Whether support payments of $ 4,800 received by the petitioner in each of the taxable years from her former husband are includible in her gross income under section 22 (k), Internal Revenue Code. (2) Whether insurance premiums of $ 1,200, paid in each of the taxable years on a policy insuring the life of the petitioner's former husband, and under which she is the primary beneficiary, are includible in the petitioner's gross income, as alimony, under section 22 (k).Petitioner filed her income tax returns for the years 1945 and 1946 with the collector for the sixth district of California at Los Angeles.FINDINGS OF FACT.The facts which have been stipulated 17 are found as facts; the stipulation and all of the exhibits are incorporated herein by this reference.Petitioner is a resident of Los Angeles, California. In 1936, the petitioner married Sydney A. Smith. She was employed in the moving 354 picture industry as an actress at the time of the marriage. Sydney Smith, at the time of the marriage, was a life beneficiary, to the extent of one-half of the income, of a trust created by the will of Andrew W. Smith, deceased. The Bank of New York in New York City is the trustee.Following the marriage, Sydney Smith took out a policy of insurance on his life with the Aetna Life Insurance Company. The policy, number 1-146660, dated October 17, 1936, was in the principal amount of $ 50,000. The petitioner was named the primary beneficiary, and her mother the secondary beneficiary of the policy. The method of payment of the net proceeds of insurance, as provided by the terms of the "Beneficiary Agreement" part of the insurance contract, was as follows:The net sum payable by the Company under this policy by reason of the death of the insured shall be payable as follows:If Lillian [sic] B. Smith, wife of the insured, survives the18 insured, said net sum shall be payable in accordance with Mode 4 in monthly installments for a fixed period of Ten (10) years and for as long thereafter as said wife lives. Each installment shall be payable when due to said wife if then living, otherwise to Harriet Bond, mother-in-law of the insured, if then living, otherwise the commuted value of any unpaid installments for the period of Ten (10) years certain under Mode 4 shall be payable in one sum to the executors or administrators of the survivor of said wife and said mother-in-law.If said wife does not survive the insured, but said mother-in-law survives the insured, said net sum shall be payable in accordance with Mode 4 in monthly installments for a fixed period of Ten (10) years and for as long thereafter as said mother-in-law lives. Each installment shall be payable when due to said mother-in-law if then living, otherwise the commuted value of any unpaid installments for the period of Ten (10) years certain under Mode 4 shall be payable in one sum to the executors or administrators of said mother-in-law.If neither said wife nor said mother-in-law survives the insured, said net sum shall be payable in one sum to the executors19 or administrators of the insured.The insured, Sydney Smith, reserved certain rights in the insurance policy, as follows:During the life of the insured, the right to receive all cash values, loans and other benefits accruing hereunder, to exercise all options and privileges described herein and to agree with the company to any change in, amendment to, or cancellation of this policy shall vest alone in the life owner (hereinafter so called) designated as follows: the insured. Provided that said life owner shall not have the right to make any change in the beneficiary during the life time of his wife, Lillian [sic] Bond Smith, without her written consent.The insurance policy was not assigned to petitioner at any time.On or about March 27, 1937, petitioner and Sydney Smith became separated, and thereafter they lived separate and apart from each other. On March 27, 1937, petitioner and Sydney executed a separation agreement, and in July 1937, they executed a supplemental agreement 355 which modified part of the original agreement. The separation agreement, as amended, in so far as material here, contained the following provisions: The parties agreed to an immediate separation, 20 and to live apart. For the purpose of settling their property rights and to make provision for the support of Lilian Smith, it was agreed that: (a) All property owned by the parties on March 27, 1937, would be the separate property of the party owning and possessing the same, and that all property acquired by the parties in the future would be the separate property of the person acquiring the same. (b) Each party renounced and released his and her interest in the estate of the other, including the right to inherit from each other as the husband or wife. (c) Sydney agreed to pay Lilian $ 400 per month for her support and maintenance beginning on April 1, 1937, and continuing for her life, or until her lawful remarriage. (d) Sydney agreed to keep the life insurance policy numbered 1-146660 in effect and to pay the premiums due thereon, for as long as Lilian lived, or until her remarriage in the event Sydney and Lilian should become divorced.The provisions of paragraph three of the agreement, as amended, dealing with the obligations of Sydney, the party of the first part, to make support payments to Lilian, the party of the second part, and to keep the life insurance policy in 21 effect are as follows:Said party of the first part promises and agrees to pay to the said party of the second part for her support and maintenance during such separation the sum of Four Hundred Dollars ($ 400.00) per month. Such payments shall be made on the first day of each calendar month, commencing April 1, 1937, and shall continue until the death of the party of the second part, or until her remarriage, if the parties hereto are at any time divorced and the said party of the second part does remarry subsequent to any such divorce.The party of the first part agrees to keep in effect that certain life insurance policy numbered 1-146660 and pay and discharge the premiums due thereon. In said life insurance policy the party of the second part is named as beneficiary. However, there shall be no obligation or liability on the part of the party of the first part to so keep said policy in effect or so pay and discharge said premiums in the event of the death of the party of the second part or in the event of her remarriage if the parties hereto are at any time hereafter divorced.In the event that the parties hereto are at any time hereafter divorced and in the event that subsequent22 to said divorce the party of the second part remarries, she hereby waives and relinquishes any and all rights that she now has or may at any time have had as beneficiary under the terms of said policy.The agreement provides further, in paragraph seven,That neither this agreement nor anything herein contained shall prejudice the right of either party to institute an action for divorce and any decree that may be entered in any such action shall not vary or change the terms of this agreement to any extent whatsoever.356 Under paragraph three of the original separation agreement, executed on March 27, 1937, Sydney agreed to pay the petitioner $ 400 a month for her support, commencing on April 1, 1937, and continuing thereafter for her life or until her lawful remarriage, provided, however, that if Sydney's gross income for any month should fall below $ 1,700, he was to pay the petitioner 25 per cent of his gross income for that month in lieu of the $ 400. Below the signatures of the parties on the original agreement, Sydney wrote an addenda in longhand whereby he stated that he agreed to keep in force the Aetna policy of insurance on his life, of which petitioner is the primary23 beneficiary, "during such a time as [she] lives and until such a time that she shall remarry after which time I am at liberty to cancel same."Paragraph three of the original separation agreement was amended in July 1937 in two respects. The provision for reducing the support payments of $ 400 a month, in the event Sydney's gross income should fall below $ 1,700 a month, was deleted; and there was added a provision requiring Sydney to pay the premiums on the Aetna life insurance policy during the petitioner's life or until her lawful remarriage.Sydney failed to pay the insurance premiums due on the Aetna policy on October 17, 1939, January 17, 1940, and April 15, 1940. Thereafter, on May 6, 1940, petitioner commenced an action in equity in the Supreme Court of New York for New York County against Sydney Smith and the Bank of New York, trustee under the will of Andrew W. Smith, deceased, defendants, to compel Sydney to perform his agreement to keep the life insurance policy in effect, to furnish assurance that he would keep the insurance in effect, and to recover from Sydney reimbursement for the insurance premiums, plus interest, which petitioner had paid. The Bank of New York, 24 as trustee of the Andrew W. Smith trust, was joined as a defendant so that the court might direct it to pay out of trust income accruing to Sydney such amounts as would be sufficient to pay the insurance premiums in the future, and so that the court might direct it to pay any money judgment which might be awarded to the complainant. Petitioner attached to her complaint, filed in the New York Supreme Court, copies of the separation agreement of March 27, 1937, and the amendment thereto executed in July 1937, as exhibits A and B, respectively. Sydney and the bank filed separate answers to the complaint. In his answer, Sydney alleged, inter alia, that the supplemental agreement of July 1937, was illegal, void, and without consideration. The support payments provided for in the separation agreement were not in issue in the action instituted by the petitioner in New York. Sydney, at all times material hereto, 357 has recognized and fulfilled his obligation to make the support payments of $ 400 a month.The litigation in New York was settled by a stipulation of the parties, and the entry of a consent judgment by the court in accordance therewith.The stipulation was executed25 by the parties and filed with the court on July 26, 1940. In the stipulation, Sydney ratified and reaffirmed the separation agreement of March 27, 1937, and the amendment thereto of July 1937, and expressly conceded that they were valid and enforceable agreements, under which he was obligated to pay Lilian $ 400 a month "as alimony," and to pay the premiums on the Aetna policy of insurance on his life. In addition, he agreed, inter alia, not to avail himself of the loan or cash surrender provisions of the policy, nor to borrow upon the security of the policy, nor to do any act which would diminish Lilian's interest in the policy without her consent in writing, during Lilian's life or until her lawful remarriage. Also, in order to insure the performance of his obligations under the separation agreement, as amended, he authorized and directed the aforementioned trustee to make the premium and support payments out of the income in its possession accruing to him under the terms of the trust. The pertinent provisions of the stipulation are as follows:3. For the purpose of insurance [sic] performance of the terms of said agreements and of this agreement, and in order to further26 secure unto said Lillian [sic] Bond Smith, the rights and benefits therein and herein provided for, the said Sydney A. Smith:(A) Covenants and warrants that he has no right, without the express consent in writing of the said Lillian [sic] Bond Smith, to avail himself of the loan or cash surrender provisions of said policy, or to borrow upon the security of said policy, or to reduce the equity therein, or to perform any act or thing which would in any way affect the present cash value of said policy or diminish any of the plaintiff's interest therein;(B) Hereby requests, authorizes and empowers Bank of New York, as trustee under the last will and testament of Andrew W. Smith, deceased, to execute this stipulation and consent to the entry of the judgment hereinafter referred to, and authorizes and empowers it, and/or its successors or assigns, to make the following payments out of any sums in its possession accruing unto him under and by virtue of any trust created by and under the last will and testament of Andrew W. Smith, deceased, late of Saratoga County: (1) To Lillian [sic] Bond Smith the sum of $ 400 monthly, payable on the first day of each month commencing 27 with August 1, 1940, in accordance with the aforesaid agreements;(2) To said Aetna Life Insurance Company of Hartford, Connecticut, of any and all premiums or instalments thereof which are now or hereafter may become due under the aforesaid policy #N1-146660, issued by said company on the life of said Sydney A. Smith, and to deliver to said Lillian [sic] Bond Smith, or her representatives, within ten days after receipt thereof, the original or a duplicate original of the receipt for such premium payments;358 (3) To Lillian [sic] Bond Smith, of the amount of any judgment which may be entered herein;and the said Sydney A. Smith further consents, covenants and agrees that the plaintiff's right to said payments of alimony and for life insurance premiums shall be a first lien upon the income of the said trust, prior to the right of the defendant Sydney A. Smith to receive any of said income now accrued or hereafter accruing so long as plaintiff shall be alive, but in the event plaintiff and said Sydney A. Smith shall be divorced and the plaintiff shall remarry, then and in that event, the plaintiff's right to receive such alimony and to have such payments of insurance28 premiums made, and her rights in the said policy of life insurance shall continue up to and shall terminate simultaneously with such remarriage after such divorce.And the said Sydney A. Smith for the purpose of further assuring the due and prompt payment of said alimony and the aforesaid premiums and judgment, hereby assigns, transfers and sets over unto Bank of New York, so much of such income, as may come into its possession, as shall be necessarily required for the prompt and due payment of the aforesaid alimony and premium charges and judgment hereby designating said Bank of New York, its successors and assigns, his true, lawful and irrevocable attorney in its own name or in his name, to acknowledge for his account receipt from Bank of New York, as trustee under the last will and testament of Andrew W. Smith, deceased, or any successor trustee, of any and all moneys so received by it and applied for the purposes aforementioned, and to make payment of such sums for the purpose aforesaid to Aetna Life Insurance Company of Hartford, Connecticut.4. The answer and amended answer of the defendant Sydney A. Smith, heretofore interposed in this action, are hereby withdrawn.5. Defendant29 Sydney A. Smith hereby consents that a judgment may be entered herein ex-parte or otherwise on this stipulation providing for the enforcement of the provisions hereof and embracing the terms of this stipulation. * * 7. It is expressly understood and agreed that the foregoing covenants and the entry of judgment as heretofore provided, shall not, nor shall they be deemed to, limit or restrict the plaintiff's rights under said agreements of March 27, 1937 and July 1937, nor shall they be deemed a waiver of any of plaintiff's rights under said agreements which are not expressly included herein and expressly adjudicated and enforced by said judgment to be entered herein.On September 27, 1940, an order and decree of the New York Supreme Court was entered (which is incorporated herein by this reference in its entirety), by which the court ordered, adjudged, and decreed, inter alia, that the agreement of March 27, 1937, and the modification agreement executed in July 1937, as supplemented by the stipulation dated July 26, 1940, were valid contracts; directed Sydney Smith to specifically perform the agreements and the stipulation of July 26, 1940, and in particular, directed Sydney30 to make payment of "alimony" and of all premiums due or accruing on the Aetna life insurance policy; authorized and directed the Bank of New York, trustee, to make payment, out of any sums credited to Sydney under the Andrew W. Smith trust, of $ 400 per month to Lilian commencing with October 1, 1940, and of the premiums on policy 1-146660 to Aetna on or before the due date without resort 359 to any grace period, and to deliver receipts for premium payments to Lilian; and directed the bank to make payment of $ 703.21 to Lilian. The court also adjudged and declared all payments of "alimony" and insurance premiums to be a first lien on the income of the Andrew W. Smith trust to which Sydney might have any right for "so long as plaintiff [Lilian] shall live, or in the event plaintiff and said defendant Sydney A. Smith are divorced and the plaintiff remarries, then and in such event the plaintiff's right to receive and to have such payments made, and her rights in the aforesaid policy of insurance shall continue up to and shall terminate simultaneously with such remarriage after such divorce";The court's decree contained, also, the following:ORDERED, ADJUDGED AND DECREED, that31 the making and entry of this judgment shall not prejudice or be deemed a waiver of any of plaintiff's rights under said agreement dated March 27, 1937, as modified by said agreement dated July 1937, and said stipulation dated July 26, 1940, in so far as the provisions of said agreements and stipulation are not expressly included in, adjudicated or enforced by this judgment; * * On October 22, 1943, Sydney filed a bill of complaint for divorce from Lilian in the Florida Circuit Court in Dade County. Lilian did not appear in this divorce action, and service of summons upon her was by publication only.On January 31, 1944, a final decree of divorce was entered in the Florida suit. The separation agreement of March 27, 1937, and the modification agreement of July 1937, were attached to and made part of the final decree of divorce as "Plaintiff's Exhibits Nos. 7 and 8." The final decree of divorce contained the following:ORDERED, ADJUDGED AND DECREED that the bonds of matrimony existing between the Plaintiff and Defendant be, and they are hereby forever dissolved, and that the said SYDNEY A. SMITH and LILIAN B. SMITH be, and they are hereby divorced each from the other, a Vinculo 32 Matrimonii, and that all the rights of an unmarried person are hereby restored to said parties, and it is furtherORDERED, ADJUDGED AND DECREED that all the matters which are contained in an Agreement and an Amendment thereto, which Agreement and Amendment thereto are part of this record as Plaintiff's Exhibits Nos. 7 and 8, are hereby approved and confirmed in all respects thereto, and are hereby made part and parcel of this Final Decree as if set out in Haec Verba and that the original of said Agreement and Amendment thereto, known as Plaintiff's Exhibits Nos. 7 and 8, be recorded upon the Public Records along with this Final Decree.On November 9, 1943, petitioner, Lilian B. Smith, filed suit for divorce against Sydney in the Superior Court of California in Los Angeles County. Summons filed by petitioner in the Superior Court was served on Sydney by publication only, and he made no appearance.On March 29, 1944, an interlocutory judgment of divorce in favor of Lilian was entered, and on April 2, 1945, a final decree of divorce 360 was entered granting Lilian a final divorce from Sydney. Neither the interlocutory decree nor the final decree made any reference to the separation33 agreement of March 27, 1937, or to the modification agreement of July 1937, and these agreements were not approved by or made a part of the decrees of the Los Angeles County Superior Court. The court did not award any alimony or support payments to Lilian, but simply adjudged that plaintiff was entitled to a final divorce.Since the judgment and decree of the New York Supreme Court on September 27, 1940, the monthly payments of $ 400 have been paid to Lilian by the Bank of New York, trustee, and it has paid all the premiums on the Aetna policy of life insurance.Lilian B. Smith has not remarried since the decrees of divorce were entered by the Florida and California courts in 1944 and 1945.In her income tax return for each of the years 1945 and 1946, the petitioner reported, as gross income, the support payments of $ 4,800 received by her from her former husband. She did not report, as income, the premiums of $ 1,200 paid in each of those years on the Aetna policy of insurance on his life.On September 9, 1948, the petitioner filed claim for a refund of income taxes for each of the years 1945 and 1946, with the collector for the sixth district of California. In her claim for refund34 for each of the years, the petitioner alleged that the support payments of $ 4,800 were erroneously included by her in gross income.By notice dated June 12, 1952, the Commissioner rejected the petitioner's claim for refund for each of the years 1945 and 1946, and determined a deficiency for each of the years. The deficiency is due, principally, to the determination by the Commissioner that the premiums of $ 1,200, paid in each of the taxable years on the Aetna policy insuring the life of the petitioner's former husband, and under which she is the primary beneficiary, are includible in her gross income, as alimony, under section 22 (k) of the Code.OPINION.The first question presented is whether the payments of $ 4,800 received by the petitioner in each of the taxable years from her former husband are includible in her gross income, as alimony, under section 22 (k) of the Internal Revenue Code. 1 There 361 is no issue relating to the fact that the payments were made by the trustee of a trust under which the petitioner's former husband is a life income beneficiary.35 Section 22 (k) of the Code provides that periodic payments of alimony or support, received by a wife subsequent to a decree of divorce or of separate maintenance, in discharge of a legal obligation arising out of the marital or family relationship, and imposed upon or incurred by the husband under such decree or under a written instrument incident to such divorce or separation, shall be includible in the gross income of the wife.The respondent contends that the payments in question meet all of the requirements of the statute. The petitioner claims that the obligation of her former husband to make the payments was not imposed upon or incurred by him under a decree of divorce, or under a written instrument incident to such divorce. She concedes that the other requirements of section 22 (k) have been satisfied.The petitioner argues that the obligation to make the payments was imposed on Sydney by the judgment of the New York court entered in 1940, pursuant to a stipulation of the parties, in the proceedings instituted by petitioner against Sydney A. Smith, for specific performance of the provision of the separation agreement of 1937, as amended, requiring Sydney to pay the premiums36 on a policy of insurance on his life of which she is the primary beneficiary. The argument is based on the fact that the provision of the separation agreement relating to the support payments, although not in issue in the New York proceedings, was included in the stipulation of the parties and the consent judgment of the court, and the further fact that the Florida decree of divorce, in which the separation agreement was incorporated, was not obtained until January 1944. Petitioner seeks to avoid the impact of section 22 (k) by reliance on the doctrine of merger. The petitioner also argues that the separation agreement was not incident to the Florida divorce, alleging that divorce was not considered or contemplated by the parties when the separation agreement of 1937 was entered into. In support of this argument, petitioner relies on Joseph Lerner, 15 T. C. 379, revd. 195 F.2d 296">195 F. 2d 296. We have carefully considered the petitioner's arguments and find that they are without merit.We need not concern ourselves with the legal niceties of the doctrine of merger. The present issue arises under a Federal statute, the intent and 37 purpose of which is clear. Section 22 (k) of the Code was enactedin order to provide in certain cases a new income tax treatment for payments in the nature of or in lieu of alimony or an allowance for support as between divorced or legally separated spouses. These amendments are intended to treat such payments as income to the spouse actually receiving or actually entitled to receive them and to relieve the other spouse from the tax burden upon whatever 362 part of the amount of such payments is under the present law includible in his gross income. * * See H. Rept. No. 2333, 77th Cong., 2d Sess. (1942), pp. 71, 72. Congress did not intend that its application should depend on the "variance in the laws of the different states concerning the existence and continuance of an obligation to pay alimony." See H. Rept. No. 2333, supra. Nor, in our opinion, did Congress intend that its application should depend on the effect of a judgment in an action for specific performance of a separation agreement or one of the provisions of a separation agreement, where that judgment is entered prior to the date the parties obtain a decree of divorce. Such an application of the statute38 would tend to circumscribe its purpose.Furthermore, we note, in the instant case, that the provision of the separation agreement requiring Sydney to make support payments of $ 400 a month to the petitioner was not in issue in the court proceedings in New York. Sydney, at all times, has recognized his obligation to make the support payments. The litigation in New York arose solely because of Sydney's failure to honor the obligation he had assumed in the amended agreement to pay the premiums on the policy of insurance on his life of which petitioner is the primary beneficiary. The litigation was settled by a stipulation of the parties and the entry of a consent judgment by the court in accordance therewith. The stipulation filed by Sydney and the petitioner in the New York litigation, insofar as it embraced the payments for support, was nothing more than a reaffirmation by Sydney of his existing and continuing obligation to make those payments in accordance with the provisions of the separation agreement as amended.There is no dispute that the obligation of Sydney to make support payments arose out of his marital relationship with the petitioner. The obligation was incurred by39 him, initially, under a separation agreement. The terms and provisions of the agreement were later incorporated in and made a part of a decree of divorce. Sydney was personally before the Florida court which awarded him the decree of divorce incorporating the separation agreement, and the petitioner does not attack the jurisdiction of that court to impose upon him the obligation to pay her alimony, albeit in accordance with the terms of the existing separation agreement. We conclude that, insofar as the application of section 22 (k) is concerned, the obligation to make the support payments was imposed upon or incurred by Sydney by a decree of divorce. Furthermore, it is difficult to comprehend the petitioner's argument that the separation agreement was not incident to a divorce where, as here, the agreement was incorporated in a decree of divorce. This fact sharply distinguishes the instant case from Joseph Lerner, supra, relied on by the petitioner.363 It is held that the support payments in question are includible in the petitioner's gross income, as alimony, under section 22 (k) of the Code.The second question is whether insurance premiums40 of $ 1,200 paid in each of the taxable years on a policy, insuring the life of petitioner's former husband in the amount of $ 50,000 and under which the petitioner is primary beneficiary, are includible in the petitioner's gross income, as alimony, under section 22 (k) of the Code. The insurance premiums were also paid by the aforementioned trustee.The respondent contends that the premium payments were in the nature of additional alimony, and that they were constructively received by, and are taxable to, the petitioner under section 22 (k), Internal Revenue Code. He argues that the policy of insurance was for the benefit of the petitioner since she was the irrevocable primary beneficiary for her life, and that the premium payments are periodic payments and otherwise qualify as alimony under the statute, since they were paid in accordance with a separation agreement which was incorporated in a decree of divorce. The respondent relies on Anita Quinby Stewart, 9 T.C. 195">9 T. C. 195; Estate of Boise C. Hart, 11 T.C. 16">11 T. C. 16; and Lemuel Alexander Carmichael, 14 T.C. 1356">14 T. C. 1356.The petitioner argues that she 41 is not the owner of the policy; that it is not for her sole benefit; that her rights and interest in the policy are contingent upon her death or remarriage; and that although the separation agreement does not specifically so provide, the obvious intent and purpose of the provision of the agreement requiring Sydney to keep the insurance in force, is to secure to the petitioner support payments in the event she remains unmarried and survives Sydney. The petitioner relies, principally, on Meyer Blumenthal, 13 T. C. 28, affd. 183 F. 2d 15, and a Memorandum Opinion of this Court. We agree with the petitioner.The petitioner is not the owner of the insurance policy. It was never assigned to her and she never acquired the right to exercise any of the incidents of ownership therein. The policy provides that all the rights and incidents of ownership are vested in the insured, i. e., Sydney A. Smith, subject only to the limitation that he "shall not have the right to make any change in the beneficiary during the life time of his wife [petitioner], without her written consent." The petitioner did not make the premium payments in question42 and she did not actually or constructively receive the sums paid as premiums. Furthermore, she did not realize any economic gain during the taxable years from the premium payments. For example, any increase in the cash surrender or the loan value of the policy resulting from the premium payments inured to the benefit of the owner of the policy and not to the petitioner.364 It is clear from the terms of the policy, and from the provisions of the separation agreement that the petitioner's rights under the policy are contingent on her death or remarriage. Under the terms of the policy, the petitioner or her estate is entitled to receive the proceeds only in the event the petitioner survives the insured. The policy provides that, if neither the petitioner nor her mother survives the insured, the proceeds "shall be payable in one sum to the executors or administrators of the insured." The fact that a secondary beneficiary of the petitioner's choice is designated in the policy is not here important.Under the provisions of the separation agreement, the petitioner's interest in the policy is more remote since it may be terminated either by her death or lawful remarriage. The 43 separation agreement, as amended by the stipulation of the parties filed in the proceedings in the Supreme Court of the State of New York, required Sydney to keep the policy of insurance in force, and to refrain from exercising the incidents of ownership therein only until the death or lawful remarriage of the petitioner. In the event of the petitioner's lawful remarriage, Sydney regains full dominion and control over the policy. It is therefore apparent that the petitioner's only interest in the policy is contingent, and that the premiums on the policy were not paid for her sole benefit. See Estate of Frank Charles Smith, et al. v. Commissioner, (C. A. 3, 1953) 208 F. 2d 349; Seligmann v. Commissioner, (C. A. 7, 1953) 207 F.2d 489">207 F. 2d 489.Furthermore, we agree with the petitioner that the obvious intent and purpose of the provision of the separation agreement relating to the policy of insurance, is to secure to the petitioner payments for her support in the event she survives Sydney without remarrying. Although the agreement does not specifically so provide, the inference is warranted from the evidence and record 44 before us. It is well established that premiums paid by a former husband on a policy of insurance which merely provides security for continued alimony or support payments to his divorced wife in the event of his death are not includible in the gross income of the wife as additional alimony. See F. Ellsworth Baker, 17 T. C. 1610, 1615, affirmed this issue (C. A. 2) 205 F. 2d 369; Halsey W. Taylor, 16 T. C. 376, 384; William J. Gardner, 14 T. C. 1445, 1447, affd. 191 F.2d 857">191 F. 2d 857; Meyer Blumenthal, supra.The authorities relied on by the respondent are distinguishable on their respective facts from this proceeding. In both Anita Quinby Stewart, supra, and Lemuel Alexander Carmichael, supra, the wife was the owner of the policies of insurance. In Estate of Boise C. Hart, supra, the wife agreed to take as alimony a fixed percentage of her husband's annual income and agreed that the premiums on insurance for her benefit, 45 and which she could cause to be reduced were 365 to be paid out of, and subtracted from the agreed percentage of his income which she was to receive.It is held that the insurance premiums in question are not includible in the petitioner's gross income as alimony under section 22 (k) of the Code.Decision will be entered under Rule 50. Footnotes1. SEC. 22. GROSS INCOME.(k) Alimony, Etc., Income. -- In the case of a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, periodic payments (whether or not made at regular intervals) received subsequent to such decree in discharge of, or attributable to property transferred (in trust or otherwise) in discharge of a legal obligation which, because of the marital or family relationship, is imposed upon or incurred by such husband under such decree or under a written instrument incident to such divorce or separation shall be includible in the gross income of such wife, * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623441/	Wallace O. Leonard, et al. * v. Commissioner. Leonard v. CommissionerDocket Nos. 26966, 27349, 27357, 27358, 27365, 27366, 27367.United States Tax Court1952 Tax Ct. Memo LEXIS 355; 11 T.C.M. (CCH) 12; T.C.M. (RIA) 52001; January 11, 1952355 Petitioners' wives reported as their own certain income from joint ventures involving the purchase and sale of war surplus motors. Respondent determined deficiencies against petitioners as a result of attributing the income to them instead of their wives. Held, respondent sustained. The income was produced and earned by the husbands. On a business expense issue involving operation of an airplane, held, for petitioner after application of the Cohan rule. John M. Hudson, Esq., 1170 Penobscot Bldg., Detroit, Mich., for the petitioners. Cyrus A. Neuman, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: These consolidated proceedings involve asserted deficiencies in income tax for the taxable year 1946 against the petitioners, as follows: DocketNo.PetitionerDeficiency26966Wallace O. Leonard$ 9,474.7427349Harry W. Holt9,762.5127357Rodney B. Pierce19,394.9227358Donald P. Kipp16,511.6127365W. J. Laughlin14,821.4827366Duffield W. Yacks20,247.4827367Frank O. Blunden15,646.40The principal issue for determination, which is common to all proceedings, is whether356 certain income received by the respective wives of the petitioners from three transactions consummated in 1946 involving the purchase and resale of war surplus motors is income taxable to the wives or to the petitioner husbands. A second issue is whether petitioner Pierce is entitled to a claimed deduction of $583.14 as the expense of operating an airplane in connection with his business. A third issue is raised in the case of W. J. Laughlin. It involves dividends amounting to $59.60 received by his wife and reported on her return which respondent treated as income of the husband. Petitioner Laughlin introduced no evidence on this issue and despite disclaimer in his reply brief that the issue has been abandoned, we must decide the issue against petitioner for lack of proof. The resolution of medical deduction issues in several of the proceedings will depend on determination of the main question. A further issue in the cases of petitioners Pierce and Yacks involving the time of dissolution of a partnership was conceded by respondent at the hearing. Findings of Fact A portion of the facts is stipulated and the stipulated facts are so found. Petitioners are individuals who resided357 in the State of Michigan during the calendar year 1946. Each petitioner filed a separate individual income tax return on the cash basis for that year with the collector of internal revenue for the district of Michigan. The wife of each petitioner also filed a separate individual income tax return for 1946 with the said collector and reported thereon her separate income, including the profits from the three transactions here in question. In 1946 petitioner Kipp was vice president and general manager of Kramer Brothers Freight Lines, Inc., (hereinafter called Kramer), a motor common carrier engaged in transporting general commodities by motor vehicle under certificates issued by the Interstate Commerce Commission. In discharge of his duties as such officer Kipp was required to do a considerable amount of traveling in 1946 and in prior years. In 1946 and at other times material to the issue in these proceedings petitioner Blunden was vice president of Kramer. In prior years he had held other offices with that firm and had also been president of a labor relations association for the trucking industry over 15 states and had held other positions in the trucking industry. In the same358 year George Ray Dalrymple (not a party to these proceedings, but a party to certain agreements involved herein) also was an officer of Kramer. In 1946 petitioner Laughlin was the district sales manager for the Diamond T. Motor Car Company for Ohio, Indiana, and Michigan. The Diamond T. Company was a manufacturer of motor trucks. Laughlin had had business contacts previously with the other petitioners, except Leonard and Holt. In 1946 petitioner Leonard was the president of Wilson Foundry and Machine Company of Pontiac, Michigan, (hereinafter called Wilson Company). Wilson Company was engaged in the manufacture of automotive engines and the production and machining of engine castings. In 1946 petitioner Holt was vice president and general sales manager of Wilson Company and the man next in line to Leonard. In 1946 petitioners Pierce and Yacks were equal partners in the partnership of Yacks and Pierce which was engaged in the truck and trailer business. Throughout 1946 Pierce did a considerable amount of traveling on partnership business. Yacks was the partner in charge of sales. In 1946 and long prior thereto Yacks and Pierce had had business dealings with Kramer and as a result, 359 Kipp and Blunden were acquainted with and had frequent contacts with Yacks and Pierce. Sometime during the fall of 1945 a representative of the War Assets Administration came to Blunden to ask his advice on the feasibility of adapting surplus army half-track motors to civilian use. Blunden thereupon discussed with Kipp and Dalrymple, his fellow officers, the possibility of purchasing quantities of the surplus motors for the purpose of adaptation and resale. Afterwards the matter also was discussed with Yacks and Pierce and with Laughlin who, as an automotive engineer, was consulted on the technical aspects of adapting the surplus motors to civilian use. All these men knew from their extensive experience in and association with the trucking business that the trucking industry was greatly in need of motors to replace those which had deteriorated during the war and for which replacements were not as yet being manufactured. As a result of these discussions they evolved the idea of forming a syndicate to purchase surplus motors from the War Assets Administration and to resell them to the public for civilian use. In furtherance of this plan, Kipp and Pierce contacted Holt who, in turn, 360 consulted Leonard. Wilson Company was eligible to purchase Government equipment, had adequate credit standing, and had the necessary facilities for reconditioning and adapting the army motors for civilian use. The Wilson Company was interested in any business that would produce a profit and after discussion between Leonard and the chairman of the Wilson Company board of directors the Company through its appropriate officers determined to join the venture. On or about November 27, 1945, the petitioners together with Dalrymple (hereinafter referred to collectively as Kipp and Pierce Associates) entered into an agreement to join together for the purchase from Wilson Company of some 400 surplus motors and to resell them. At or about the same time Kipp and Pierce Associates entered into an agreement of purchase and sale with the Wilson Company under which the Wilson Company agreed to sell and Kipp and Pierce Associates agreed to buy the 400 motors. The motors described in the 1945 agreements were ordered from the War Assets Administration by Wilson Company on November 21, 1945. They had been located by one Broadwell, a "finder", whom Blunden had contacted originally and to whom the361 Associates arranged to pay a finder's fee. The motors were resold by Kipp and Pierce Associates early in 1946 to various persons though so-called agents who were paid a commission on the sales. Several employees of Kramer in various cities were active in making important sales of motors. The office facilities of the Yacks and Pierce partnership were used in carrying out the transactions. The motors were shipped by the Wilson Company to the purchasers upon orders or shipping instructions placed by Kipp and Pierce Associates. The Wilson Company invoiced the Associates for the cost of the motors plus service, storage, and shipping charges, and such invoices were paid by Kipp and Pierce Associates. The sales prices of the motors were paid by the ultimate purchasers to Kipp and Pierce Associates. The Yacks and Pierce partnership was paid by Kipp and Pierce Associates for the expenses incurred for the use of its offices. The total proceeds received by Kipp and Pierce Associates for the sale of such motors amounted to $206,388.25, and the net profits to the Associates on the sales amounted to $102,890.50. This net profit was distributed to the petitioners and Dalrymple in accordance with362 their agreement of November 1945; i.e., 8.3 per cent each to Leonard and Holt and 13.9 per cent to each of the others. In connection with the above described venture the Yacks and Pierce partnership acted as sales agent for the Associates. A great many circular letters were mailed in January 1946 from the partnership office to persons in the trucking industry announcing the availability of the motors through that office. The response to these letters was "terrific". The worth of the motors became generally known through installations made in Kramer trucks and many sales were made through employees of Kramer in various cities. Word was spread about by the Associates that a commission of $50 per motor would be paid to anyone who produced a sale. This fact together with the general utility of the motors resulted in their rapid sale with very little further direct sales activity or effort on the part of Kipp and Pierce Associates. Additional surplus motors were ordered by the Wilson Company on January 15, 1946, their availability having been brought to the attention of Kipp or Pierce by the finder Broadwell, and through Kipp or Pierce to the attention of Leonard and Holt. A few days363 prior to March 31, 1946 the Wilson Company received advice that the motors had been shipped and on March 29, 1946, petitioners' wives, together with Dalrymple signed an agreement joining together in a common enterprise under the name of Michigan Accessories Company to purchase 150 motors from the Wilson Company and to resell them. The agreement provided that each of the parties was to contribute $3,000 in cash as capital for the enterprise and that after payment of all costs and expenses the net profits should be distributed among the parties to the agreement in the same proportion as the husbands' agreement had provided; i.e., 8.3 per cent to Ruth B. Holt; 8.3 per cent to Marjorie W. Leonard; and 13.9 per cent to Dalyrmple and each of the other wives. Michigan Accessories Company, (hereinafter sometimes called the first wives' venture), was formed after several of the petitioners had consulted a tax lawyer. The wives were advised to join by their husbands who thought it was an opportunity for the wives to gain independent income. Possible tax consequences were also considered. Each wife paid over the required $3,000 to Michigan Accessories Company. Five of the wives acquired their364 capital contributions by outright gifts from their husbands; Marjorie W. Leonard acquired her $3,000 by loan from her husband, (repaid May 1, 1946); and Ruth B. Holt paid in her $3,000 from her own independent funds. The total sum of $24,000 corresponding to the contribution of $3,000 made by each party was deposited in a special bank account maintained by Michigan Accessories Company. This amount, together with other sums deposited in the account, was disbursed or withdrawn on checks signed in the name of Michigan Accessories Company by two of the wives designated in the agreement to represent all parties thereto. Also, on March 29, 1946, the Wilson Company agreed to sell and the first wives' venture agreed to buy 150 surplus motors purchased by Wilson Company from Reconstruction Finance Corporation. The Wilson Company agreed to perform at reasonable compensation all necessary services to place the motors in condition for civilian use. The agreement also provided that from the proceeds of sale of the motors there should first be paid to Wilson Company the cost to it of such motors, including the service charges, and, in addition, 10 per cent of the net profits realized from the365 resale after deducting all reasonable and necessary expenses incident to the resale. It was further provided in the proceeds from the sale of any of the motors should be deposited by Michigan Accessories Company in a separate bank account on which the Wilson Company should have a lien for any sum due it under the agreement. The motors were sold to the public in much the same way that Kipp and Pierce Associates had previously sold their motors. The Michigan Accessories Company paid a finder's fee to Broadwell. Little direct sales effort was required primarily because the market had been established by the husbands' venture. Commissions were paid to so-called agents by the first wives' venture for arranging the sale of motors. These persons were not employed or appointed expressly to make sales. The office facilities of the Yacks and Pierce partnership were again utilized in making sales and the first wives' venture reimbursed the partnership for its expenses. Orders were sent in to the office of the partnership and a girl in that office took care of their receipt and the placing of shipping instructions with Wilson Company. The sales price of the motors was paid by the purchasers366 to the first wives' venture which, in turn, was invoiced by Wilson Company for its costs pursuant to its agreement with the venture. On June 3, 1946, the wives together with Dalrymple embarked on a second venture under the name of Wayne Materials Company, (hereinafter sometimes called the second wives' venture). This venture was substantially similar in all respects to the first wives' venture. Its purpose was to buy from Wilson Company for resale, 310 surplus motors. The second wives' venture opened a separate bank account, but in this instance the agreement did not require any capital contribution from the parties. The percentages allocated to the wives were the same as those in the first venture. The sales procedure was the same and the agreement entered into with the Wilson Company for the purchase of the motors was in all essentials similar to the agreement made between Wilson Company and the first wives' venture. On July 11, 1946, the wives and Dalrymple entered into an agreement similar in most respects to the preceding ventures. This association was called the New Baltimore Equipment Company, (hereinafter sometimes called the third wives' venture). The third wives' venture367 agreed to buy 1,000 surplus motors from the Wilson Company on substantially the same terms as the previous wives' ventures had bought surplus motors from Wilson Company. These motors together with 38 motors owned by the second wives' venture were sold in one block by the third wives' venture to the Sears Roebuck Company. This sale was negotiated by petitioner Pierce through an intermediary salesman or agent known only by the name of "Pete" who was connected with the Allied Machinery Company in Indiana. The sale and all of its details as to price, etc., were arranged as a result of discussions between Pierce and "Pete". "Pete's" connection, if any, with Sears Roebuck is not disclosed. On July 11, 1946, a purchase order for 1,000 motors was received from Sears Roebuck. It was made out to New Baltimore Equipment Company. On the same day, the third wives' venture was formed. The instructions to Wilson Company relative to the delivery of the motors in specific quantities to particular branches of Sears Roebuck, and the other clerical details were again handled by the Yacks and Pierce partnership office. During the calendar year 1946, Marjorie W. Leonard and Ruth B. Holt received as their368 respective shares of the profits from the three wives' ventures a total of $15,359.52 each. The total amount received in 1946 by the wives of the other five petitioners was $25,599.22 each. These funds were deposited by each of the wives in her separate bank account and none of the funds were expended by any of the wives for the benefit of any of the husbands. Other than as outlined above in connection with Kipp and Pierce Associates, all the petitioners did not join together in any other ventures to buy or sell surplus war materials. None of the petitioners contributed any capital other than by way of gift or loan as outlined above to the three wives' ventures and none of the profits from those ventures were paid over to the petitioners. Petitioners did not act on behalf of their wives in connection with the wives' ventures. Only two or three of the wives had had any previous business experience prior to 1946. The record does not show that any of the wives performed services in connection with their ventures other than to sign checks through designated representatives. Wilson Company did not require the wives to contribute any capital and capital was not an important factor369 in any of the wives' ventures. In the case of each petitioner respondent determined that the income received by the wife from the three wives' ventures should have been reported as the income of the petitioner. Petitioner Pierce claimed a deduction for the year 1946 of $583.14 as an expense incurred in the operation of a private airplane in connection with his business. The airplane was used during 1946 partly for business purposes. The amount claimed represents 80 per cent of the alleged total airplane expenses of $728.92 This was an estimate. Petitioner Pierce incurred expenditures of $400 for the use of the airplane in connection with his business in 1946. Ultimate Finding The income from the three wives' ventures was earned and produced by the husbands and was income of the husbands. Opinion The main question here is the sometimes troublesome one of "Whose income?". Are the profits of the three wives' ventures to be taxed to petitioners or to petitioners' wives? Respondent, relying on the broad principles expressed in such cases as , and , contends that petitioners, rather than their370 wives, earned the income and hence that petitioners should be taxable on it. On the other hand, petitioners contend that their wives earned, realized, and received the profits and accordingly should be the taxpayers. We agree with respondent. It is often said that taxation is an intensely practical matter, concerned with realities. Looked at in that light the facts here lead us to but one conclusion - the husbands produced the income, the wives but collected it. It was the husbands' wide experience, knowledge, contacts, and long association with the trucking and automotive business that enabled them in the first instance to recognize and take advantage of the civilian demand for war surplus motors. The husbands' venture, Kipp and Pierce Associates, utilizing this experience and know-how, developed the mechanics and set the pattern for profitably finding, adapting, and reselling the motors. That venture was highly successful. Not long afterwards the "finder", Broadwell, reported to the husbands that more motors were available. Convinced that the opportunity for profits still existed and knowing that the market was still there, as well as the facilities for adapting and reselling371 the motors, the husbands consulted a tax attorney with a view to giving their wives an opportunity to make some money. The agreement constituting the first wives' venture resulted. The purchase and resale of the motors followed the same pattern as the husbands' venture. The market found by the husbands was again tapped. The same sales channels were used. Orders were again handled by the office of a partnership composed of two of the husbands. The principal salesmen were again employees of Kramer, the firm of which two other husbands were officers, and, again the motors were put in shape by Wilson Company, of which yet another two of the husbands were officers. Significantly, too, the profit split followed the same unequal pattern as the division in the husbands' enterprise. Nothing was changed, except time and the names appearing on the agreements. Petitioners point out that the wives each put $3,000 into the first wives' venture and attach importance to it. However, we find nothing in the record to indicate that capital was of importance in producing the income and have found as a fact that capital was not important. The motors, in the first place, were purchased by Wilson Company372 from the Governmental agencies. There was nothing in the Wilson Company agreement with the wives requiring them to start off with money in the bank. They were simply to pay Wilson Company for the motors from the proceeds of the sale of any of the motors and Wilson Company, for its protection, had a lien on the special bank account into which the wives agreed to place the sales proceeds. Thus it was Wilson Company credit and capital that put the venture in business in the first instance. It did not depend on the wives' credit. The agreements for the second and third wives' ventures required no capital contribution at all. The relative unimportance of the wives' capital contribution is further shown by the fact that with an initial capital of $24,000, profits of approximately $200,000 were realized within the year. As far as services are concerned, the wives contributed little, if anything, other than to sign the agreements, open the bank accounts, and through their designated representatives, sign checks for the expenses. None of the wives had any business experience helpful to the ventures. There is nothing to establish that they ever met together for any purpose in connection with373 the business. None of the wives was called to testify and we have only the testimony of the husbands concerning the ventures. It is reasonable to assume this was because only the husbands really knew anything about the business. The insignificance of the part played by the wives in these transactions is forcefully shown by a glance at the third venture which involved the sale of 1,000 motors, more than twice the total number handled by the preceding ventures, to a single customer. This sale was arranged virtually alone by petitioner Pierce through discussions with a person whose connection with Sears Roebuck was not disclosed. All of the details were worked out before the wives were brought into the picture at all. Then, on the day the transaction was to be closed, the wives signed the necessary papers. So far as the record discloses, that is all they had to do with the sale. There is no evidence that they even met together to discuss the matter before sitting down to affix their signatures. The husbands planted the seed, nurtured the tree, and then shook the fruit into the laps of their wives. We have carefully studied the numerous cases cited by petitioners to sustain their374 contention; but the issue here is one to be determined solely by the ultimate conclusion to be drawn from the facts in this case, and we do not think a detailed analysis of the facts in other cases, (none of which is on all fours with this one) would be helpful. We conclude and hold that respondent was correct in attributing the income in question to petitioners. Our finding of fact on the airplane expense issue disposes of that issue. While the evidence is of a general nature we think the rule of , is properly applicable and that petitioner Pierce should be allowed to deduct the amount of $400 as a business expense. As stated above, respondent's determination on the third issue involving dividends of $59.60 is sustained in the case of petitioner Laughlin. Decision will be entered for the Respondent in Docket Nos. 26966; 27349; 27358; 27365; 27367; and under Rule 50 in Docket Nos. 27357; 27366. Footnotes*. Proceedings of the following petitioners are consolidated herewith: Harry W. Holt, Rodney B. Pierce; Donald P. Kipp; W. J. Laughlin; Duffield W. Yacks; and Frank O. Blunden.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623442/	International Flavors & Fragrances Inc., Petitioner v. Commissioner of Internal Revenue, RespondentInternational Flavors & Fragrances, Inc. v. CommissionerDocket No. 7768-70United States Tax Court62 T.C. 232; 1974 U.S. Tax Ct. LEXIS 104; 62 T.C. No. 26; May 16, 1974, Filed 104 Decision will be entered under Rule 155. Petitioner and its foreign affiliates are engaged worldwide in the manufacture and distribution of flavoring extracts. In order to offset any loss which might be sustained in event of the devaluation of the British pound sterling, petitioner entered into a short sale contract for pounds sterling. After the pound was devalued, but before the delivery date, petitioner either sold or closed out its contract. Held, the gain to petitioner on the transaction is taxable as ordinary income under the principles of Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46 (1955). George Rowe, Jr., and Michael J. Gaynor, for the petitioner.Marion L. Westen and Warren W. Dill, for the respondent. Quealy, Judge. Tannenwald, J., concurring. Goffe and Wiles, JJ., agree with this concurring opinion. Hall, J., dissents. Forrester and Sterrett, JJ., agree with this dissent. QUEALY232 Respondent has asserted a deficiency in the Federal corporate income tax of petitioner for the taxable year 1967 in the amount of $ 73,715.Certain concessions having been made by the parties, the following issues remain for decision:(1) Whether petitioner's gain on a contract for the short sale of 1.1 million pounds sterling, entered into with First National City Bank and subsequently sold or transferred to Amsterdam Overseas Corp. just prior to the closing date, is taxable as ordinary income under the doctrine of106 Corn Products Co. v. Commissioner, 350 U.S. 46 (1955), making the gain realized on the transfer thereof taxable as ordinary income.(2) Alternatively, whether the gain to petitioner on the above transaction should be taxable under the provisions of section 1233 1 on the basis that Amsterdam was, in substance, acting as a broker for petitioner in purchasing the pounds sterling used to close out the short sale.233 FINDINGS OF FACTSome of the facts have been stipulated by the parties. Such facts and the exhibits attached thereto are incorporated herein by this reference.International Flavors & Fragrances Inc. (hereinafter referred to as petitioner or IFF (U.S.)) is a New York corporation with its principal place of business in New York, N.Y. Petitioner filed a United States corporate income tax return (Form 1120) and an information return with respect to controlled107 foreign corporations (Form 2952), respectively, for the taxable year 1967 with the district director of internal revenue, Manhattan District, New York, N.Y.IFF (U.S.) is engaged in the creation and manufacture of flavor and fragrance products used by other manufacturers to impart or improve flavor or fragrance in a variety of consumer products. Its activities are conducted on a worldwide basis through numerous foreign corporations which it, directly or indirectly, owns or controls.IFF (U.S.) prepares consolidated financial statements which it publishes regularly to its shareholders and to the public. For the purpose of such consolidated statements, the accounts of its foreign affiliates, which are expressed in foreign currencies, are converted into United States dollars. The accounts of its foreign affiliates, however, are not consolidated for United States income tax purposes. No other financial statements are published.Of primary concern to the present inquiry is the relationship between IFF (U.S.) and its foreign affiliate, International Flavors & Fragrances I.F.F. (Great Britain) Ltd. (hereinafter referred to as IFF (G.B.)). IFF (G.B.) is a wholly owned foreign subsidiary108 of International Flavors & Fragrances I.F.F. (Nederland) N.V. (hereinafter referred to as IFF (Holland)) which, in turn, is wholly owned by IFF (U.S.). IFF (G.B.) has manufacturing, research, and administrative facilities in Enfield, England. It has additional manufacturing facilities in Haverhill, England.During the latter part of 1966, IFF (U.S.) became concerned about a possible devaluation of the British pound sterling and the adverse effect it would have in converting the operations of IFF (G.B.) into dollars for purposes of its annual consolidated statement. In a letter to the comptroller in charge of European operations for the company, H. G. Reid, Financial Vice President of IFF (U.S.), suggested that the company sell short a sufficient amount of British pounds sterling to cover, on an after-tax basis, the exposed net current assets of IFF (G.B.), approximated to be, in terms of dollars, $ 1,600,000. Reid accordingly recommended the purchase of a 1-year pounds sterling contract in the dollar equivalent of $ 3 million, since on an after-tax basis, the protection afforded from such contract would be only 53 percent thereof.234 On December 29, 1966, IFF (U.S.) entered109 into a written contract with First National City Bank of New York (hereinafter referred to as FNCB) pursuant to which IFF (U.S.) sold to FNCB 1.1 million British pounds sterling at $ 2.7691 per pound, delivery and payment to be made on January 3, 1968. The price FNCB agreed to pay per pound was approximately three-fourths of 1 percent below the then-prevailing dollar-pound exchange rate of $ 2.7918. The discount represented consideration for the risk to FNCB in writing a 1-year contract.The contract provided that if, prior to the closing date, the market value of pounds sterling exceeded the exchange rate which FNCB was required to pay thereunder, FNCB could request IFF (U.S.) to deposit, as security for its own obligation under the contract, cash or its equivalent. IFF (U.S.) was additionally subject to certain penalties for noncompliance with the terms of the agreement. The contract further provided that FNCB had the power to place liens on any funds of IFF (U.S.) that were or might come into the possession or control of FNCB to enforce its rights under the contract.IFF (U.S.) had the following dollar deposits on account with FNCB as of the following dates:Dec. 31, 1966$ 302,616.60Dec. 20, 1967688,691.19Jan. 3, 19681,928,354.37110 On November 18, 1967, the British Government devalued the pounds sterling in terms of the U.S. dollar from $ 2.80 to $ 2.40.On December 20, 1967, IFF (U.S.) entered into an agreement with Amsterdam Overseas Corp. (hereinafter referred to as Amsterdam), a large international banking institution located at 70 Pine Street, New York City. Neither IFF (U.S.) nor Amsterdam held stock in the other. The agreement, which was in letter form from IFF (U.S.) to Amsterdam and accepted by Amsterdam, read in pertinent part, as follows:Enclosed is the original of our agreement of December 29, 1966 with First National City Bank which we hereby sell to you today for $ 387,000. This sale is on the understanding that you will fulfill the obligation to deliver Sterling 1.1 million to First National City Bank on January 3, 1968 without recourse to us.On the same day as the above agreement was entered into, the following events also transpired:(1) IFF (U.S.) notified FNCB that it had sold its contract with FNCB to Amsterdam.(2) Amsterdam notified FNCB that it had bought the contract. It agreed to assume liability thereunder if FNCB would confirm its intent to pay the sum of $ 3,046,010 upon the111 delivery of 1.1 million pounds sterling on January 3, 1968.235 (3) At 4:18 p.m., Amsterdam received notification from FNCB of its approval of Amsterdam's purchase of the contract. FNCB also confirmed that on January 3, 1968, it would credit the dollar account of Amsterdam with the difference between its own obligation under the contract, $ 3,046,010, and the dollar cost to Amsterdam of purchasing from FNCB, at the prevailing rate of exchange, the 1.1 million pounds sterling needed to close out the contract on such date.(4) At 4:30 p.m., Amsterdam purchased 1.1 million pounds sterling at the rate of $ 2.4080 from FNCB for delivery on January 3, 1968.On December 21, 1967, Amsterdam sent a check to IFF (U.S.) in the amount of $ 387,000 representing the price agreed upon for the purchase of the contract. On January 3, 1968, Amsterdam closed out the contract with the 1.1 million pounds sterling purchased short from FNCB on December 20, 1967. The net gain to Amsterdam on the transaction was $ 10,210.In 1967, IFF (G.B.) paid the dollar equivalent of $ 476,000 in dividends to IFF (Holland). In the same year, IFF (U.S.) received the dollar equivalent of $ 1,421,136 in dividends112 from IFF (Holland).With respect to IFF (G.B.), its assets and liabilities per books, stated in British pounds sterling, for the years 1966-68 were as follows:IFF (G.B.) Comparative Balance Sheet 1966-68196619671968Current assets:Cash on hand$ 2,191 $ 7,439 $ 2,389 Marketable securities135,000 40,000 Notes receivable -- trade9,155 12,182 7,718 Accounts receivable -- trade and affiliateand other433,433 571,521 1,022,208 Allowance for bad debts(11,818)(13,805)(15,451)Inventories522,699 578,774 734,195 Prepaid expenses and deferred charges19,369 19,973 21,927 Total current assets975,029 1,311,084 1,812,986 Other assets:Loans to employees -- long term25,561 20,143 2,497 Fixed assets752,257 840,863 1,096,963 Less: Accumulated depreciation(248,334)(284,885)(327,093)Total current and other assets1,504,513 1,887,205 2,585,353 Current liabilities:Notes payable -- short term95,958 Accounts payable -- trade and affiliate120,826 209,443 236,551 Taxes withheld from employees5,807 6,177 8,026 Other accounts payable and accrued expenses35,099 38,474 28,788 Accrued taxes on income292,632 336,309 540,389 Total current liabilities454,364 590,403 909,712 Long-term liabilities:Reserves for retirement benefits and pensions4,607 4,690 8,690 Deferred taxes on income33,508 42,952 91,138 Total current and long-term liabilities492,479 638,045 1,009,540 Excess of assets over liabilities1,012,034 1,249,160 1,575,813 Shareholders equity:Capital stock issued and outstanding250,000 250,000 250,000 Retained earnings762,034 999,160 1,325,813 Total shareholder equity1,012,034 1,249,160 1,575,813 113 236 The reconciliation of retained earnings of IFF (G.B.) per books, stated in British pounds sterling, for such years was as follows:Retained earnings 12/31/65$ 652,393Net income for year 1966329,641Total982,034Less: Dividends declared220,000Retained earnings 12/31/66762,034Retained earnings 12/31/66762,034Net income for year 1967407,126Total1,169,160Less: Dividends declared170,000Retained earnings 12/31/67999,160Retained earnings 12/31/67999,160Net income for year 1968517,442Total1,516,602Less: Dividends declared190,789Retained earnings 12/31/681,325,813During each of the years 1965, 1966, and 1967, IFF (G.B.) purchased $ 559,538, $ 626,850, and $ 855,113 worth of raw materials from IFF (U.S.), respectively. The billings were made in dollars and as of December 31, 1967, there was an unpaid balance of $ 175,632. Correspondingly, IFF (U.S.) incurred obligations in pounds sterling of 15,888-0-8, 13,348-15-1, and 11,127-19-1 on account of various raw materials purchased from and services rendered by IFF (G.B.) in each of such years.IFF (G.B.) also owed certain dollar amounts pursuant to an agreement 114 entered into with IFF (U.S.) on January 1, 1963. In substance, the agreement provided a formula by which IFF (G.B.) was to share the cost of making certain management services of key personnel from IFF (U.S.) and its foreign affiliates, including IFF (G.B.), available to the affiliated group on an international basis. It also set forth the basis on which IFF (G.B.) would share in certain research expenses incurred by IFF (U.S.) and IFF (Holland) from which it derived some benefit. The net dollar amounts owed under such agreement were as follows:196519661967International management group expense$ 65,090$ 164,162$ 172,777Share of group basic flavor research expense47,87463,19290,800Net share of basic aromatic chemicals researchexpense84,635128,769177,336Total197,599356,123440,913237 The billings under the agreement were made quarterly. The balance due for the last quarter of 1966 was $ 81,467, while the balance for the last quarter of 1967, during which the pound was devalued, was $ 119,304.Except as described above, no other obligations were incurred between the parties during the period of 1965-68.In addition to the 115 transaction in question, the petitioner made short sales of British pounds sterling in 1967 and 1968 with respect to which losses were sustained. In the determination of its tax liabilities for those years, such losses were deducted as ordinary losses.On it corporate return for the taxable year 1967, IFF (U.S.) reported the $ 387,000 gain realized from the purported sale of its contract with FNCB as long-term capital gain. The respondent asserted deficiencies for such year on the basis that IFF (U.S.)'s sale of the contract to Amsterdam was a sham and the gain therefrom should have been reported as short term. In the alternative, he asserted the short sale was a hedging transaction and the gain should have been taxable as ordinary income.OPINIONThe petitioner both directly and indirectly through its foreign affiliates was engaged worldwide in the preparation and distribution of flavoring extracts. During the latter part of 1966, the petitioner became concerned that a devaluation of the English pound sterling would adversely affect, at least on paper, petitioner's investment in its second-tier subsidiary, IFF (G.B.), which was organized and operated in the United Kingdom. In116 an effort to protect against that risk, petitioner entered into a short sale contract with FNCB on December 29, 1966, whereby it sold 1.1 million British pounds sterling at the rate of $ 2.7691 per pound for delivery on January 3, 1968.On November 18, 1967, of the succeeding year, the pound was devalued in terms of the U.S. dollar from $ 2.80 to $ 2.40.On December 20, 1967, only a few days prior to the closing date of the contract, petitioner purported to sell its contract to Amsterdam for $ 387,000, treating such amount as long-term capital gain from the sale of a capital asset held for more than 6 months. That same day Amsterdam made an offsetting purchase of the 1.1 million pounds sterling from FNCB at the current exchange rate of $ 2.4080, delivery set for January 3, 1968.On January 3, 1968, both contracts were closed out with Amsterdam realizing a net gain of $ 10,210 on the transaction.At the outset, the Court is faced with the question whether, on the basis of the facts in this case, either the contract entitling the petitioner to sell to FNCB 1.1 million pounds sterling on January 3, 1968, 238 or the subject of that contract, i.e., pounds sterling, constituted a117 "capital asset" in the hands of the petitioner within the meaning of section 1221. Foreign currency is recognized as "property" as that term is used in the internal revenue laws. Such property meets the literal definition of a capital asset as set forth in section 1221. 2 However, the respondent contends that petitioner's transactions in foreign currency come within the exception to a literal reading of the statute which was carved out under the decision in Corn Products Co. v. Commissioner, supra, and the innumerable cases which followed. See Chemplast, Inc., 60 T.C. 623">60 T.C. 623 (1973).118 In response to this argument, petitioner points to the ostensible basis upon which it decided to enter into the short sale contract, namely, as suggested in an internal memorandum, to offset a possible write-down of the net current assets of IFF (G.B.) in preparing the annual consolidated statements of the petitioner and its affiliated corporations in the event of the devaluation of the pound sterling. The amount of pounds sterling to be sold short was supposed to have been calculated with that in mind.In determining the effect of the short sale with respect to petitioner's business, this Court is not prepared to accept that memorandum as controlling. 3 Rather, we must look to the facts. Any diminution in value of the assets of IFF (G.B.) as measured in pounds sterling would be offset by a corresponding reduction in its liabilities, which 239 likewise were payable in pounds sterling. The only loss that the petitioner could sustain was the loss on the conversion into U.S. dollars of the earnings and profits of its British affiliate and, secondly, the loss in U.S. dollars on account of its investment, if any, in the capital stock of such corporation. So long as IFF (G.B.) 119 stayed in business, the latter would never be realized. All the petitioner really accomplished by the short sale of the pounds sterling was to recoup an amount equivalent to the ultimate losses in earnings which might be sustained when and if the pounds sterling earned by its British affiliate were remitted to the petitioner and converted into U.S. dollars. 4120 In this case, the business of IFF (G.B.) was the business of the petitioner. The loss which the petitioner sought to offset by the short sale of pounds sterling was a loss to which its British affiliate was exposed in its everyday business. Purchases and sales of foreign currency, which in terms of the Internal Revenue Code must be considered as property other than money, for the purpose of offsetting losses which might result from fluctuations in the exchange rates, are part and parcel of a multinational business. If the petitioner had conducted its foreign business in the United Kingdom through a branch of the parent corporation rather than a British subsidiary, applicability of the Corn Products doctrine to such transaction in foreign exchange could hardly be questioned. The fact that a U.S. corporation conducts its foreign business through foreign subsidiaries rather than branches, does not necessarily warrant applicability of a different rule. See, e.g., Schlumberger Technology Corp. v. United States, 443 F. 2d 1115 (C.A. 5, 1971). 5121 The short sale of pounds sterling by the petitioner must be regarded as an ordinary income-related transaction and not an "investment." It constituted a loose "hedge" against the risk of future losses of income. See Wool Distributing Corporation, 34 T.C. 323">34 T.C. 323 (1960). If petitioner in this case had closed out its short sale of British pounds in accordance with its contract with FNCB by purchasing pounds at the lower rate resulting from the devaluation, the resulting gain would have been taxable as ordinary income. Wool Distributing Corporation, supra;America-Southeast Asia Co., 26 T.C. 198">26 T.C. 198 (1956). See also Corn 240 v. Commissioner, supra;Commissioner v. Farmers & G C. Oil Co., 120 F. 2d 772 (C.A. 5, 1941), reversing 41 B.T.A. 1083">41 B.T.A. 1083 (1940), certiorari denied 314 U.S. 683">314 U.S. 683 (1941). The fact that petitioner chose to sell the contract instead does not change the character of the transaction.In view of our decision with respect to the applicability of the Corn122 Products doctrine, it is not necessary to decide the alternative question whether the petitioner has met its burden of proving that the transaction between the petitioner, Amsterdam, and FNCB was not in substance a purchase by the petitioner of pounds sterling to meet its obligation under the short sale, thereby making the gain taxable under the provisions of section 1233. In view of the sequence of events, however, it is clear that Amsterdam did not intend to assume any risk. In the absence of any testimony from the representatives of Amsterdam, suffice it to say that its role appears to be more nearly that of the broker than a purchaser. Cf. Frank C. LaGrange, 26 T.C. 191">26 T.C. 191 (1956).Decision will be entered under Rule 155. TANNENWALDTannenwald, J., concurring: I agree with the result reached by the majority, but on a different basis, namely, that petitioner realized a short-term capital gain. In so concluding, I eschew issues relating to the reaches of the "integral part of the business" doctrine upon which Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46 (1955), is founded and to the applicability of section123 1233, either directly or by analogy, to transactions of the type involved herein. 1 Rather, I rest my conclusion upon the factual basis that Amsterdam was in reality acting on behalf of petitioner in contracting to purchase pounds from the First National City Bank, that, in effect, such contract to purchase was used to close IFF's short position with First National City Bank on December 20, 1967, with the result that IFF became absolutely entitled to payment of the amount of the difference between $ 2.7691 and $ 2.4080 per pound, and that such amount represented short-term capital gain to IFF, the assignment of which to Amsterdam did not divest IFF of liability for tax on such gain.My conclusion is founded upon a careful analysis of the facts revealed -- or, to put it more correctly, not revealed -- by the record herein, in light of the well-established principle that the taxpayer124 has the burden of proof. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Albino v. Commissioner, 273 F. 2d 450 (C.A. 2, 1960), affirming per curiam T.C. 241 Memo. 1959-1; Rule 142, Tax Court Rules of Practice and Procedure. The contract to purchase pounds between Amsterdam and First National City Bank, the notifications by IFF and Amsterdam to First National City Bank of Amsterdam's "purchase" of the 1966 contract between IFF and First National City Bank, and the acknowledgement of First National City Bank to Amsterdam are all dated the same day, namely, December 20, 1967. The acknowledgement by First National City Bank to Amsterdam is very revealing. I quote it in full:In reply to your letter of December 20, 1967, this is to confirm that we have agreed to your purchase from International Flavors and Fragrances Inc. their contract with us wherein they have sold to us on December 29, 1966 Pounds Sterling 1,100,000-0-0 for delivery on January 3, 1968 at the rate of $ 2.7691 per Pound. We also wish to confirm that we shall credit your Dollar Account with us on January 3, 1968 the dollar125 difference between our original purchase price of $ 2.7691 per Pound and the rate of exchange applied to your purchase from us of Pounds Sterling 1,100,000-0-0 to close this contract out.We have also received a letter from International Flavors and Fragrances Inc. confirming their sale of this contract to you.Awaiting your further instructions in connection with closing out this contract.A longhand notation to this letter reads as follows: "bt. Ls1,100,000 forward 1/3/68 at 2.4080 12/20/67 4:30 p.m."The only evidence as to the foregoing documents relates to the source of the three documents which set forth the arrangements between First National City Bank and Amsterdam, namely, that they came from the files of the bank. The record is totally silent as to the extent of IFF's knowledge, if any, of the arrangements. The only witness was IFF's comptroller, who was not employed by IFF until 1970 (long after the transactions involved herein occurred) and therefore was not competent to testify as to such knowledge. Under these circumstances, I cannot conclude, as petitioner, who has the burden of proof, would have us do, that "No arrangement was made between IFF and Amsterdam to purchase126 pounds to close the short sale." Indeed, given the clear confirmation in the letter from First National City Bank to Amsterdam with respect to the crediting of the latter's purchase obligation, I think it reasonable to infer that the existence of Amsterdam's contract to purchase pounds was a precondition of the purported acquisition of the short sale contract from IFF and that an immediate offset of the two obligations was intended with the crediting of the differential in price on January 3, 1968, the only act remaining to be performed. 2127 242 The cases relied upon by petitioner, dealing with the assignment of anticipated profit from the transfer of preferred stock, bonds, or notes to the issuing corporation, are distinguishable. In those cases, the right to receive the profit was close -- indeed, very close -- to fruition, but had not yet become a fixed legal right to receive payment. Stanley D. Beard, 4 T.C. 756">4 T.C. 756 (1945); W. P. Hobby, 2 T.C. 980">2 T.C. 980 (1943); Clara M. Tully Trust, 1 T.C. 611">1 T.C. 611 (1943); John D. McKee, Et Al., Trustees, 35 B.T.A. 239">35 B.T.A. 239 (1937). See also Conrad N. Hilton, 13 T.C. 623">13 T.C. 623 (1949). The "near but yet so far" distinction upon which such decisions are posited stands sharply revealed when considered in light of the authorities which hold that a taxpayer cannot divest himself of capital gain to which he has become entitled as a result of an irreversible corporate liquidation or sale of stock. Kinsey v. Commissioner, 477 F. 2d 1058 (C.A. 2, 1973), affirming 58 T.C. 259">58 T.C. 259 (1972); Hudspeth v. United States, 471 F. 2d 275128 (C.A. 8, 1972); Rollins v. United States, 302 F. Supp. 812">302 F. Supp. 812 (W.D. Tex. 1969); Stephen S. Townsend, 37 T.C. 830">37 T.C. 830 (1962). Compare Simmons v. United States, 341 F. Supp. 947 (M.D. Ga. 1972); W. B. Rushing, 52 T.C. 888">52 T.C. 888, 896-898 (1969), affd. 441 F. 2d 593 (C.A. 5, 1971).Nor is petitioner helped by such cases as Joseph Maloney, 25 T.C. 1219">25 T.C. 1219 (1956), Morris Shanis, 19 T.C. 641">19 T.C. 641 (1953), affirmed per curiam 213 F. 2d 151 (C.A. 3, 1954), and Pacific Affiliate, Inc., 18 T.C. 1175">18 T.C. 1175, 1221 (1952), affirmed per curiam 224 F. 2d 578 (C.A. 9, 1955). In those cases, the subject matter was of a nonmonetary character, and the purchase and sale transactions were treated separately by the parties and were consummated through public stock or commodity exchanges. Additionally, with the possible exception of Shanis, the purchase and sale arrangements were between the taxpayer and different parties. Lack129 of identity of parties also existed in Frank C. LaGrange, 26 T.C. 191">26 T.C. 191 (1956). Given the foregoing complicating elements, offsetting was either impossible or considered inappropriate. 3 No such obstacles to immediate offsetting exist herein. In this case, the transactions were privately arranged and consummated, and the First National City Bank was a party to both the sale contract and the purchase contract (acquired at the same time as the transaction between IFF and Amsterdam occurred) and treated the two contracts as offsetting items with, for aught that appears in the record herein, IFF's knowledge and participation. 4 These critical facts distinguish the instant situation from that which might have obtained if the record had revealed that IFF simply sold its short sale contract, leaving it to the subsequent exercise 243 by Amsterdam of its discretion whether to resell it, buy pounds in anticipation of closing it, or do neither in the hope that a change in the exchange rate would increase its profits. 5 In this connection, I am constrained to note that the opportunity for offsetting, which I consider to have existed in the instant case, 130 would not necessarily have been avoided if Amsterdam had contracted to purchase the pounds from a source other than First National City Bank; in such a situation, it would still be pertinent to inquire as to the involvement of First National City Bank in order to determine whether a circuitous form of transaction was utilized to camouflage the application of the offset rationale.Finally, 131 I consider inapposite Stavisky v. Commissioner, 291 F. 2d 48 (C.A. 2, 1961), affirming 34 T.C. 140">34 T.C. 140 (1960), also cited by petitioner to support its position. There, to be sure, there were two "when, as, and if issued" transactions -- one a sale and the other a purchase -- between the taxpayer and the same person. But these two transactions occurred practically simultaneously at the very outset 6 and they were treated separately by the parties involved, including disposition in two different taxable years. More importantly, the issue in that case was framed in terms of whether a payment by the taxpayer upon the transfer of the contract of sale was an ordinary loss or a capital loss -- an issue which turned upon whether the taxpayer had made a sale or a payment in exchange for a cancellation of a liability. After finding that section 117(1) of the Internal Revenue Code of 1939 (the predecessor of section 1233) was inapplicable because the transactions occurred prior to its enactment, this Court held that all that had been sold was the "when, as, and if issued" sale contract which had been held for more than 6 months. 132 Indeed, the rejection of the taxpayer's claim for an ordinary loss, based upon its release from liability by the other party to that contract, coupled with the fact that the taxpayer did not, at that time, transfer the "when, as, and if issued" purchase contract, lends support to treatment of the facts in this case as a transfer of a capital asset by IFF, namely, the offsetting contract to purchase pounds -- an asset which had clearly been held only momentarily. See fn. 2 supra; Raymond B. Haynes, 17 T.C. 772">17 T.C. 772, 777 fn. 2 (1951). Compare KVP Sutherland Paper Co. v. United States, 377">344 F. 2d 377, 383 (Ct. Cl. 1965); Loewi & Co., 23 T.C. 486">23 T.C. 486, 489-490 (1954), affirmed on other grounds 232 F. 2d 621 (C.A. 7, 1956). See also Skelton, J., concurring in Gillin v. United States, 423 F. 2d 309, 314-316 (Ct. Cl. 1970).133 HALL 244 Hall, J. I respectfully dissent, believing the gain to be long-term capital gain.Fearing diminution of the dollar value of its stock in its British subsidiary in the event of devaluation of the pound, petitioner acquired by contract the right to sell to City Bank 1,100,000 pounds at $ 2.7691 per pound. This contract right, I believe, was a capital asset. It clearly is not excluded from the definition of that term under the literal language of section 1221(1). Although respondent asserts, and the Court holds, that the contract is caught within the sweep of the Corn Products doctrine, this cannot be so. Corn Products teaches that capital gain treatment is reserved for "transactions in property which are not the normal source of business income." 350 U.S. 46">350 U.S. 46, 52 (1955). The contract here and the property (pounds) were clearly not the normal source of petitioner's business income. There is no indication that the transaction was recurring. As such, it was unlike that in Corn Products. Intended, as the majority finds it was, to offset possible anticipated decline in the dollar value of the sterling subsidiary's stock, the134 transaction was more closely related to that stock, a capital asset in petitioner's hands, than to the subsidiary's routine business operations. While the majority refers to currency hedges as "part and parcel of a multinational business," there is no evidence that this transaction was routine or customary for petitioner. Furthermore, nothing in the evidence or findings justifies us in ignoring the separate corporate identities of petitioner and its subsidiary. The business of the subsidiary was not that of the parent. National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422 (1949); Moline Properties v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943).Since the contract was a capital asset, concededly held for more than 6 months, long-term capital gain treatment was appropriate if the disposition of the contract on December 20, 1967, constituted a sale. Sec. 1222(3), I.R.C. 1954. On this issue I respectfully disagree with the concurring opinion. After the devaluation the contract right to sell pounds for more than their value was a valuable and readily marketable asset. No shenanigans or special deals were required to sell135 it, and we have no evidence either occurred. While the purchaser, Amsterdam, froze its profits by simultaneously hedging, there is no reason this circumstance should convert petitioner's sale into something else. Petitioner clearly divested itself of all title to, and realistic further concern regarding, the contract, and became unconditionally entitled to the price. No more is required for a "sale," which has the same meaning in tax law as in ordinary parlance. Commissioner v. Brown, 380 U.S. 563">380 U.S. 563 (1965); Helvering v. Flaccus Leather Co., 313 U.S. 247">313 U.S. 247 (1941). Petitioner's failure to prove its lack of knowledge of what Amsterdam planned to do with the contract is immaterial, for such 245 knowledge could not add to or subtract from the finality of petitioner's disposition. The concurring opinion also refers to petitioner's failure to prove absence of "participation" in the Amsterdam-City Bank arrangement, but the record is clear enough to support, indeed to require, the Court finding as a fact that the participants in that transaction were Amsterdam and First National City Bank. Moreover, petitioner could136 properly claim unfair surprise if taxed with the concurring opinion's theory that it failed to disprove that Amsterdam acted as petitioner's agent. Respondent's counsel, in his opening statement, admitted that "IFF transferred its agreement with First National City Bank to Amsterdam Overseas Corporation for $ 387,000." This admission, while in effect belatedly retracted by respondent's advancing a new theory at a second trial session, is quite inconsistent with any notion of IFF's subsequent retention of ownership. Accordingly, I would find that a sale took place and the gain was long-term capital gain. See Conrad N. Hilton, 13 T.C. 623">13 T.C. 623 (1949); Stanley D. Beard, 4 T.C. 756">4 T.C. 756 (1945); Clara M. Tully Trust, 1 T.C. 611 (1943). Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. SEC. 1221. CAPITAL ASSET DEFINED.For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include -- (1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;(3) a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, held by -- (A) a taxpayer whose personal efforts created such property,(B) in the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced, or(C) a taxpayer in whose hands the basis of such property is determined, for purposes of determining gain from a sale or exchange, in whole or part by reference to the basis of such property in the hands of a taxpayer described in subparagraph (A) or (B);(4) accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1); or(5) an obligation of the United States or any of its possessions, or of a State or Territory, or any political subdivision thereof, or of the District of Columbia, issued on or after March 1, 1941, on a discount basis and payable without interest at a fixed maturity date not exceeding one year from the date of issue.↩3. It should be noted that for accounting purposes the transaction whereby the petitioner realized a gain on the short sale of pounds sterling would have no effect on the consolidated balance sheet except as reflected in the computation of earnings and profits. The petitioner merely realized a nonrecurring gain.↩4. For tax purposes, any adjustment on account of the devaluation of the pound sterling would be limited to the pounds sterling which might ultimately be remitted to the petitioner. See G.C.M. 4954, VII-2 C.B. 293; cf. Methods of adjustment with respect to branches, O.D. 489, 2 C.B. 60, and O.D. 550, 2 C.B. 61↩.5. The decision with respect to the applicability of the Corn Products doctrine in the Schlumberger case may appear to be in conflict with a prior decision of the Court of Claims in KVP Sutherland Paper Co. v. United States, 344 F. 2d 377↩ (Ct. Cl. 1965), in that the Court of Claims there found that the loan in Canadian currency by the taxpayer to its subsidiary and the subsequent repayment thereof in kind was a "capital transaction." However, since that court proceeded to tax the gain realized at each step of the transaction either as ordinary income or as a short-term capital gain, the net result was the same.1. See also Duncan, "Lowering the Value of the Dollar Raises Certain Tax Problems," 37 J. Taxation 115 (1972)↩.2. It makes no difference, for the purpose of this case, whether we view the transaction as an accrual in 1967 in favor of IFF (an accrual-basis taxpayer) of a short-term capital gain deriving from the right to receive $ 397,000 as a result of the transfer of the contract to purchase pounds to the First National City Bank in exchange for the termination of the short sale obligation plus the right to receive cash followed by the immediate sale of that right for $ 387,000, giving rise to a short-term capital loss of $ 10,000, or the anticipatory assignment by IFF of a fixed, although not technically "accrued," right to receive the profit from the closing of the short sale for $ 387,000.↩3. Lack of identity of parties made it necessary for this Court, in LaGrange↩, to articulate its decision in terms of the continued liability of the taxpayer in order to find the necessary agency relationship, a distinguishing factor upon which petitioner heavily relies.4. As a consequence, the absence of continued liability by IFF becomes totally irrelevant. See fn. 3 supra↩.5. By virtue of the purchase of the same amount of pounds at $ 2.4080 per pound, any subsequent fluctuation in the value of the pound was totally without effect upon the amounts to be received or paid by IFF, Amsterdam, or First National City Bank.↩6. Under such circumstances, they were akin to "arbitrage." Cf. sec. 1233(f).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623443/	JOHN M. SEELY and BARBARA J. SEELY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSeely v. CommissionerDocket No. 22230-83.United States Tax CourtT.C. Memo 1986-216; 1986 Tax Ct. Memo LEXIS 390; 51 T.C.M. (CCH) 1087; T.C.M. (RIA) 86216; May 29, 1986. Debra L. Bowen, for the petitioners. Paul H. Weisman, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: YearDeficiency1976$778197712,87119788,900197911,729392 The issues for decision are (1) whether petitioners' corporation executed a valid subchapter S election for the years in issue; (2) whether petitioners are entitled to an investment tax credit and depreciation and other expense deductions regarding their master recording activity; and (3) whether petitioners are liable for additional interest under section 6621(d). 1FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner John M. Seely (petitioner or John M. Seely) and Barbara J. Seely resided in Manhattan Beach, California, at the time their petition was filed. They filed joint Federal income tax returns for each of the years in issue. Petitioner was employed by the Los Angeles City College as a physical education and health instructor, and petitioner's wife ws employed by an elementary school to teach a variety of subjects. They reported on their tax returns combined wages of $45,898, $53,276, $52,097, and $58,189393 for years 1976, 1977, 1978, and 1979, respectively. In 1976, petitioners and two other individuals, Clarke and Pritko, purchased Harbor Village Inn, a restaurant and cocktail lounge. They initially operated the business as a general partnership, and petitioners' interest in the partnership was held in the name John M. Seely. The form of ownership was changed to a corporation entitled Clarke, Pritko, and Seely, Inc. (the corporation) in or about November 1976. A Form 2553 (Election by Small Business Corporation) was executed on December 4, 1976, by petitioner, who was Treasurer of the corporation, and subsequently submitted to the Internal Revenue Service Center in Fresno, California. That form provided that the corporation was incorporated on November 1, 1976, and commenced business on November 14, 1976. It identified the following shareholders and their respective shares: Clarke, 1,350 shares; Pritko, 1,350 shares; and John M. Seely, 2,700 shares. The form further provided as follows: "For this election to be valid, the consent of each stockholder must accompany this form or be shown below. See instruction D." Instruction D, on the reverse side of the form, included394 the following requirement: "[t]he consent must be signed by both husband and wife if they have a community interest in the stock or the income from it, and by each tenant in common, each joint tenant, and each tenant by the entirety." Under the heading "Shareholders' statement of consent," John M. Seely signed and dated the form on December 5, 1976, and Clarke and Pritko signed and dated the form on December 8, 1976. Barbara J. Seely did not sign the form. The shares in John M. Seely's name were held as community property by petitioners. In or about 1977, petitioner met by happenstance Paul Hendison (Hendison), a sales representative for Jackie Resources, Inc., a corporation which offered master recordings for sale. Hendison explained to petitioner about his business and about master recordings. Petitioner then listened to a number of recordings and particularly liked one by Johnny Dark entitled "Avocado Summer." Approximately one week later, petitioner returned to Jackie Resources with his wife. She listened to "Avocado Summer" and also liked it. Petitioners, who had no prior experience with master recordings, were provided a document dated October 17, 1977, and entitled395 "Jackie Resources, Inc. Presents Information Memorandum Relating to Purchase of a Master Recording" (memorandum). The memorandum contained information regarding the following: product - a master recording, purchase price, distribution, and tax considerations. The memorandum stated that the records to be sold commercially might be distributed by the purchaser or a distributor selected by the purchaser. A list of prospective distributors, including International Record Distributing Associates, was attached to the memorandum. The memorandum noted that if a distributor is used, a portion of the initial distribution expenses may be borne by the purchaser. The memorandum stated that the profit potential for any record was "extremely speculative" and that a record rarely generated enough receipts to pay the full purchase price or produce any profits. The memorandum emphasized tax considerations such as depreciation and investment tax credit. For example, based on a hypothetical purchase price of $137,500 ($12,500 cash at closing, a $12,500 promissory note due the subsequent year at 8 percent interest and secured by a letter of credit, and a $112,500 nonrecourse promissory note due396 in 8 years at 6 percent interest), an income forecast method of depreciation (7 years useful life), and an assumed individual income tax bracket of 50 percent, the memorandum set forth the following information in a table identified as "Master Record Purchase Tax Write-Off Illustration": Cash OutlayDown-DistributionDepreciationYearpaymentCostTotalPercentage1$12,500$2,700$15,20040%212,50012,50050%3-710%TOTAL$25,000$2,700$27,700100%DeductionsDistributionYearDepreciationCostTotal1$ 55,000$2,700$ 57,700268,75068,7503-713,75013,750TOTAL$137,500$2,700$140,200TaxEquivalent Write-OffTax SavingsInvestmentYearOn DeductionsTax CreditTotalDollarsMultiple1$28,850$9,167$38,017$ 76,0345.0234,37534,37568,7505.53-76,8756,87513,750TOTAL$70,100$9,167$79,267$158,5345.7More than 45 percent of the text of the memorandum was devoted to "tax risks" and "income tax factors." It repeatedly recognized the potential397 for challenge by the Internal Revenue Service, particularly with regard to basis, at-risk rules, and section 183. The memorandum stated that the seller would provide the purchaser with two "appraisals" of the master recording and recommended that the purchaser obtain an independent appraisal. Petitioners were given two letters addressed to Jackie Resources, Inc. and dated March 1977. One letter, from Ernie Freeman of Hollywood, California, stated that "Avocado Summer" was "well produced and conceived in recording," that it should realize sales of up to 250,000 units, and that $110,000 seemed to be a fair price for the master recording. The other letter, from Douglas L. A. Foxworthy of La Jolla, California, stated that "Avocado Summer" was an "excellent instrumental country vocal easy listening master" and that sales should exceed 350,000 units. Petitioners did not seek any other appraisal; however, Hendison estimated to petitioners that they would sell 100,000 copies during the first year. On December 20, 1977, petitioners executed an agreement to purchase the master recording for "Avocado Summer." The purchase price was $110,000, comprised of a $20,000 cash downpayment and a398 nonrecourse promissory note for $90,000 due May 31, 1985, and payable solely out of proceeds from record sales. A security agreement and an assignment of sales proceeds on the $90,000 note were also executed by the parties. Under the assignment of sales proceeds, petitioner agreed to pay to Jackie Resources $ .75 for each album sold ($ .25 if the selling price of album was under $3.95) and $ .10 for each single record sold until the note was paid in full. Petitioners paid the cash protion of the purchase price by two cashiers checks dated December 22 and 29, 1977. At some time in 1977 or 1978, petitioners received literature on International Record Distributing Associates (IRDA), an association of small independent record companies headquartered in Nashville, Tennessee. Subsequent to a conversation with the president of IRDA, petitioners received the following letter: November 20, 1978 Dear Mr. Seely: As per our conversation today, please find enclosed two executed copies of our Employment Contract. Please sign both, retaining one for your files and return the other to me with your check for $2,250.00. We shall obtain the master tape and label copy from Jackie Resources399 and your album "AVOCADO SUMMER" by Johnny Dark will go into production as soon as we receive all the materials. Also, please find enclosed our company's press kit which will give you more information about IRDA. We are very happy to be working with you on this project and if there is anything else you require, olease let me know. Very truly yours, /s/ Hank Levine Hank Levine, President, IRDA/ALBUM WORLD The employment contract referenced in the letter quoted above was dated November 20, 1977, and provided for the distribution of "Avocado Summer" by IRDA. In the employment contract, petitioner represented that he owned all rights, title, and interest in and to the master recording of "Avocado Summer" by Johnny Dark. Petitioner agreed to pay IRDA $2,250 to produce 1,000 records and to exploit, advertise, and promote the records. For each album sold and not returned, IRDA agreed to pay petitioner $1.69, and for each single record sold and not returned, IRDA agreed to pay petitioner $ .20. The contract required IRDA to submit to petitioner periodic statements every 180 days and granted petitioner the right to terminate the contract by giving IRDA 10 days' written notice. 400 Petitioners made several phone calls to IRDA regarding the progress of production and distribution of "Avocado Summer." In response, petitioner received a letter from IRDA on March 19, 1979, stating that it would soon be ready to go into full distribution of "Avocado Summer" and that the albums might reach the market place in 4 to 6 weeks.On April 11, 1979, petitioner received another letter from IRDA. That letter stated that the primary cause for delay in distribution was approval of the album cover and test pressing and that the album would be a big commercial success because of Johnny Dark's recent television exposure on "Make Me Laugh." Petitioners received copies of the album "Avocado Summer." They played the album in their lounge and also handed out promotional copies. Petitioners telephoned several radio stations to verify that the stations had received "Avocado Summer" and that the album was being promoted by IRDA. Although stations contacted had received the album, petitioners learned that IRDA had conducted no promotional campaigns. Petitioners did not receive the periodic statements promised by IRDA except for two royalty statements, one of which was marked "final401 statement." These statements reflect three transaction dates: December 30, 1980; June 30, 1981; and December 30, 1981. On these dates, the statements report some or all of the following: zero consignments sales in units, zero net units sold or unreturned, zero units paid or previously reported and paid, and zero dollars due. Petitioners maintained no business records or bank accounts regarding the master recording. Subsequent to petitioners' taxable years in issue, Johnny Dark's success as a performer grew. He performed in Law Vegas, Nevada, at the Hacienda Resort Hotel and Casino in 1981 and at the MGM Grand Hotel in 1984. On their Federal income tax returns for each of the years in issue, petitioners deducted 50 percent of the corporation's losses. On their 1976 tax return, petitioners computed their share of the corporation's investment tax credit; however, the credit did not reduce their tax liability because they reported no tax due. On their 1977 tax return, petitioners deducted from their tax liability an investment tax credit for their purchase of the master recording. On their 1977, 1978, and 1979 tax returns, petitioners deducted losses arising from their master402 recording activity; these losses were composed of depreciation expenses, a distribution fee, and other nominal expenses. In his notice of deficiency, respondent disallowed petitioners' share of the corporation's loss deductions and petitioners' share of the corporation's investment tax credit on the ground that petitioners' corporation did not execute a valid election for subchapter S status. Respondent disallowed the losses arising from petitioners' master recording activity on the grounds that the purchase of the master recording was a sham and that the activities associated with the master recording did not constitute trade or business activities under section 162 or income producing activities under section 212. Respondent also disallowed the 1977 investment tax credit on the ground that the master recording did not qualify for the investment tax credit. Before the trial of this case, respondent amended his answer to assert that petitioners are liable for additional interest under section 6621(d). OPINION Subchapter S IssueSection 1372(a) provides that any small business403 corporation may elect not to be subject to taxation under chapter 1 of the Internal Revenue Code and that "such election shall be valid if all persons who are shareholders in such corporation * * * consent to such election." Section 1372(c) provides that the election shall be made in such manner as the Secretary shall prescribe by regulations. Section 1.1372-3(a), Income Tax Regs., provides in pertinent part as follows: The consent of a shareholder to an election by a small business corporation shall be in the form of a statement signed by the shareholder in which such shareholder consents to the election of the corporation. * * * Each person who is a shareholder of the electing corporation must consent to the election; thus, where stock of the corporation is owned by a husband and wife as community property (or the income from which is community property), or is owned by tenants in common, joint tenants, or tenants by the entirety, each person having a community interest in such stock and each tenant in common, joint tenant, and tenant by the entirety must consent to the election. * * * Respondent determined that petitioners' corporation's subchapter404 S election was invalid because petitioner's wife, Barbara J. Seely, did not sign the election form. Petitioners argue that although they held the corporate stock as community property, petitioner John M. Seely's signature is sufficient for a valid election because the signature of both spouses is not required by California community property law regarding personal property. We disagree. Federal tax statutes are not to be limited by State laws that identify and describe the relationship between individuals and other potential taxpayers. Commissioner v. Tower,327 U.S. 280">327 U.S. 280, 288 (1946); Burnet v. Harmel,287 U.S. 103">287 U.S. 103, 110 (1932). Petitioners also argue that respondent is estopped from denying the election because the language on respondent's Form 2553 did not, during the years in issue, require the consent of both spouses holding the stock as community property. In support of this argument, petitioners cite Allied Steel Construction Co. v. Employers Casualty Co.,422 F.2d 1369">422 F.2d 1369, 1371 (10th Cir. 1970), for the proposition that "estoppel405 arises where one party makes by its words or actions a false representation of fact, and the other party reasonably relies on the misrepresentation and is prejudiced thereby." Petitioners contend that estoppel applies because the 1976 Form 2553 failed to require on its face the consent of petitioner's wife and because subsequent Forms 2553 promulgated by the Internal Revenue Service have included this requirement on the face of the document. Although the face of the 1976 form did not set out the consent requirement, the instructions on the back of the form did. Petitioners argue that because the form was subsequently revised, respondent has admitted that the 1976 form was misleading. This argument lacks merit. The fact that the form could be improved does not mean that it was misleading or that the instructions, or the applicable law, could be ignored. Neither respondent nor any agent of respondent made any misrepresentation regarding the consent requirement for a valid subchapter S election. These circumstances do not give rise to an estoppel. Cases applyig section 1372 to stock held406 as community property have consistently denied subchapter S status to corporations where the election form failed to include the spouse's consent, Clemens v. Commissioner,453 F.2d 869">453 F.2d 869 (9th Cir. 1971), affg. a Memorandum Opinion of this Court, and where the spouse's written consent ws untimely, Forrester v. Commissioner,49 T.C. 499">49 T.C. 499 (1968). Petitioners argue that Forrester, on which the court in Clemens exclusively relied, can be distinguished factually. Petitioners contend that in Forrester, the wife (of a record shareholder) filed a separate untimely consent and that therefore the husband was not purporting to act for the community. Here, petitioner's wife, according to testimony, orally consented to whatever action petitioner might take; therefore, petitioner argues that he was acting for the community. Petitioners' reliance, however, on the "acting for the community" dictum of Forrester ignores our application therein of a hard and fast rule which requires a spouse's filed consent and which has been consistently and strictly applied since about 1960. As we stated in Forrester in our analysis of the relevant statutes, 407 regulations, and particularly the legislative history, Congress consented to and approved the Commissioner's requirement that both spouses must make the election in community property states. See Forrester v. Commissioner,49 T.C. at 506-507. Cf. Wilson v. Commissioner,560 F.2d 687">560 F.2d 687 (5th Cir. 1977) (where an election was upheld without a record shareholder's wife's consent; because the record shareholder held only a nominal interest in the corporation, he did not have a "beneficial ownership" and therefore did not meet the definition of a shareholder for purposes of the consent requirement). Although we are not unsympathetic to petitioners' position on this issue, they have not brought themselves within any exception to the controlling authorities. Petitioners' deductions of the corporate losses and the corporate investment tax credit were therefore properly disallowed by respondent. Master RecordingPetitioners argue that the purchase of the master recording was a valid business transaction entered into with a bona fide objective of making a profit and that therefore they are entitled to depreciation and other expense deductions and408 an investment tax credit based on their $20,000 cash investment in the master recording. Because petitioners are now asserting entitlement only with regard to the $20,000 cash paid, we recognize this as a concession that they are not entitled to any deductions of an investment tax credit with respect to the the $90,000 nonrecourse note. Respondent argues that the master recording activity was not engaged in for profit and that the purchase of the master recording was a sham transaction. Respondent further argues that the property does not qualify for investment tax credit. If we find that the purchase of the master recording was not a sham transaction but that the activity was engaged in for profit, respondent argues that petitioners' basis in the master recording cannot include any excess of the purchase price over the fair market value of the master recording. According to respondent (and the only evidence of fair market value), that is $10,000. To qualify for the claimed depreciation and other expense deductions with respect to the master recording, petitioners must demonstrate that the master recording was used in a trade or business or was held for the production of income. 409 Sections 162, 167, and 212. Under section 48(a)(1), the investment tax credit is allowable only for property for which depreciation (or amortization in lieu thereof) is allowable. Thus, petitioners' right to the deductions and investment credit depends on their showing that the activity in question constituted a trade or business or was undertaken and carried on for the production of income. See Beck v. Commissioner,85 T.C. 557">85 T.C. 557, 569 (1985). Essential to such a showing is a demonstration that petitioners had "an actual and honest objective of making a profit." Beck v. Commissioner,supra;Estate of Baron v. Commissioner,83 T.C. 542">83 T.C. 542, 553 (1984), on appeal (2d Cir., Mar. 26, 1985); Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642, 646 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983). A reasonable expectation of making a profit is not required; however, petitioners' objective of making a profit must be bona410 fide. Beck v. Commissioner,supra;Estate of Baron v. Commissioner,supra;Fox v. Commissioner,80 T.C. 972">80 T.C. 972, 1006 (1983), affd. without published opinion 742 F.2d 1441">742 F.2d 1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner,731 F.2d 230">731 F.2d 230 (4th Cir. 1984), affd. without published opinion sub nom. Zemel v. Commissioner,734 F.2d 9">734 F.2d 9 (3d Cir. 1984), affd. without published opinion sub nom. Rosenblatt v. Commissioner,734 F.2d 7">734 F.2d 7 (3d Cir. 1984), affd. without published opinion sub nom. Krasta v. Commissioner,734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Leffel v. Commissioner,734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Hook v. Commissioner,734 F.2d 5">734 F.2d 5 (3d Cir. 1984). Courts often use words such as "basic," "dominant," "primary," "predominant," and "substantial" to describe the requisite profit objective. Beck v. Commissioner,85 T.C. at 570, and cases cited therein. In this context, "profit" means economic profit, independent of tax savings. 411 Beck v. Commissioner,supra, and cases cited therein. If the activity is not engaged in for profit, the deduction of petitioners' expenses relating to the activity is allowed only to the extent of gross income generated by the activity. Section 183(a) and (b). Whether petitioners possessed the requisite profit motive is a question of fact to be determined on the basis of all the facts and circumstances.2Beck v. Commissioner,85 T.C. at 570; Estate of Baron v. Commissioner,supra.No one factor is determinative; however, greater weight will be given to objective facts than to petitioners' statements of intent. Beck v. Commissioner,supra;section 1.183-2, Income Tax Regs. The burden of proof is on petitioners. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Surloff v. Commissioner,81 T.C. 210">81 T.C. 210, 233 (1983); Rule 142(a), Tax Court Rules of Practice and412 Procedure.Based on our consideration of all the facts and circumstances, we conclude that petitioners did not engage in their master recording activity with an actual and honest objective413 of making a profit. Therefore, because no income was generated by the activity, petitioners are not entitled to any deductions or an investment tax credit regarding the master recording activity. Petitioners testified that they purchased the master recording hoping to make a lot of money so they could buy their "dream house." Even assuming we accept this testimony, it does not mean that petitioners had an "actual and honest objective of making a profit" when they purchased the master recording. Increased spendable income resulting from increased deductions may have satisfied the objective they described. 3Petitioners' conduct prior to their purchase of the master recording of "Avocado Summer" did not indicate a profit objective. Petitioners argue that their decision to purchase the master recording was based on the following: (1) petitioners met a record promoter; (2) petitioners listened to a recording of "Avocado Summer" and liked it; (3) petitioners read two "appraisal" letters provided by the seller which favorably described the profit potential of "Avocado Summer"; and414 (4) petitioner allegedly calculated a profit of $50,000 to $60,000 on the sale of 100,000 albums. Petitioners, however, did not have any experience in the distribution of master recordings. They did not consult any independent experts regarding the distribution of master recordings or specifically regarding the profit potential of the master recording of "Avocado Summer." Petitioners' information memorandum on the purchase of master recordings repeatedly warned that profit potential was extremely speculative and that a record rarely generated enough receipts to pay for the purchase price. Furthermore, if petitioners had seriously considered the nontax merits of the investment, it is improbable that they would have blindly relied on appraisals furnished by the seller, particularly in view of the cautionary language in the information memorandum. See Beck v. Commissioner,85 T.C. at 572. Petitioner testified as follows regarding his alleged profit calculation: My profit margin was roughly a $1.70 per album and at that rate, 100,000 albums would have been about $170,000. I would have owed $110,000, so I figured about a $50,000 or $60,000 profit. * * Petitioner415 provided no details or documents to explain or support his alleged computation. It is incomplete and unrealistic. Petitioner ignored the interest to be paid on the $90,000 debt obligation and failed to take into account the costs of production and distribution. Those costs were $2,250 for the first 1,000 albums, or $2.25 per album, which is 56 cents more than the $1.69 per album actually sold that petitioner would have earned under the agreement with IRDA had any of the 1,000 albums been sold. Because petitioner made no arrangements for production of additional albums, we do not know what those costs would have been. But apparently neither did petitioner. Petitioner testified that he knew nothing about the potential tax consequences resulting from the purchase of a master recording. This testimony is difficult to believe, especially in view of the information memorandum.More than 45 percent of the text of that memorandum was devoted to the tax ramifications of purchasing a master recording. Also, petitioner testified that he did not see the information memorandum until after the decision had been made to purchase the master recording of "Avocado Summer." If this is true, 416 it supports the conclusion that petitioners did not have an actual and honest profit objective, particularly in view of their lack of experience in the distribution of master recordings. Petitioner may not have understood the tax concepts discussed in the memorandum, but we cannot believe that he ignored the "bottom line" calculations. Petitioner testified that he negotiated the terms of the purchase agreement. He gives no details, however, as to these negotiations. Also, the purchase agreement appears to be a standard form agreement prepared by or for Jackie Resources, Inc., to which names, dates, signatures, and other relevant data are added in the blanks. Petitioners' conduct after their purchase of the master recording also fails to indicate a profit objective. Petitioners did not maintain separate bank accounts or separate business records for their master recording activity. See Beck v. Commissioner,85 T.C. at 576-577. Petitioners' distributor, IRDA, did not distribute any records and did not provide petitioners the periodic statements as required by the employment contract. Nevertheless, petitioners did not change distributors although they could have417 done so with 10 days' prior written notice. Petitioners testified that they made several phone calls to IRDA in monitoring the distribution of the albums; that they also phoned several radio stations to see if the radio stations had received copies of the album; and that they played the album in their lounge and gave out promotional copies to patrons of their lounge. Petitioners, however, never made arrangements to manufacture more than 1,000 records, although the projections on which the seller's appraisals were based assumed sales of 250,000 or 300,000 albums, and petitioners' own profit calculations assumed sales of 100,000 albums. Petitioners' use of a large nonrecourse not indicates the lack of an actual and honest objective of making a profit because the note was contingent, illusory, and without any real economic substance. Even the information memorandum specifically stated that a record rarely generated enough receipts to pay the full purchase price. On numerous occasions, we have stated that "the existence of large nonrecourse notes in circumstances where it is unlikely that the notes will be paid is itself an indication that the primary objective of an activity is to418 generate tax deductions rather than to earn an economic profit." Seaman v. Commissioner,84 T.C. 564">84 T.C. 564, 596 (1985). See Estate of Baron v. Commissioner,83 T.C. at 556. The lack of order and chronology of transaction dates as reported on various documents and as testified to by petitioners also shows an absence of businesslike conduct. Of particular importance is a letter from Jackie Resources dated November 20, 1978. That letter stated (1) that petitioners should sign the enclosed "employment contract and return it with the required payment of $2,250; (2) that when IRDA received the master recording and other necessary materials from Jackie Resources, the album would soon go into production; and (3) that its enclosed press kit would provide more information in IRDA. This letter suggests that the employment contract with IRDA had not, at that time, been executed by both parties and that IRDA had not, at that time, received a master recording from Jackie Resources. Petitioner testified, however, that he received his own copies of the album (which must be made from the master recording) from IRDA in the spring of 1978, more than 6 months before419 the date of this letter. The employment contract is dated November 20, 1977, a year before the date of the latter and before petitioner was asked to sign the employment contract enclosed in the letter. Petitioners claimed depreciation deductions and an investment tax credit in 1977 regarding the master recording activity although, according to this letter, the album was not even in production as of November 20, 1978. Furthermore, petitioner, in the employment contract, confirmed his title to and ownership of the master recording; however, petitioner did not even purchase the master recording until one month after the date of the employment contract. Based on these inconsistencies, we find it difficult to accept petitioner's unconrroborated testimony and petitioners' assertions that they had an actual and honest objective of making a profit. Respondent analogizes the facts in this case to those in Estate of Baron v. Commissioner,supra, wherein we denied a taxpayer's claimed deductions regarding a master recording activity. In Baron, the taxpayer purchased a master recording for $650,000, comprised of $90,000 cash and nonrecourse notes for $560,000420 payable solely out of the record sales proceeds. The master recording was a sound track to the movie "The Deep"; it had a famous artist, Donna Summer, and a well-known distributor, Casablanca. Nevertheless, because of Baron's lack of experience in the area, Baron's lack of investigative efforts, the extensive amount of the nonrecourse notes, and Baron's failure to check production and distribution progress, we held that no profit objective existed. Petitioners argue that Estate of Baron is distinguishable from this case because (1) petitioners, unlike the taxpayers in Estate of Baron, were not actively seeking investments; (2) the purchase price and the nonrecourse financing were much larger in Estate of Baron; (3) the taxpayers in Estate of Baron were in a higher tax bracket than petitioners; (4) no appraisals were available before the purchase of the master recording in Estate of Baron; and (5) petitioners took a more active role in the master recording activity than the taxpayers in Estate of Baron. Mindful of those assertions, we nevertheless conclude that the determinativefactors are the same in both cases, i.e., (1) lack of prior experience421 in the area, (2) very little prepurchase investigation of the activity, (3) a large nonrecourse note payable solely out of sales proceeds, and (4) very little monitoring of production and distribution of the record. 4 The applicable rules do not vary based on the particular tax bracket or the dollar amounts involved. Also, petitioners' conduct, while arguably more active than the conduct of the taxpayers in Estate of Baron, was only minimal. Having made a few telephone calls, having played the album and given away promotional copies, and having read an "appraisal" before the purchase of the master recording do not carry petitioners' burden of proving a profit objective. Cf. Independent Electric Supply, Inc. v. Commissioner,781 F.2d 724">781 F.2d 724 (1986), affg. a Memorandum Opinion of this Court. Petitioners have, on brief, apparently conceded the issue with respect to the nonrecourse note; however, that concession does not affect our analysis of petitioners' intent at the time they entered into and conducted the master recording422 activity. As in Estate of Baron, the most reasonable conclusion is that the anticipated tax benefits resulting from the inclusion of the nonrecourse note in the purchase price were the primary incentive for petitioners' involvement in the master recording activity. Where an asset is purchased using nonrecourse indebtedness, whether the fair market value of the asset approximated its purchase price may be considered in determining whether the taxpayer possessed the necessary profit objective. Beck v. Commissioner,85 T.C. at 577, and cases cited therein. Respondent offered the only expert witness at trial and also produced a report prepared by the expert witness summarizing his examination of the album and the relevant documents associated with petitioners' master recording activity. Petitioners' cross-examination failed to impeach respondent's witness, and his testimony and report were not contradicted by other evidence. (Although petitioners argue that they relied on the appraisals provided by the seller, those appraisals are hearsay and can only be considered423 in relation to petitioner's intent and not as evidence of value.) In his report, respondent's witness stated that in his opinion the master recording of "Avocado Summer" was worth approximately $10,000. This value of the master recording was substantially less than the purchase price of $110,000 on which petitioners based their deductions and credits during the years in issue. In conclusion, we hold that petitioners failed to satisfy their burden of proving that they engaged in the master recording activity with an actual and honest objective of making a profit. As a result, we need not address respondent's alternative arguments that the purchase of the master recording was a sham transaction, that the property was not eligible for the investment tax credit, and that petitioners' basis in the master recording cannot include any excess of the purchase price over the fair market value of the master recording. Additional InterestBy Amendment to the Answer, respondent asserted the applicability of section 6621(d), dealing with interest on substantial underpayments attributable to tax motivated transactions.Because respondent has raised a "new matter," he bears the burden of424 proof on that issue. Rule 142(a), Tax Court Rules of Practice and Procedure.Section 6621(d) provides for an interest rate of 120 percent of the adjusted rate established under section 6621(b) where there is a "substantial underpayment" (an underpayment of at least $1,000) in any taxable year "attributable to 1 or more tax motivated transactions." This section applies only 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(d). Solowiejczyk v. Commissioner,85 T.C. 552">85 T.C. 552 (1985), on appeal (2d Cir., Mar. 24, 1986). Section 6621(d)(3) includes within the definition of tax motivated transactions (1) any valuation overstatement (within the meaning of section 6659(c)) and (2) any loss disallowed by reason of section 465(a). Section 6621(d)(3)(B) permits the Secretary of the Treasury to prescribe by regulation other types of transactions that constitute tax motivated transactions. 425 Section 301.6621-2T, Q and A-4, Proced. & Admin. Regs. (Temporary), includes within the definition of tax motivated transactions any deductions disallowed for any period under section 183, relating to an activity engaged in by an individual that is not engaged in for profit. Section 301.6621-2T, Q and A-5, Proced. & Admin. Regs. (Temporary), provides the following method by which the amount of an underpayment of tax attributable to one or more tax motivated transactions is determined: (1) Calculate the amount of the tax liability for the taxable year as if all items of income, gain, loss, deduction, or credit, had been reported properly on the income tax return of the taxpayer ("total tax liability"); and (2) Without taking into account any adjustments to items of income, gain, loss, deduction, or credit that are attributable to tax motivated transactions (as defined in A-2 through A-4 of this section), calculate the amount of the tax liability for the taxable year as if all other items of income, gain, loss, deduction, or credit had been reported properly on the income tax return426 of the taxpayer ("tax liability without regard to tax motivated transactions"). (3) The difference between the total tax liability and the tax liability without regard to tax motivated transactions is the amount of tax motivated underpayment. At the conclusion of trial, the Court directed respondent to comment in his brief as to the appropriate means of calculating the amount of the underpayment "attributable "to tax motivated transactions referred to in section 6621(d). Petitioners were told that they would have to deal with respondent's approach. Alternative calculations apply because of the separate issues in this case, i.e., the claimed subchapter S losses and the master recording items, as well as the alternative grounds for disallowance of the master recording deductions and credits. See Law v. Commissioner,84 T.C. 985">84 T.C. 985, 993 (1985). Respondent carefully laid out in his brief his contentions and computations on each alternative basis for our decision. Respondent's primary position is that the deductions and investment tax credits claimed with respect to the master recording activity are not allowable because the activity was not engaged in for profit427 and there was no income received from the activity during the years in issue. He computed the amount attributable to the master recording items as follows: 1977AmountAmount Properly ReportableProperlyWithout Regard toReportableTax-Motivated TransactionAdjustmentsSubchapter S Loss$ 5,277 $ 5,277 Master Recording2,925 Total$ 8,202 $ 5,277 Taxable IncomeAs Previously Adjusted37,429 37,429 Revised Taxable Income$45,631 $42,706 Tax from Tax Rates13,307 11,918 Less creditsGeneral Tax Credit(180)(180)Investment Credit(1) (256)(2) (11,256)Balance$12,871 $482 Plus: Tax from recomputingprior year investmentcredit (1)179 179 Total Correct Tax Liability$13,050 $661 Total Tax Shown onReturn or as PreviouslyAdjusted179 179 Increase in Tax$12,871 $482 1978AmountAmount Properly ReportableProperlyWithout Regard toReportableTax-Motivated TransactionAdjustmentsSubchapter S Loss$ 6,855 $ 6,855 Master Recording15,839 Total$22,694 $ 6,855 Taxable IncomeAs Previously Adjusted22,429 22,429 Revised Taxable Income$45,123 $29,284 Tax from Tax Rates13,063 Tax from Tax Tables(3) 6,227 Less creditsGeneral Tax Credit(180)Investment Credit (1)(500)(500)Contribution to Candidates(10)(10)Balance$12,373 $ 5,717 Plus: Tax from recomputingprior year investmentcredit (2)801 801 Total Correct Tax Liability$13,174 $ 6,518 Total Tax Show onReturn or as PreviouslyAdjusted4,274 4,274 Increase in Tax$ 8,900 $ 2,244 428 1979AmountAmount Properly ReportableProperlyWithout Regard toReportableTax-Motivated TransactionAdjustmentsSubchapter S Loss$14,561 $14,561 Master Recording15,841 Total$30,402 $14,561 Taxable IncomeAs Previously Adjusted19,921 19,921 Revised Taxable Income$50,323 $34,482 Tax from Tax Rates14,936 Tax from Tax Tables(2) 7,894 Less creditsInvestment Credit (1)(337)(337)Balance$14,599 $ 7,557 Plus: Tax from recomputingprior year investmentcredit (1)342 342 Total Correct Tax Liability$14,941 $ 7,899 Total Tax Shown onReturn or as PreviouslyAdjusted4,498 4,498 Increase in Tax$10,443 $ 3,401 The above tables set forth the amount of the properly reportable tax liability in column one and the tax liability without regard to the tax motivated transaction in column two. The difference between429 the amount of the properly reportable tax liability and the tax liability without regard to the tax motivated transaction equals the following underpayments of tax attributable to the tax motivated transaction: $12,389 in 1977, $6,656 in 1978, and $7,042 in 1979. Because the underpayments attributable to the tax motivated transaction each exceed $1,000, a substantial underpayment attributable to a tax motivated transaction exists in taxable years 1977, 1978, and 1979 to which the 120 percent interest rate set forth in section 6621(d) applies after December 31, 1984. Notwithstanding our comments at trial and respondent's detailed analysis, petitioners ignored the section 6621(d) issues in their briefs. Because petitioners have not given us any reason to reject these computations, Decision will be entered in accordance with the above computations.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩2. Section 1.183-2(b), Income Tax Regs., lists some of the factors to be considered in determining whether an activity is engaged in for profit. The factors listed in the regulations are as follows: (1) 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) Expectation that assets used in 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 losses with respect to the activity. * * * (7) The amount of occasional profits, if any, which are earned. * * * (8) The financial status of the taxpayer. * * * (9) Elements of personal pleasure or recreation.↩ * * *3. See Holland v. Commissioner,T.C. Memo. 1985-626↩, slip opinion at page 17.4. See also Watts v. Commissioner,T.C. Memo. 1985-531; Snyder v. Commissioner,T.C. Memo. 1985-9↩.(1). As previously agreed--Spring Valley Farms Partnership. ↩(2). ↩Per return in full$11,000Additional agreed256Total11,256(3). Tax Table Income: $29,284 + $1,500 = $30,784.↩(1). As previously agreed--Spring Valley Farms Partnership. ↩(2). As previously agreed. ↩(2). Tax Table Income: $34,482 + $2,000 = $36,482.↩(1). As previously agreed. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623444/	FERRARI CARANO VINEYARDS and WINERY, DONALD L. CARANO, TAX MATTERS PARTNER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Ferrari Carano Vineyards & Winery v. CommissionerDocket No. 19117-96United States Tax Court1997 U.S. Tax Ct. LEXIS 77; November 12, 1997, Entered 77 Joseph H. Gale, Judge. GaleDECISIONPursuant to Rule 248(a) of the Tax Court Rules of Practice and Procedure, and following submission of this case without trial, it isORDERED AND DECIDED: That the following statement shows the adjustments to the partnership items of the Ferrari Carano Vineyards and Winery partnership for the year ended October 31, 1991:Partnership ItemAs ReportedAs DeterminedGrape Growing Costs$ 1,042,775$ 1,042,775 Interest Capitalized To Wine167,36142,360 COGS-Interest Capitalized to Wine00 Interest Capitalized to CIP Bldgs25,1580 Depreciation/Capitalized interest0(340)Joseph H. GaleJudgeEntered: NOV 12 1997It is stipulated that the Court may enter the foregoing decision pursuant to Tax Court Rule 248(a).It is further stipulated that this decision shall be treated as a resolution on the merits binding on all of the parties.It is further stipulated that the undersigned Tax Matters Partner of Ferrari Carano Vineyards and Winery for the taxable year ending October 31, 1991, by executing this stipulation, consents to the entry of the foregoing decision in this case and certifies that no party objects.STUART L. BROWN78 Chief CounselInternal Revenue ServiceDONALD L. CARANOTax Matters PartnerROBERT H. KAPP, ESQ.Counsel for PetitionerTax Court Bar No. KR0416555 Thirteenth Street, N.W.Washington, D.C. 20004-1109Tel. (202) 637-5600By:KATHRYN K. VETTERAttorneyTax Court Bar No. VK0018Internal Revenue ServiceSuite 470, 4330 Watt AvenueNorth Highlands, CA 95660P.O. Box 2900, SA-2801Sacramento, CA 95812-2900Telephone: (916) 974-5700	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623445/	ALFRED RICE and PEARL RICE, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Rice v. CommissionerDocket Nos. 4808-72, 4809-72, 5057-72, 5058-72, 5059-72, 5060-72.United States Tax CourtT.C. Memo 1979-249; 1979 Tax Ct. Memo LEXIS 277; 38 T.C.M. (CCH) 990; T.C.M. (RIA) 79249; June 28, 1979, Filed 277 Held, Ps failed to carry their burden of proving that the Commissioner erred in his determination of the fair market value of property donated to a charitable organization.Held, further, Ps are liable for the additions to tax under sec. 6653(a), I.R.C. 1954, because part of the underpayments of tax for each of the years in issue was due to negligence or intentional disregard of the applicable rules and regulations. Maurice C. Greenbaum,Laurence Vogel, and Jonathan M. Harris, for the petitioners. H. Stephen278 Kesselman, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined the following deficiencies in, and additions to, the petitioners' Federal income taxes: Addition to TaxSec. 6653(a)PetitionerYearDeficiencyI.R.C. 1954 2Alfred Rice and1966$16,236.96 $ 811.85Pearl Rice196710,852.59542.64196811,051.32552.57Mary Hemingway196637,265.461,863.27196750,218.402,510.92196837,479.571,873.98Lila Werner and19667,751.00387.55William J.196719,387.87969.39Werner196817,782.04889.1019693,404.76170.24Estate of Maurice196629,387.271,469.36Urdang, Leonore196754,644.302,732.22Urdang, Execu-196846,003.002,300.00trix, and196948,667.532,433.38Leonore UrdangJoseph Abrams19664,569.00228.45and Mildred19678,198.00409.90Abrams196812,947.00647.00196914,264.39713.22The parties have settled most of the issues. The issues remaining for279 decision are: (1) What was the fair market value of certain property contributed by the petitioners to the Hospital for Joint Diseases on the date of such contribution; and (2) if there was an underpayment of tax for each year, whether any part thereof was due to negligence or intentional disregard of rules and regulations, within the meaning of section 6653(a). FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioners, Alfred Rice and Pearl Rice (husband and wife), Mary Hemingway, Maurice Urdang and Leonore Urdang (husband and wife), William J. Werner, Lila Werner, and Joseph Abrams and Mildred Abrams (husband and wife), maintained their legal residences in New York, N.Y., at the time they filed their petitions in this case. All the petitioners filed their Federal income tax returns for the years in issue with the District Director of Internal Revenue for the District of Manhattan, N.Y. Since the filing of the petition, Mr. Urdang has died, and his estate has been substituted as a party. Although Mr. and Mrs. Werner filed joint Federal income tax returns for the years in issue and received a joint notice of deficiency, each of280 them has filed a separate petition. Alfred Rice, Mary Hemingway, Maurice Urdang, William Werner, Lila Werner, and Joseph Abrams will sometimes be referred to as the petitioners. During 1972, Smith-Corona Marchant, Inc. (SCM), acquired title to a 71.7-acre tract in Orangeburg, S.C., and thereafter, it substantially improved the tract so that by March 1, 1963, its total investment in the 71.7-acre tract as improved (the property) was as follows: Calculator building$1,752,853Warehouse-type shell building363,863Machinery368,924Land improvements39,311Land cost64,500Total investment$2,589,451In early 1963, SCM conveyed title to the property to Wrexham Properties, Inc. (Wrexham), and at or about the same time: (1) Wrexham and SCM entered into a lease (the lease); (2) Wrexham mortgaged the property by executing an "Indenture of Mortgage and Deed of Trust" (the indenture); and (3) Wrexham and the trustee under the indenture executed an "Assignment of Lease and Agreement" (the assignment). Under the lease between SCM as leassee and Wrexham as lessor, there was an "Interim Term," which commenced on March 1, 1963, and ended on March 31, 1963, and281 a "Primary Term," which commenced on April 1, 1963, and ended on March 31, 1983. The rent for the interim term was $12,396, and the rent for the primary term was $211,860 a year for the first 6 years and $212,172 a year for the remaining 14 years. The annual rent was to be paid in four equal quarterly installments, due on the last day of March, June, September, and December. In addition, SCM was granted the option to extend the lease in its discretion for up to six "Extended Terms" of 5 years apiece under the same basic terms and conditions as prevailed during the primary term, except that the annual rent for each year of an extended term was $62,500 payable in quarterly installments. Upon appropriate notice, SCM could terminate the lease at any time after April 1, 1973, provided that it included with the notice of termination an irrevocable offer to purchase the property at a price equal to the approximate outstanding balance of the notes plus, in some cases, $150,000. Rejection of such an offer would result in the termination of the lease. The lessee was also allowed to assign and sublet its interest in the lease. In contemplation of the indenture, Wrexham issued five mortgage282 notes. Four of the notes bore interest at 6 percent and matured in 1983, and one of the notes bore interest at 5-3/4 percent and matured in 1969. Under the indenture, Wrexham agreed to, inter alia, the following terms and conditions: (1) Wrexham was to lease the property to SCM or its successor or assignee during the term of the mortgage. Wrexham also agreed to charge rent to cover the quarterly principal and interest payments under the indenture. From 1963 through 1968, the average annual mortgage payment was to be $207,336. From 1969 to 1983, the average annual payment was to be $210,704. (2) The trustee was authorized to act as Wrexham's agent in the collection of all rents and other moneys required to be paid under the lease. (3) Wrexham could not prepay the notes prior to April 1, 1973. Thereafter, Wrexham was permitted to prepay the outstanding notes, at its option, at a price equal to 100 percent of the unpaid balance of such notes plus accrued and unpaid interest and a premium equal to the following percentages of the unpaid principal amount: If Prepaid During12-Month PeriodEnding WithPercentage3/31/746.03/31/755.43/31/764.83/31/774.23/31/783.63/31/793.03/31/802.43/31/811.83/31/821.23/31/830.6283 (4) If the 6-percent notes were held to maturity, Wrexham was required, in addition to making all payments of principal and interest, to pay the holders thereof an amount equal to approximately $400,000, or in lieu of such payment, Wrexham could transfer to the trustee for the benefit of the holders of such notes an undivided 50-percent interest in the property. (5) Wrexham could sell or otherwise transfer the property, provided the transferee agreed to be subject to the indenture and the assignment to the same extent as Wrexham. (6) If the lessee exercised its option under the lease to give Wrexham notice of its intention to terminate the lease together with a qualifying offer to purchase the property, Wrexham could either accept the offer or reject it. However, if the offer was rejected, Wrexham was required to pay the trustee an amount equal to approximately the outstanding principal of the notes plus the then value of the $400,000 payable at maturity, computed by discounting such amount at 6 percent annually. If the offer from the lessee to Wrexham was unacceptable to all of the note holders, they could preclude Wrexham from accepting such offer. In such case, Wrexham could284 be released from the indenture by making the above payment to the trustee. The assignment provided, in relevant part, that in compliance with the provisions of the indenture, and as further security for the payment of all sums payable on the notes issued and to be issued under the indenture and for the performance of all its other obligations in the indenture, Wrexham assigned, transferred, conveyed, and set over to the trustee under the indenture all of Wrexham's estate, right, title, and interest in the property as lessor, including the immediate right to collect all rent, income, etc. Such assignment also provided that upon payment of all sums payable under the indenture and compliance with all of the terms of the indenture and assignment, the assignment and the rights granted to the trustee thereunder would terminate and the estate, right, title, and interest of Wrexham would revert to Wrexham. By deed recorded as of March 11, 1963, Wrexham conveyed title to the property to five individuals in the following shares: PurchaserInterestMary Hemingway50 percentMaurice Urdang35 percentAlfred Rice5 percentJoseph Abrams5 percentFrank Zuckerbrot5 percent285 They acquired the property subject to the lien of the indenture in the amount of $2,467,100, and the tax stamps on the deed indicated they paid a cash consideration of $125,000. They executed an assumption agreement pursuant to the indenture under which (1) they acknowledged the conveyance was subject to the lien of the indenture and the lease; (2) they appointed the trustee under the indenture as their agent and attorney in fact and authorized it to act as authorized by the indenture; and (3) they agreed to assume all of Wrexham's obligations under the indenture other than its obligation to pay the notes. The trustee was also informed that Wrexham's stock would be transferred to William J. Werner and that rentals in excess of the mortgage payments should be paid to the transferees in proportion to their interests. On May 7, 1963, Mr. and Mrs. Werner became directors and officers of Wrexham. Subsequent to March 1, 1963, Frank Zuckerbrot died. On June 2, 1966, Clair Zuckerbrot, sole devisee under his will, conveyed his 5-percent interest to Mr. and Mrs. Werner without consideration. On December 28, 1966, the petitioners executed a deed conveying their interests in the property286 to the Hospital for Joint Diseases and Medical Center (the hospital) in New York, N.Y., as a charitable contribution. The petitioners claimed charitable contribution deductions on their Federal income tax returns for the years in issue based on their interests in the property. Mr. Werner, a tax attorney, valued such interests in the property, as follows: The law as I understand it was that the mortgage companies or life insurance companies or banks who furnished said mortgage would lend up to 65% of their appraised value of the property. On the presumption that the lending institutions lent up to the maximum of 65% and not below, I multiplied the approximate figure of 2 1/2 million dollars times 1 1/2 to give me what 100% of the value of the property would be. This is the formula that I used in obtaining the fair market value of the property at the time that the charitable contribution was made. Mr. Werner also allowed for appreciation in value from 1963 to 1966. Using such formula, Mr. Werner valued the property as of December 28, 1966, at $4,230,769.25, and after subtracting from such amount the outstanding mortgage of $2,171,032.58 and depreciation recapture of $121,517.51, 287 he determined the value of the charitable contribution was $1,938,219.16. Each of the petitioners used such value in claiming the charitable contribution deductions. On July 21, 1972, the hospital sold its interest in the property and the stock of Wrexham to Marchant Properties, Inc. (Marchant), a wholly owned subsidiary of SCM, for $115,000 in cash. Marchant took the property subject to the then outstanding mortgage indebtedness of $1,660,416. The hospital disposed of its interest in the property because it believed that continued ownership of the property might jeopardize its tax-exempt status. In August 1972, Marchant paid $1,695,775.80 to discharge the remaining indebtedness on the property. Such payment was computed as follows: Principal$1,632,646.60Interest14,149.88Penalties (3 percent ofoutstanding principalamount)48,979.42Total$1,695,775.80 3Thereafter, the property and the lease were entirely free and clear of the lien of the indenture. In August and September 1972, Marchant and288 SCM sold the property, the leasehold, leasehold improvements, certain personal property, and some additional land to two unrelated third parties, Roper Corporation (Roper) and Wilbur B. Driver Company (Driver), for an aggregate consideration of $2,800,000. The parties to such sale allocated approximately $1,900,000 of the aggregate purchase price to Marchant's interest in the property which it had acquired from the hospital. The remainder of the purchase price was allocated to the additional land, the leasehold, the leasehold improvements, and personal property. For tax purposes, the buildings on the property were depreciated on the basis of a 37-year useful life. However, such buildings had a useful life of 50 years. The land improvements and machinery were depreciated on the basis of useful lives of 20 years and 12 years, respectively. In his notices of deficiency, the Commissioner determined that the petitioners were entitled to no charitable contribution deductions because the fair market value of their interests was less than the sum of the applicable depreciation recapture and the outstanding indebtedness on the property on the date of the gift. In addition, the Commissioner289 determined that the petitioners were liable for the additions to tax under section 6653(a) because the underpayments of tax resulted from their negligence or intentional disregard of rules and regulations. The parties stipulated that under section 170(e), depreciation recapture of $200,000 must be deducted from the fair market value of the petitioners' interests in the property in order to determine the amount of the charitable contribution. OPINION The primary issue presented for decision is the fair market value of the petitioners' interests in the property on December 28, 1966, the date they donated it to the hospital. Generally, section 170 allows a deduction, subject to certain limitations, for charitable contributions made within the taxable year. If the contribution is made in property other than money, the amount of the deduction is equal to the fair market value of the property reduced by the sum of the outstanding liabilities on the property and the amount of depreciation required to be recaptured pursuant to section 170(e). Sec. 1.170-1(c), Income Tax Regs.290 The parties have agreed that the property was subject to liabilities of $2,171,032.58, and that $200,000.00 of depreciation must be recaptured; therefore, the petitioners are entitled to a charitable contribution deduction only to the extent that the fair market value of the petitioners' interests in the property exceeded $2,371,032.58. Generally, the fair market value of property is the price at which a willing buyer will purchase it from a willing seller, when neither is acting under compulsion and both are fully informed of the relevant facts and circumstances. Bankers Trust Co. v. United States,207 Ct. Cl. 422">207 Ct. Cl. 422, 518 F. 2d 1210, 1219 (1975), cert. denied 424 U.S. 966">424 U.S. 966 (1976); Kimmelman v. Commissioner, 72 T.C. (May 9, 1979); McShain v. Commissioner,71 T.C. 998">71 T.C. 998 (1979). In his notices of deficiency, the Commissioner determined that the fair market value of the petitioners' interests in the property was less than $2,371,032.58. The Commissioner's291 deficiency determinations are presumptively correct, and the petitioners bear the burden of proving a higher value. Rule 142, Tax Court Rules of Practice and Procedure; Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). At trial, both parties presented the testimony of expert witnesses to establish the fair market value of the petitioners' interests in the property. The petitioners' expert witness was president of a large international commercial and industrial real estate brokerage firm. Such company has acted as broker for many major national and international corporations, and such expert, in his capacity as president of such company, has been involved in the sale, leasing, acquisition, and development of industrial and commercial real estate, especially in the southeastern part of the United States. In his valuation report, the petitioners' expert generally used a market analysis to calculate the fair market value of the property. He ascertained the relevant characteristics of the property, the market conditions, new construction cost, and the cyclical nature of the textile industry. He also analyzed ten sales of other industrial and commercial real estate occurring292 from 1972 to 1975 and considered them to be comparable to the property. He concluded that the buildings on the property encompassed approximately 341,273 square feet, and that a reasonable price per square foot was approximately $10. Accordingly, he valued the property at $3,400,000. At the trial, he also used a direct capitalization-of-earnings method to value the property at $3,476,800. In determining a capitalization rate of 6.16 percent, he allowed for a yearly depreciation factor of 1.66 percent and an interest rate of 4.50 percent. He used $212,000, approximately the annual rental payment during the primary term of the lease, as the income to be capitalized. The Commissioner's expert is also a highly qualified and experienced real estate appraiser. Since 1965, he has been engaged primarily as a valuation engineer either for the Government or in the private sector. He is a Registered Professional Engineer in several States and has been qualified as an expert witness in State and Federal courts on numerous occasions. In determining the fair market value, the Commissioner's expert inspected the property, analyzed the market conditions, considered prior and subsequent293 transfers of the petitioners' interests in such property, and thoroughly analyzed the lease, the indenture, and the assignment. Based on such analysis, he valued the property using two methods: an annuity capitalization method and the reproduction cost method. Under the annuity capitalization approach, the Commissioner's expert first determined an appropriate capitalization rate. He noted that the prime interest rate, which was 4-1/2 percent in 1963, had risen to 6 percent by December 1966, and his analysis of the money markets revealed that it was common for first mortgages of the kind involved in this case to bear interest at a rate in excess of 7 percent. Taking into consideration these and other factors, he concluded that a capitalization rate of 7 percent was reasonable, even though he believed a higher rate would also be justified under the circumstances. Next, he computed the income to be capitalized. In his view, the lease and mortgage were of primary importance to such determination. Though the annual rental payments during the remaining 16 years of the primary term of the lease would be approximately $212,000, the hospital would only actually receive during such period294 the amount by which the annual rental payments exceeded the mortgage payments. In addition, SCM could, at its option, extend the lease in 5-year terms through the year 2013 at annual rental payments of $62,500. However, the transferee of the petitioners' interests would be entitled to the full annual rental payments during the extended terms only if it paid the note holders $400,000 in 1983; otherwise, the note holders would be entitled to one-half of the annual rental payments during the extended terms of the lease. The Commissioner's expert assumed that SCM would exercise its option to extend the lease so long as the fair rental value of the property exceeded $62,500. If the fair rental value of the property declined to less than such amount and if SCM terminated the lease, the expected return to the owners of the petitioners' interests would also decline. Finally, he determined that the buildings on the property had a useful life of 50 years, notwithstanding that they had been depreciated for tax purposes on the basis of a 37-year useful life. With these factors in mind, he determined that the income to be capitalized should be the rental income from 1966 through 2013, adjusted295 for the mortgage liability, payments required of the owner of the petitioners' interests or the reduction in interests if such payments are not made, and for the reversionary interest to the lessor at the termination of the lease. Accordingly, under this annuity capitalization approach, he determined the value of the property to be equal to the sum of (1) the present worth of the amount by which the rental payments exceeded the mortgage payments from the date of the gift to 1983, plus (2) either (a) the present worth of the full annual rental payments during the extended terms of the lease minus the present worth of $400,000 payable in 1983, or (b) the present worth of one-half of the annual rental payments during the extended terms of the lease, whichever is higher, plus (3) the present worth of the estimated reversionary value of the property, which, after the 50-year lease, would be the value of the land and the salvage value of the buildings, since they had a useful life of only 50 years. Such computations produced a fair market value for the petitioners' interests in the property which was less than the $200,000 depreciation recapture. Under the reproduction cost approach, 296 the Commissioner's expert first determined the original cost of the buildings and the other improvements on the property. Then, using various cost indexes for similar construction projects in the southeast, he determined the extent to which the cost of reproducing the same improvements had increased from 1962 to 1966. By multiplying the original cost of the improvements by a factor which reflected the average increase in such cost, by adding to such value $70,000 for the value of the land, and then by making appropriate adjustments to reflect depreciation in the improvements occurring from 1962 to 1966, he determined that the value of the property was $2,545,000. After reducing such value by the outstanding indebtedness, the $200,000 depreciation recapture, and the value of the leasehold interest, he concluded that the petitioners were not entitled to charitable contribution deductions. On brief, the Commissioner also computed the fair market value of the petitioners' interests in the property using a variation of his expert's annuity capitalization method. During the primary term of the lease, he substituted the present worth of the full rental payments unreduced by the annual297 mortgage payments for the present worth of the excess rental payments. He left the remainder of his expert's computation intact. Under such alternative approach, it is necessary to reduce the resulting amount by the outstanding liabilities and the depreciation recapture, since neither of these were reflected in computing the present value of the anticipated income. This alternative computation also yielded a fair market value which was insufficient to produce charitable contribution deductions. After carefully evaluating all the evidence and the opinions of both experts, we are convinced that the conclusion of the petitioners' expert cannot withstand analysis. Notwithstanding his impressive credentials, both of his approaches to fair market value contain fatal defects. His market approach to valuation is defective because his "comparable" sales transactions, the heart of such method, are not comparable to the petitioners' interests in the property for the following reasons: (1) The "comparable" sales all occurred from 6 to 9 years after the applicable valuation date; (2) four of the "comparables" were constructed after 1970, and five were constructed from 1967 to 1969, whereas298 improvements on the property were constructed in 1962-1963; (3) for the most part, the buildings on the property were twice as large as the buildings involved in the "comparables"; (4) in several instances, the square footage of the buildings on the "comparables" was grossly underestimated, thereby increasing the price per square foot; and (5) most importantly, there is absolutely no evidence that nine of the ten "comparables" were encumbered by a long-term lease, much less a long-term lease with such favorable terms for the lessee. One "comparable" was subject to a net 20-year lease; but such property, which was constructed in 1973, was sold in 1975 for $2.17 per square foot. The precise issue in this case involves determining the fair market value of the petitioners' interests in the property, which were severely limited by the terms of the lease, the indenture, and the assignment, and the petitioners' expert gave virtually no consideration to those restrictions.Accordingly, his market analysis is of little help in determining the fair market value of the petitioners' interests.We are equally unimpressed with his capitalization-of-earnings analysis. First, the 6.16-percent capitalization299 rate used by him was too low. Such rate was the sum of two components: an interest rate factor of 4.50 percent and a depreciation factor of 1.66 percent. He determined a 4.50-percent interest rate was appropriate because certain similar construction was financed by 4.50-percent tax exempt municipal bonds. However, the prime rate of interest in 1966 was 6 percent, and it was common for similar first mortgage financing to bear interest in excess of 7 percent. Though the interest rate on tax exempt bonds may have been 4.50 percent, such interest rate was possible only because the income was tax exempt, a situation not present with respect to the property. In any event, the interest rate on tax exempt bonds is only one factor to be considered in selecting a capitalization rate, not the sole factor. In addition, the evidence supports the use of a larger depreciation factor. He concluded that a depreciation factor of 1.66 percent was reasonable based on a useful life for the buildings of 60 years. However, for tax purposes, the machinery was depreciated on the basis of a 12-year useful life, the land improvements on the basis of a 20-year useful life, and the buildings on the basis300 of a 37-year useful life. Though the actual useful lives of the machinery, the land improvements, and the buildings may exceed their tax useful lives, we believe that on the evidence, a depreciation factor based on a 50-year useful life was more reasonable. Second, the earnings capitalized by the petitioners' expert were far in excess of the income the property could reasonably be expected to produce. He used $212,000 as the income to be capitalized. However, under the lease, the annual rent was approximately $212,000 only until 1983, or for 16 years. Thereafter, the annual rent would be reduced to $62,500 for up to the next 30 years. The average annual rent over the possible 46 years remaining on the lease was $114,500, not $212,000. See Bryant Trust v. Commissioner,11 T.C. 374">11 T.C. 374, 380 (1948). Using a capitalization rate of 7 percent and average annual rent of $114,500, the capitalization of such earnings would produce a value far less than the sum of the outstanding mortgage liabilities and the depreciation recapture. 4 Furthermore, since the owner of the petitioners' interests either must pay $400,000 in 1983 or forfeit an undivided one-half interest in the301 rental payments under any and all extended terms of the lease, the average annual rent, and hence the income to be capitalized, must be adjusted downward to take such conditions into consideration. On the other hand, the analysis of the Commissioner's expert provides us with a fairly reliable estimate of the fair market value of the petitioners' interests in the property. Under his capitalization-of-earnings approach, he took into consideration that the terms and conditions of the lease have the effect of limiting the income-producing potential of the property to the designated rental payments, that the useful lives of the improvements on the property were 50 years or less, that at the expiration of the lease, there would be a nominal salvage value, and that as long as the lessor and lessee were not related parties, the lessee would not terminate the lease unless the fair rental value of the property declined to less than $62,500, in which case, the lessor's expected annual return would be less than302 such amount. In addition, the Commissioner has demonstrated that in this case, it is irrelevant whether the mortgage payments are factored out of each rental payment or the total liability is subtracted from the fair market value after the rental payments have been capitalized. In either case, the value of the petitioners' interests in the property is inssufficient to support charitable contribution deductions. Under his reproduction cost analysis, the Commissioner's expert reaches a similar result. Though we recognize that such method is less reliable than other methods, especially where a long-term lease is involved, such analysis does lend support to the Commissioner's determination that the petitioners are not entitled to charitable contribution deductions. The conclusion of the Commissioner's expert is strongly corroborated and conformed by several other factors. On five separate occasions, the petitioners' interests in the property were transferred and hence valued by independent market factors; on each of such occasions, the price paid for or allocated to such interests is in line with the Commissioner's conclusion. In 1963, when Wrexham acquired such interest, it303 assumed the outstanding liabilities but apparently paid no other consideration. Subsequently, in 1963, when four of the petitioners and Mr. Zuckerbrot acquired such property from Wrexham, they took the property subject to the outstanding liabilities and paid a cash consideration of only $125,000. In 1966, Clair Zuckerbrot, sole devisee under Mr. Zuckerbrot's will, conveyed a 5-percent interest in the property to the Werners without any consideration. In 1972, the hospital sold its interest in the property and the stock of Wrexham to Marchant for $115,000. Finally, in 1972, when Marchant and SCM conveyed their unencumbered lessor's and lessee's interests in the property, plus additional land, to Roper and Driver, only approximately $1,900,000 was allocated to the interest in the property which Marchant had acquired from the hospital. Such amount exceeded the mortgage which had just been discharged by only approximately $200,000. These transactions all involved the particular interests to be valued, and they reflect the market's valuation of such interests. Consequently, they represent persuasive evidence of the fair market value of those interests. See generally Ambassador Apartments, Inc. v. Commissioner,50 T.C. 236">50 T.C. 236 (1968),304 affd. per curiam 406 F.2d 288">406 F.2d 288 (2d Cir. 1969). The petitioners argue that some of these transactions are not indicative of the fair market value of the property. For example, they point out that the sales to Roper and Driver were in 1972 and that the sale by the hospital was allegedly for less than fair market value. Yet, the sales to Roper and Driver were as close to the valuation date as those comparables used by the petitioners' expert, and though the hospital may have been anxious to sell its interests in the property, we cannot believe that, as a public charity, it would have disposed of such interests at a price significantly lower than the value. The petitioners also claim that the transfer from Mrs. Zuckerbrot to the Werners was a family transaction, but they introduced no evidence to support such claim. What is most significant is that between 1963 and 1972, the petitioners' interests in the property were valued on the open market in five separate transactions, and in none of such transactions were such interests valued at a price in excess of the outstanding or discharged indebtedness plus the $200,000 of depreciation to be recaptured. The petitioners305 also raise three objections to the valuation approach employed by the Commissioner's expert, but there is no merit in such objections. First, they argue that they possessed certain "rights of ownership" with respect to the property which allowed them "to realize the full fair market value of the property at any time." However, such argument begs the question. Though it is true that the petitioners had several rights, including the right to sell their interests in the property, the right to terminate the lease upon default, the right to reject purchase offers, and the right to prepay the indebtedness in accordance with the terms of the indenture, the issue is not whether they possessed such rights, but how much would a willing buyer pay for their interests in the property which included such rights. Consequently, the petitioners' reliance on the Supreme Court's decision in Frank Lyons Co. v. United States,435 U.S. 561">435 U.S. 561 (1978), is misplaced, since that case merely decided who was to be treated as the owner of the property for depreciation purposes. Second, the petitioners argue that we should accept their capitalization-of-earnings analysis rather than the Commissioner's306 "annuity method." Both experts used capitalization-of-earnings approaches: The petitioners' expert used a so-called direct capitalization method, while the Commissioner's expert used an annuity capitalization method. The annuity capitalization method differs from the direct method primarily because it takes into consideration a compound interest factor, and because it distinguishes between returns on and returns of capital. See E. Friedman, Encyclopedia of Real Estate Appraising 41-62 (3d ed. 1978). Though the parties argue vigorously over which method is proper, it is not necessary for us to decide the issue; if the method of the petitioners' expert is properly applied--that is, a 7-percent capitalization rate is applied to a weighted average of the annual rental payments, it yields a fair market value which is similar to that determined by the Commissioner, and such value is insufficient to justify charitable contribution deductions. In addition, the petitioners' reliance on Honigman v. Commissioner,55 T.C. 1067">55 T.C. 1067 (1971), affd. 466 F. 2d 69 (6th Cir. 1972), and Gottlieb v. Commissioner,T.C. Memo. 1974-178, is misplaced. 307 Such cases merely decided the fair market value of the property at issue based on the evidence presented, which included a capitalization-of-earnings analysis by each party as well as other valuation methods; they did not hold that the capitalization-of-earnings methods used in those cases had to be used in all valuation cases. Similarly, Bryant Trust v. Commission,supra, does not require us to adopt the petitioners' valuation method. There, the petitioner had inherited property subject to a long-term lease under which the rentals in the first few years could be retained by the lessee to reimburse it for certain expenditures, and the issue involved the petitioner's basis in the property which under the applicable statutory provisions was the fair market value of the property on the date the devisor died. Citing Crane v. Commissioner,331 U.S. 1">331 U.S. 1 (1947), the Court held that the petitioner's basis in the property equaled the fair market value of the property on the date of the devisor's death undiminished by the rent which the lessee was permitted to retain. Then, the Court proceeded to determine the fair market value of the property. Absent308 the lease, the property had a fair market value of around $1 million, but because the lease limited the income from the property to the rental payments under the lease, the average annual rental payment over the term of the lease was capitalized to produce a value of approximately $530,000. Clearly, such case not only fails to support the petitioners' argument, but it supports the Commissioner's contention that the effect of the lease on the value of the petitioners' interests in the property must be considered. Third, the petitioners argue that section 1.170-1(d)(1), Income Tax Regs., requires the Commissioner to use a capitalization rate of 3-1/2 percent, since he is using an annuity capitalization method to value their interests. There is no merit in such argument. Section 1.170-1(d)(1) provides: (d) Transfers of income and future interest--(1) In general. A deduction may be allowed for a contribution of an interest in the income from property or an interest in the remainder * * . The income or remainder interest shall be valued according to the tables309 referred to in paragraph (d) of § 1.170-2. * * * The "tables referred to in paragraph (d) of § 1.170-2" are the tables in section 20.2031-7, Estate Tax Regs., which compute the present worth at 3-1/2 percent interest, compounded annually, of constant periodic payments over a designated number of years. By their own terms, such regulations apply only where the specific interest involved is an income or remainder interest. In such cases, the regulations specify which method is to be used to value the interest and how such method is to be applied. However, here, the petitioners owned the property and they trnasferred such ownership interests, and not an income or remainder interest, to the hospital. Under these circumstances, the regulations place no restrictions on the methods to be used to value such interests; they only require that the fair market value of such interests be ascertained. To obtain such fair market value, the parties used various capitalization-of-earnings, market, and reproduction cost methods. Even though one of such methods, the annuity capitalization method, was similar to the method the regulations require to be used to value income and remainder interests, 310 the Commissioner is not thereby required to use the capitalization rate specified by such regulations. Moreover, the 3-1/2 percent discount rate in such tables only considers the interest income which the annuitant must forego because he does not have the immediate use of the income stream. Yet, the capitalization rate which is appropriate in this case must take into consideration alternative investments, the risk factor, and the fact that a portion of the periodic payments represents a return of capital in addition to a return on capital. In conclusion, we hold that based on the evidence presented, the petitioners have failed to carry their burden of proving that the Commissioner erred in determining that the fair market value of their interests in the property did not exceed the sum of the outstanding indebtedness at the time of the gift plus the $200,000 depreciation recapture. The second issue for decision is whether any part of the petitioners' underpayment of tax for each of the years in issue was due to negligence or intentional disregard of rules and regulations within the meaning of section 6653(a). 311 The petitioners also have the burden of proof on this issue. Vaira v. Commissioner,444 F. 2d 770 (3d Cir. 1971), affg. on this issue 52 T.C. 986">52 T.C. 986 (1969); Rosano v. Commissioner,46 T.C. 681">46 T.C. 681 (1966).To meet such burden, they argue only that the method used by Mr. Warner to compute the value of their interests in the property was reasonable. We disagree. To value the property, Mr. Werner, a tax attorney, contacted a national brokerage firm in New York. He asked someone at such firm if there was a general rule for valuing mortgaged property, and he was informed that financial institutions in many instances will not lend more than 65 percent of the appraised value of the property. Using such information, Mr. Werner simply multiplied the cost of constructing the improvements by 150 percent, and he increased such amount to reflect 3 years of appreciation in value, resulting in a total value of approximately $4,200,000 for the property. In our view, such method of valuing the property was at the very least negligent. Mr. Werner is apparently an experienced tax attorney, who must have been aware of the importance of a bona fide estimate312 of fair market value, and who was intimately involved in the various negotiations and transactions involving the property. He was aware of how much it cost to build the improvements on the property; he was aware of how much Wrexham paid for such property; he was aware of how much the petitioners paid for their interests in the property; and he was aware of the substantial tax benefits to be derived from placing a high value on the property. As a professional man intimately familiar with all such transactions, Mr. Werner must have realized that his method of computing value was not at all reliable. Insofar as the record discloses, he did not reveal to the spokesman at the brokerage firm any information concerning the terms and conditions of the lease, the indenture, and the assignment to which the property was subject.As an experienced attorney, he must have been aware that the general observation of the spokesman was not relevant to financing transactions of this type and that in many such transactions, the amounts lent exceed 65 percent of the value.Moreover, he had no knowledge that any such limit was in effect in South Carolina. Nor can the other petitioners escape responsibility313 for their conduct by claiming that they relied on Mr. Werner. Though he is an attorney, he was not, so far as this record reveals, acting as an attorney for them at that time, and they have not claimed that they relied upon him as their attorney in such matter. They relied upon his determination of value, and they must bear the consequences of his action. Moreover, the result of Mr. Werner's computation of value was that the petitioners' interests in the property increased in value more than ten times in a period of about 4 years; though such a rapid increase in value was not unprecedented in those times, it was unusual, and it should have caused the petitioners to question Mr. Werner's results. On the basis of this record, we hold that the petitioners have failed to carry their burden of showing that the underpayments of tax were not due to negligence or the intentional disregard of rules and regulations. Decisions will be entered under Rule 155.Footnotes1. Cases of the following petitioners are consolidated herewith: Mary Hemingway, docket No. 4809-72; Lila Werner, docket No. 5057-72; Estate of Maurice Urdang, Leonore Urdang, Executrix, and Leonore Urdang, docket No. 5058-72; William J. Werner, docket No. 5059-72; and Joseph Abrams and Mildred Abrams, docket No. 5060-72.↩2. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue.↩3. The parties stipulated to the total amount paid and as to the component parts of such total. However, these figures add up to $1,695,775.90↩4. Using a capitalization rate of 7 percent, average annual rent would have to exceed $165,000 before the petitioners would be entitled to charitable contribution deductions.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623446/	APPEAL OF HUB SHOE CO.Hub Shoe Co. v. CommissionerDocket No. 1170.United States Board of Tax Appeals2 B.T.A. 836; 1925 BTA LEXIS 2249; October 12, 1925, Decided Submitted April 9, 1925. 2249 When a business conducted by a corporation is continued after its charter expires by limitation, the income is not taxable to the corporation, which has no existence either de jure or de facto.Edwin C. Dutton and D. R. Hutchinson, Esqs., for the taxpayer. B. G. Simpich, Esq., for the Commissioner. 836 Before STERNHAGEN, TRAMMELL, and PHILLIPS. This appeal is from the determination of a deficiency in income and profits taxes for the year 1919 in the sum of $5,209.93. From the 837 depositions of witnesses taken under an order of this Board and the documentary evidence, the Board makes the following FINDINGS OF FACT. The Hub Shoe Co. was a Michigan corporation formerly engaged in the retail shoe business at Flint. The company was organized June 1, 1909, and the charter provided for a term of existence of 10 years. In 1910 Elwyn Pond acquired all of the stock of the corporation and it was all transferred into his name, except for certain qualifying shares which he controlled. This ownership continued during the period in question in this appeal. For some years prior to 1919 the taxpayer was conducting its business at2250 223 South Saginaw Street under a lease which expired April 15, 1919. The Taxpayer continued to do business in this store for from 30 to 35 days after the expiration of the lease, attempting to sell out its old stock. This lease stood in the name of Pond and was never transferred to the corporation. In August, 1918, Pond entered into a lease for the premises at 410 South Saginaw Street for a period of 10 years from May 1, 1919. The premises were not ready for occupancy on that date and no business was conducted in the new store until on or about June 13, 1919. While the business was being transacted in the old store one Benedict was employed as a salesman. It was agreed between him and Pond that when the business was moved into the new store he should share in the profits. Before the removal to the new store efforts were made to dispose of all of the stock in trade of the old store as it was the desire of both parties that the new store should start with a new line of stock. The taxpayer claims that the business in the new store was conducted by a partnership consisting of Pond and Benedict. The Commissioner claims that the business in the new store continued to be conducted2251 by the corporation until October 14, 1919, and has determined a deficiency in the income and profits taxes for 1919 upon this basis. The bank deposits of the new store were entered on the same pass book as was used for the old store, the name appearing upon the bank book being "Hub Shoe Store." The transactions of the new business were all entered on the same books as had been used to record the transactions of the old store. Under date of September 13, 1919, the attorneys for the company forwarded to the Secretary of State of Michigan a certificate of increase of capital stock of the company, together with $19 in payment of fees. This certificate was returned to the attorney by the Secretary 838 of State on September 17, 1919, with a letter calling attention to the fact that the corporate term of the corporation had expired by limitation on May 31, 1919. On September 23, 1919, the attorney wrote the Secretary of State as follows: We have your letter of recent date returning certificate of increase of the Capital Stock of the Hub Shoe Company and stating that the franchise of this company had expired by limitation. The stockholders of this company have decided2252 to form a copartnership instead of a new corporation. You will therefore please return to us $19.00 forwarded to you with the certificate of increase. Also please send us some blank notices of dissolution; also blank articles of association for corporation organized under Act No. 232, Public Acts of 1903. On October 14, 1919, Pond and Benedict entered into an agreement of partnership in which it was provided, among other things, "The firm name of the partnership shall be the Hub Shoe Store," "the term for which the said partnership is organized is ten years from and after May 1st, 1919," "the capital of said firm is to be the sum of thirty-five thousand ($35,000), of which Elwyn Pond is to contribute thirty-four thousand ($34,000), and Lewis D. Benedict is to contribute one thousand ($1,000) dollars on or before October 1, 1919." Under date of October 14, 1919, a notice of dissolution of the corporation was prepared which was recorded November 3, 1919. Under date of October 14, 1919, Pond and Benedict caused to be executed and filed a certificate that they were doing business under the name and style of "Hub Shoe Store," this certificate being required by law. Thereafter2253 the partners caused their accountants to prepare partnership books of account, entering in these books all transactions which took place in connection with the operation of the new store from June 13, 1919. DECISION. The deficiency determined by the Commissioner is disallowed.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623448/	PETER C. CHEN ans NATALIA L. CHEN, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, RespondentChen v. CommissionerDocket No. 2071-78.United States Tax CourtT.C. Memo 1979-407; 1979 Tax Ct. Memo LEXIS 118; 39 T.C.M. (CCH) 273; T.C.M. (RIA) 79407; September 26, 1979, Filed Peter C. Chen, pro se. Jerrome Duncan, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined a deficiency of $2,906 in petitioners' 1974 Federal income tax. The sole issue for decision is whether a $13,000 National Institute of Health grant received by petitioner Peter C. Chen during the taxable year 1974 is excludible from his gross income under section 117. 1FINDINGS OF FACT Some of the facts have been stipulated and are so found. At the time of filing their petition herein, Peter C. Chen (hereinafter petitioner) and his wife Natalia119 L. Chen, resided in Irvine, Calif.During 1974 petitioner was a candidate for a Ph.D. in Biomedical Engineering at Rutgers University (Rutgers), New Brunswick, New Jersey. The Biomedical Engineering program is a joint program between the Electrical Engineering Department and the Medical School at Rutgers. In an effort to obtain financial aid while he worked on his Ph.D., petitioner contacted Dr. Walter Welkowitz, Ph.D., the chairman of the Electrical Engineering Department at Rutgers. Dr. Welkowitz, Ph.D., in turn contacted Dr. Victor Parsonnet, M.D., who was a professor at Rutgers Medical School and Director of Surgery at Newark Beth Israel Medical Center (Medical Center) in Newark, New Jersey. In June 1974 the Medical Center applied for an subsequently received a research grant from the National Institute of Health (N.I.H.) to study the electrophysiology of pacemaker electrodes in order to extend the life of pacemakers implanted in humans. In the N.I.H. grant application, Dr. Parsonnet, M.D., was listed as the research grant director. The application also indicated that the subject of the research was petitioner's thesis topic and the petitioner's role in the project would120 be that of biomedical engineer. Because of petitioner's academic background, he was awarded $12,999.92 of the grant in 1974 by Dr. Parsonnet, M.D., to conduct research on extending the life of implanted pacemakers to satisfy the research requirement for his Ph.D. At Rutgers, research was required of all Ph.D. candidates. Rutgers, however, did not have the facilities petitioner needed to conduct experiments and do his research. Since the Medical Center was affiliated with Rutgers Medical School, petitioner was allowed to use the animal laboratory at the Medical Center to conduct his experiments. The experiments petitioner conducted were only upon animals. While petitioner used the Medical Center laboratory, he saw no hospital patients and provided no other services for the Medical Center. The laboratory petitioner used was in a different building than the hospital at the Medical Center. In addition, in a stipulated exhibit which is a letter dated March 4, 1975, Dr. Philip Katz, Ph.D., the Director of Biomedical Engineering at the Medical Center, stated that all of the research petitioner did at the Medical Center was directly related to petitioner's thesis, and that due to121 the specific nature of petitioner's research petitioner did not occupy a position that would normally be filled at the Medical Center and upon completion of petitioner's research he would not be replaced. Petitioner was required to complete 24 Credit hours of research for his Ph.D. at Rutgers. During Spring semester in 1974, petitioner was enrolled in 6 credit hours of research and in the Fall semester in 1974 petitioner was enrolled in 3 credit hours of research. To receive credit toward his Ph.D. for his research, petitioner was required to spend 4 to 5 hours per week for each credit hour of research in which he was enrolled. Thus, during 1974 petitioner spent between 30 and 45 hours per week doing research at the Medical Center animal laboratory. However, petitioner had no regularly scheduled hours during which he was required by the Medical Center to be in the laboratory. Petitioner was allowed to use the laboratory on an hourly basis only when it was not being used by the Medical Center employees. Although petitioner's experiments were not graded individually, he was required to regularly report to his advisor in the Electrical Engineering Department at Rutgers, Dr. Fich, 122 Ph.D. However, as is typical in Ph.D. programs, petitioner would receive a grade of satisfactory or unsatisfactory on his entire research project. Petitioner was paid biweekly through the Medical Center payroll for purposes of administrative convenience. Both income tax and social security tax were withheld from the amount paid to petitioner. The $12,999.92 that petitioner received during 1974 from the Medical Center was charged to the N.I.H. grant by the Medical Center. On his Federal income tax return for 1974, petitioner exclude $13,000 2 as a fellowship grant from the N.I.H. In his statutory notice of deficiency, respondent determined that the entire amount excluded by petitioner was taxable income. OPINION The sole issue for our decision is whether the $13,000 N.I.H. grant received by petitioner in 1974 is excludible from his gross income under section 117. 123 Section 117(a)(1) provides as a general rule that any amount received as a scholarship or Fellowship grant is excludible from gross income. The terms "scholarship" and "fellowship grant" are not defined in the statute. Section 1.117-3, Income Tax Regs., defines them as amounts paid to an individual to aid him in his studies or research. In addition, section 1.117-4(c)(2), Income Tax Regs., provides that amounts paid to "an individual to enable him to pursue studies or research are considered to be amounts received as a scholarship or fellowship grant * * if the primary purpose of the studies or research is to further the education and training of the recipient in his individual capacity" and the amount provided by the grantor for such purposes does not represent compensation or payment for services. Section 1.117-4(c)(2), Income Tax Regs., also provides that "neither the fact that the recipient is required to furnish124 reports of his progress to the grantor, nor the fact that the results of his studies or research may be of some incidental benefit to the grantor shall, of itself, be considered to destroy the essential character of such amount as a scholarship or fellowship grant." However, the terms "scholarship" and "fellowship grant" do not include any amount paid which "represents either compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor." Sec. 1.117-4(c)(1), Income Tax Regs.The Supreme Court sustained the validity of these regulations in Bingler v. Johnson, 394 U.S. 741 (1969). The Court stated that the definitions supplied by these regulations clearly are prima facie proper, comporting as they do with the ordinary understanding of "scholarships" and "fellowships" as relatively disinterested, "no strings" educational grants, with no requirement of any substantial quidproquo from the recipients. 394 U.S. at 751. Thus, under these regulations 125 the distinction between a scholarship or fellowship grant and a payment of compensation turns on whether the primary purpose for making the grant was to enable the recipient to pursue study or research to further his education or training in his individual capacity or whether the primary purpose was to compensate him for past, present, or future services. Adams v. Commissioner, 71 T.C. 477">71 T.C. 477, 486 (1978); Carroll v. Commissioner, 63 T.C. 96">63 T.C. 96, 103 (1973). In other words, was the recipient paid to work or paid to study? Zolnay v. Commissioner, 49 T.C. 389">49 T.C. 389, 396 (1968). This is question of fact. Zolnay v. Commissioner, supra at 395; Wells v. Commissioner, 40 T.C. 40">40 T.C. 40, 47 (1963); Bhalla v. Commissioner, 35 T.C. 13">35 T.C. 13, 17 (1960). In addition to the requirement that the amounts received constitute a scholarship or fellowship grant, section 117(b) places a further limitation on the exclusion of such amounts from gross income. Section 117(b)(1) provides that in the case of a candidate for a degree126 at an educational institution, as defined in section 151(e)(4), 3 no exclusion is followed for any amounts received which represent payment for teaching, research, or other services in the nature of part-time employment required as a condition to receiving the scholarship or fellowship grant. However, section 117(b)(1) also contains an exception to this limitation. Where teaching, research, or other services are required of all candidates for a particular degree as a condition to receiving such degree, such teaching, research, or other services shall not be regarded as part-time employment. The effect of this exception is to permit the exclusion from gross income of amounts received as a scholarship or fellowship grant where teaching, research, or other services are required of all candidates for a particular degree. Reese v. Commissioner, 45 T.C. 407">45 T.C. 407, 414 (1966), affd. per curiam 373 F.2d 742">373 F.2d 742 (4th Cir. 1967). 127 In the present case, respondent first argues that the primary purpose of the $13,000 N.I.H. grant petitioner received was to compensate him for services rendered to the Medical Center and, therefore, the grant was not excludible from petitioner's gross income in 1974 as a scholarship or fellowship grant under section 117(a)(1). Respondent's second argument is that research services were not required of all Ph.D. candidates at Rutgers and, hence, the limitation in section 117(b)(1) prevents petitioner from excluding the grant from gross income. Petitioner, on the other hand, maintains that the sole purpose of the grant he received was to enable him to perform experiments and conduct research necessary to satisfy the research requirement for his Ph.D. and since all Ph.D. candidates at Rutgers were required to do research, he is entitled to exclude the $13,000 N.I.H. grant he received from his gross income in 1974.Based on the record as a whole, we find that the primary purpose of the $13,000 N.I.H. grant received by petitioner in 1974 was to enable him to further his education and not to compensate him for services rendered at the Medical Center. We do not believe that the Medical128 Center required a substantial quidproquo from petitioner in return for the grant he received. We therefore conclude that this grant constituted a "fellowship grant" within the meaning of section 117(a)(1). 4 Our decision rests on several factors. To begin with, because of petitioner's academic background he was awarded the N.I.H. grant by Dr. Parsonnet, M.D., the research grant director, to conduct research on extending the life of implanted pacemakers to satisfy the research requirement for his Ph.D. In addition, the research petitioner conducted formed the basis of his thesis, the topic of which was the extension of the life of implanted pacemakers in humans. Thus, 129 it is clear that the primary purpose of the research petitioner conducted in the Medical Center laboratory was to satisfy the requirements for his Ph.D. and thereby further his education. That petitionerhs research may have been of some incidental benefit to the Medical Center does not destroy the essential character of petitioner's N.I.H. grant as a "fellowship grant." See Sec. 1.117-4(c)(2), Income Tax Regs.In addition, the only reason petitioner used the animal laboratory at the Medical Center was because Rutgers did not have the facilities that petitioner needed to conduct experiments and do his research. While petitioner used the Medical Center animal laboratory he saw no hospital patients and provided no other services for the Medical Center. In fact, the animal laboratory was in a different building than the hospital at the Medical Center. Furthermore, in a letter dated March 4, 1975, Dr. Katz, Ph.D., the Director of Biomedical Engineering at the Medical Center, stated that all of the research petitioner did at the Medical Center was directly related to petitioner's thesis, and that due to the specific nature of petitioner's research petitioner130 did not occupy a position that would normally be filled at the Medical Center and upon completion of petitioner's research he would not be replaced. Moreover, while petitioner spent between 30 and 45 hours per week doing research at the Medical Center laboratory, he had no regularly scheduled hours during which he was required by the Medical Center to be in the laboratory. On the contrary, petitioner was allowed to use the laboratory on an hourly basis only when it was not being used by the Medical Center employees. Finally, petitioner was plaid biweekly through the Medical Center payroll only for purposes of administrative convenience. The $12,999.92 that petitioner received during 1974 from the Medical Center was actually charged to the N.I.H. grant by the Medical Center. That the Medical Center withheld both income taxes and social security taxes from the amounts paid to petitioner does not by itself lead us to the conclusion that the payments the Medical Center made to petitioner were for services rendered. See Bhalla v. Commissioner, 35 T.C. at 17. Having concluded that the N.I.H. grant received by petitioner constituted a "fellowship grant" within131 the meaning of section 117(a)(1), we turn to respondent's second argument that research services were not required of all Ph.D. candidates at Rutgers and, therefore, the limitation in section 117(b)(1) prevents petitioner from excluding the grant from his gross income. Under section 117(b)(1) a degree candidate is allowed no exclusion for amounts received which represent payment for research in the nature of part-time employment that is required for receipt of a fellowship grant. However, this same section contains an exception which permits exclusion of amounts received in payment for research when such research is required of all degree candidates. Although respondent recognizes that all Ph.D. candidates at Rutgers were required to do research, he claims that the exception to the section 117(b) limitation applies only when equivalent research is required of all candidates for a particular degree. Respondent further argues that this exception is inapplicable here because petitioner performed research services for the Medical Center in exchange for his grant, and, thus, petitioner's research was not equivalent to the reserach required of all other Ph.D. candidates at Rutgers132 because it was in the nature of employment. Since we have already held that the primary purpose of the grant was to further petitioner's education and not to compensate him for services rendered to the Medical Center, we disagree with respondent's argument that petitioner's research was not equivalent to the research required of all other Ph.D. candidates at Rutgers. The N.I.H. grant that petitioner received simply gave him the opportunity to complete the research required of all Ph.D. candidates at Rutgers. Thus, we do not believe that petitioner's receipt of this grant created an inequality between petitioner's research and the research required of all other Ph.D. candidates at Rutgers. We, therefore, conclude that the exception to the limitation in section 117(b)(1) is applicable here and, consequently, petitioner is not prevented from excluding his "fellowship grant" from gross income because he was required to conduct research to obtain his Ph.D. at Rutgers. 5133 Accordingly, we hold that the $13,000 N.I.H. grant received by petitioner during 1974 is excludible from his gross income under section 117. To reflect the foregoing, Decision will be entered for the petitioners. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended.↩2. Although the amount of the N.I.H. grant received by petitioner during 1974 was actually $12,999.92, in claiming a $13,000 exclusion on his return it is obvious that petitioner merely rounded off the amount of the grant to the nearest dollar.↩3. Sec. 151(e)(4) defines the term "educational institution" as one which "normally maintains a regular faculty and curriculum and normally has a regularly organized body of students in attendance." In Sec. 1.117-3(e), Income Tax Regs.↩, the term "candidate for a degree" is defined as an individual who is pursuing studies or conducting research to meet the requirements for an academic or professional degree, conferred by a college or university. It is not essential that such study or research be pursued or conducted at an educational institution which confers such a degree if the purpose thereof is to meet the requirements for a degree of a college or university which does confer such a degree. In the present case, the parties do not dispute the fact that Rutgers was an "educational institution" or that petitioner was a "candidate for a degree" at such institution.4. The cases cited by respondent: Bingler v. Johnson, 394 U.S. 741">394 U.S. 741 (1969); Zolnay v. Commissioner, 49 T.C. 389">49 T.C. 389 (1968); Reese, Jr. v. Commissioner, 45 T.C. 407">45 T.C. 407 (1966), affd. per curiam 373 F.2d 742">373 F.2d 742 (4th Cir. 1967), are distinguishable from the present case on their facts. In each of those cases the Court made a finding that the taxpayer received compensation in exchange for services, i.e., there was a quidproquo↩.5. In support of his argument, respondent cites Sweet v. Commissioner, 403">40 T.C. 403 (1963). Although the Court in that case held that under sec. 117(b)(1) the grant received by the taxpayer was not excludible from gross income, it did so because the research performed by the taxpayer was not required of all other candidates for the degree he was seeking and because the taxpayer did not receive credit toward his degree for the research done. In the present case, it is clear that the research required of petitioner was also required of all other Ph.D. candidates at Rutgers and that petitioner received credit toward his Ph.D. for his research. Sweet v. Commissioner↩, is therefore distinguishable.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623560/	OREN F. POTITO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent OREN F. POTITO and HELEN M. POTITO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPotito v. CommissionerDocket No. 5304-68, 5305-68.United States Tax CourtT.C. Memo 1975-187; 1975 Tax Ct. Memo LEXIS 185; 34 T.C.M. (CCH) 804; T.C.M. (RIA) 750187; June 16, 1975, Filed 185 William R. Frazier, for the petitioners. Robert J. Shilliday, Jr., for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner determined deficiencies in petitioners' Federal income tax and additions to tax as follows: Additionto TaxTaxableIncome TaxSec. 6653(a) PetitionerDocket No.YearDeficiencyI.R.C. 1954Oren F. Potito5304-681963$2,156.18$107.81Oren F. Potito5304-6819642,170.19108.51Oren F. Potito& Helen M. Potito5305-681965574.0328.70 The cases were consolidated for trial, briefs and opinion. The following issues are presented for decision: 1. Whether petitioners omitted from their taxable income for the years 1963, 1964 and 1965, $1,100.68, $2,702.65, and $1,632.40, respectively, deposited in a checking account maintained by the Church of Jesus Christ-Christian and derived from amounts received for publication and distribution of the National Christian News newspaper and from donations by those attending church meetings; 2. Whether petitioner is taxable in the year 1963 on $2,920 in deposits made to a checking186 account maintained in the name of National Engineering Company; 3. Whether petitioner is taxable on $1,000 allegedly received for the purchase of silver in the taxable year 1963; 4. Whether a boat, motor and trailer received by petitioner in 1964 are income to him in that year at a value of $2,500; 5. Whether petitioners are entitled to part or all of the business expenses disallowed for the years 1963, 1964 and 1965 in the amount of $2,848.08, $2,502.45 and $916.10, respectively; 6. Whether petitioners are entitled to depreciation deductions of $1,124.66, $1,749.66 and $1,749.66 claimed on Federal income tax returns for the years 1963, 1964 and 1965, respectively; and 7. Whether petitioners are liable for the 5 percent negligence penalty prescribed by section 6653(a), Internal Revenue Code of 19541 for each of the years in issue. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated by this reference. At the time the petitions187 were filed, Oren F. Potito (hereinafter referred to as petitioner) and Helen M. Potito were husband and wife and resided in Ocala, Florida. Prior to his marriage to Helen in 1965, petitioner resided in St. Petersburg, Florida. Petitioner filed individual income tax returns for 1963 and 1964, and petitioners filed a joint return for 1965, all with the District Director of Internal Revenue, Jacksonville, Florida. Petitioner was the sole proprietor of Continental Engineering which had no permanent employees. Continental Engineering derived its income from servicing television sets and air conditioners owned by various motels located on beaches in the vicinity of St. Petersburg, Florida. Continental Engineering received a minor portion of its gross receipts from the sale, installation, and servicing of air conditioners, television sets, refrigerators, electronic equipment and appliances. Deposits to Continental Engineering's bank account at the St. Petersburg Bank & Trust Company were as follows: 196319641965$943.00$1,917.00$3,742.23 Petitioner did not deposit all of Continental Engineering's gross receipts in its bank account. His only record of Continental188 Engineering's gross receipts was the Continental Engineering bank account statements. Petitioner did not keep accurate records of his income as it was received. On his 1963, 1964 and 1965 income tax returns, petitioner reported gross receipts from Continental Engineering business of $7,320 for 1963, $8,730 for 1964, and $7,300 for 1965. The business deductions which petitioner itemized on his 1963, 1964 and 1965 income tax returns were attributable to Continental Engineering and not any other enterprise. The printing expense deducted each year was an expense of Continental Engineering and not the church. The depreciation deductions taken by petitioner on his 1963, 1964 and 1965 income tax returns were based on costs and useful lives of various business assets used in this Continental Engineering business. The Mercedes Benz automobile which was reported as a depreciable asset in each year was used for Continental Engineering service calls, personal transportation, and occasionally for speaking engagements. Petitioners' income tax returns for the taxable years 1963, 1964 and 1965 were prepared from written summaries of their records which were provided the return preparer in each189 of those years. The information contained in the written summaries was properly transferred to the returns by the return preparer. The gross receipts which petitioner entered on these written summaries were solely Continental Engineering gross receipts. The return preparer described the gross receipts as Continental Engineering gross receipts because petitioner had told her that his only source of income was from Continental Engineering. Petitioners' income tax returns for 1963, 1964 and 1965 do not report any income from church or other income-producing activities. Petitioners' gross receipts from Continental Engineering in 1963, 1964 and 1965 were $7,320, $8,730 and $7,300, respectively. Petitioner reported a net profit of $328.74 and $817.90 on his 1963 and 1964 income tax returns, and petitioners reported a loss of $297.66 on their 1965 return. On their income tax returns for the taxable years 1963, 1964 and 1965, petitioners claimed depreciation deductions of $1,124.66, $1,749.66 and $1,749.66, respectively. Petitioners did not pay any Federal income taxes for the taxable years 1963, 1964 and 1965. Petitioner, however, paid $44.17 in self-employment tax for the taxable year190 1964. Petitioner reported that his disposable income (depreciation plus net profit minus taxes paid) in 1963, 1964 and 1965 was $1,453.40, $2,523.39 and $1,452, respectively. On his income tax return for the taxable year 1964, petitioner claimed to have incurred $910 in doctor, hospital, dentist and drug expenses; $120 in interest on automobile loan; and $76 in taxes. Petitioner's disposable income remaining after these expenses for 1964 was $1,417.39. Petitioners incurred and paid medical expenses of $44 in 1963 and $213.25 in 1965. Petitioner purchased a Mercedes Benz automobile in 1962 for $6,700. Petitioner financed $6,500 of this amount at a bank but the terms of payment are unknown. In 1963, petitioner purchased a microfilm camera and viewer for $275, a vacuum cleaner for $249.50, a tape recorder for $395, tear gas pens for $60, and several groups of books for $355.06. In addition, petitioner purchased a 1964 Volkswagen bus in 1963 for $2,500. The record does not disclose the terms of payment. Petitioner purchased a 1963 red Chrysler convertible in 1963 for an undisclosed amount. Petitioner paid $101 for a patent, $280 for a linotype machine, $100 for a generator, $95191 for a press and $132.82 for radios in 1964. In 1965, petitioners paid $113.25 for radio equipment, $577.48 for furniture, $55.62 for a boat top and $35 for his wedding. Petitioner leased a home in Ocala, Florida, in 1965 paying $100 per month for six months as rent for his personal living quarters. Petitioner lived comfortably during 1963, 1964 and 1965 eating at good restaurants and dressing well, etc. In 1963, 1964 and 1965, petitioner expended a substantial amount of funds on personal living expenses including mower repairs, veterinary expenses, books and magazines, insurance, utilities, garbage collection, furniture, jeep repairs, repairs on other personal items, food, clothing, restaurant bills, and other miscellaneous living expenses. Petitioners' expenditures substantially exceeded reported disposable income in 1963, 1964 and 1965. Petitioners received income in taxable years 1963, 1964 and 1965 which was not reported on their income tax returns. After petitioner was designated a minister by the president of the Church of Jesus Christ-Christian (church), an organization chartered in California, he was allowed to establish his own church in St. Petersburg, Florida. Petitioner's192 church was a separate entity from the California organization. It was not recognized by the St. Petersburg Council of Churches. A minister of the church was required to have knowledge of the Bible and fully understand church doctrine. The followers of the church believed that the real biblical Israelites were the Anglo-Saxon race. During the years in issue, petitioner spoke at several churches and other establishments which were rented by his church. Petitioner held three meetings per week for the members of his church with attendance at each meeting varying from 15 to 550 people. Petitioner received income from his church members in the form of cash payments, food, clothes and reimbursement of his expenses. Petitioner exercised exclusive control over all cash receipts. He did not formally designate a portion of the cash receipts as salary, but spent the money on himself, for church or other activities at his sole discretion. Petitioner had no records of cash receipts from church members other than the bank statements of the church account at the St. Petersburg Bank & Trust Company, St. Petersburg, Florida. The deposits into the church account totaled $1,100.68 in 1963; $2,702.65193 in 1964; and $1,632.40 in 1965. Petitioner had sole authority to withdraw funds from this bank account. Petitioner was publisher, editor and distributor of the National Christian News (the newspaper) which was a church-related, income-producing activity. During the years in issue, petitioner normally had 5,000 copies of the newspaper printed each month and paid for the printing by drawing checks on the church account. The yearly subscription cost for a single copy of the newspaper was $2 in 1963, 1964 and 1965. The newspaper could also be purchased in 100 paper lots for $3 for distribution aimed at increasing circulation. Some of the funds deposited in the church account were derived from news subscriptions. Petitioner had no records of receipts from newspaper sales other than the church bank statements. The newspaper was partially distributed through the mails at bulk rates. The postal bulk rate was 2-5/8 cents in 1963; 2-3/4 cents in 1964; and 2-7/8 cents in 1965. Expenditures for postage stamps were as follows: 1963$406.731964738.731965451.58 The average number of subscribers to the newspaper in 1963, 1964 and 1965 was 1,291, 1,368 and 2,141, respectively. 194 Petitioners' income from the newspaper subscriptions in 1963, 1964 and 1965 was $2,582, $2,736 and $4,282, respectively. Petitioner omitted from his income tax returns for taxable years 1963, 1964 and 1965 at least $1,100.68, $2,702.65 and $1,632.40, respectively, which were the funds deposited in the church bank account. In response to representations that he could develop a workable automobile cooler which would revolutionize automobile air conditioning and yield huge profits, in 1963 a Mr. and Mrs. Whitman placed $2,920 at petitioner's disposal in a bank account in the First Park Bank, Pinellas Park, Florida. Petitioner was to organize a corporation called National Engineering as the business vehicle through which the coolers would be developed, manufactured and marketed. The corporation was never organized. Although these funds were to be used in developing the cooler, petitioner was secretive about expenditures from the account resulting in the Whitmans' decision to close the account in 1964 or 1965 and withdraw the $1,300 balance which remained. One thousand six hundred and twenty dollars of the $2,920 made available to develop the cooler was unaccounted for and is taxable195 to petitioner in 1963. In May 1963, petitioner received $1,000 from the Whitmans to purchase silver for the Whitmans who never received the silver. The $1,000 which petitioner received from the Whitmans in 1963 for silver constitutes taxable income to him in 1963. Petitioner received a new 19-foot Seabreeze boat, 80-horsepower Westbend motor and boat trailer in 1964 from Mr. and Mrs. Ernest Stevens in payment for his services as their minister which petitioner did not include in his income for 1964. The boat, motor and trailer are includible in petitioner's taxable income in the year 1964 at a value of $2,500. For the taxable year 1963, the Commissioner allowed petitioner the following business expenses: Rent$ 375.00Telephone180.15Repairs110.25Transportation137.45Travel110.00Storage and Equipment Rental16.20Parts and Equipment for Resale379.62Advertising56.50Labor205.00Post Office Box Rent9.00Postage406.73Printing and Supplies916.76Subscriptions8.00Other107.86TOTAL$3,018.52 On his 1963 income tax return, petitioner claimed the following business expenses: Materials and Supplies$1,944.00Depreciation1,124.66Other Expenses: Phone$1,240.00Licenses65.00Gas & Oil603.00Insurance90.00Office Expense600.00Printing50.00Dues13.00Entertainment &Promotion52.00Car Repairs416.10Tax Return Expense20.00Tolls100.00Travel Expense500.00Tool Rental25.00Laundry & Uniforms114.00Auto & Trailer34.503,922.60TOTAL$6,991.26196 At trial, petitioner contended that his business records proved he was entitled to the following business expenses for 1963: Rent$ 803.00Repairs606.86Telephone235.30Labor178.05Supplies1,195.32Printing855.96Travel294.92TOTAL$4,169.41 Petitioner failed to show he was entitled to business expenses for the taxable year 1963 in excess of those allowed by the Commissioner. For taxable year 1964, the Commissioner allowed petitioner the following business expenses: Rent$ 250.00Telephone240.11Repairs143.77Transportation236.96Storage and Equipment Rental49.55Parts and Equipment for Resale284.33Advertising95.08Labor148.00Post Office Box Rent18.00Postage738.73Printing and Supplies1,177.49Travel122.31Other155.66TOTAL$3,659.99 On his 1964 income tax return, petitioner claimed the following business expenses: Cost of Goods Sold$2,010.00Depreciation1,749.66Repairs & Maintenance530.00Insurance110.00Tax Return Preparation20.00Interest172.44Other Expenses: Telephone$1,380.00Licenses80.00Gas & Oil640.00Printing60.00Tolls100.00Travel Expenses800.00Laundry & Uniforms150.00Auto Tags45.00Entertainment &Promotion52.00Dues13.003,320.00TOTAL$7,912.10197 Petitioner contended at trial that his business records proved he was entitled to the following business expenses for 1964: Printing$ 1,279.03Telephone116.40Travel48.85Postage78.84Licenses113.96Supplies1,750.99Repairs882.05Rent1,574.16TOTAL$5,844.28 Petitioner failed to prove he was entitled to business expenses for the taxable year 1964 in excess of those allowed by the Commissioner. For taxable year 1965, the Commissioner allowed petitioners the following business expenses: Rent$1,325.00Telephone & Telegraph307.30Repairs166.22Transportation204.43Travel215.00Storage & Equipment Rental67.95Parts and Equipment for Resales744.67Advertising128.03Dues5.00Labor103.25Taxes and Licenses113.55Post Office Box Rent3.00Postage451.58Printing & Supplies1,069.85Subscriptions3.00Other24.07TOTAL$4,931.90 On their 1965 income tax return, petitioners claimed the following business expenses: Cost of Goods Sold$2,300.00Depreciation1,749.66Rent200.00Tax Return Preparation20.00Other Expenses: Phone$ 740.00Gas & Oil550.00Printing80.00Tolls50.00Travel Expense1,500.00Laundry & Uniforms100.00Auto Tags45.00Entertainment &Promotion250.00Dues13.003,328.00Total$7,597.66198 Petitioners contended at trial that their business records proved they were entitled to the following business expenses for 1965: Supplies$2,363.27Travel90.42Telephone553.06Postage352.59Repairs31.42Labor250.68Rent1,650.00Printing1,178.67TOTAL$6,470.11 Petitioners failed to show they were entitled to business expenses for the taxable year 1965 in excess of those allowed by the Commissioner. The expenses allowed in the statutory notices adequately recognized the expenses petitioners were able to prove. Petitioners understated the taxable income shown on the 1963, 1964 and 1965 income tax returns by overstating business expenses as follows: 196319641965Expenses claimedless depreciation$5,866.60$6,162.44$5,848.00Expenses allowed3,018.523,659.994,931.90Increase in Income$2,848.08$2,502.45$ 916.10The description of each of petitioners' depreciation deductions (based on the straight line method of computing depreciation) contained in the returns for the taxable years 1963, 1964 and 1965 is as follows: 1963YearUsefulDepreciation AssetCostAcquiredLifeDeduction1961 Mercedes Benz$5,387.4019624$1,096.85Less: 10% personal109.69$ 987.16Office Furniture125.0019571012.50Office Furniture &Equipment193.0019591019.30Shop Tools162.0019611016.20Tape Recorders (2)500.0019621050.00Tape Recorder395.0019631039.50TOTAL$1,124.661964 and 1965YearUsefulDepreciationAssetCostAcquiredLifeDeduction1961 Mercedes Benz$5,387.40 19624$1,096.85Less: 10% personal109.69$ 987.16Office Furniture125.0019571012.50Office Furniture &Equipment193.0019591019.30Shop Tools162.0019611016.20Tape Recorders (2)500.0019621050.00Tape Recorder395.0019631039.501964 Volks Truck2,500.0019634625.00TOTAL$1,749.66199 Petitioner purchased a 1961 Mercedes Benz 300 automobile on June 29, 1962, for a total purchase price of $6,700. Petitioners are not entitled to any depreciation deduction for the taxable years 1963, 1964 and 1965. Petitioners' records are disorganized, incomprehensible, and do not support their income tax returns for taxable years 1963, 1964 and 1965. Petitioners' omissions of income from the returns for the taxable years 1963, 1964 and 1965 and overstatement of expenses on the returns for the taxable years 1963, 1964 and 1965 were due to negligence or intentional disregard of rules and regulations. The 5 percent negligence penalty is applicable to petitioners' underpayments of tax for taxable years 1963, 1964 and 1965. OPINION The issues are factual and petitioners must prove the Commissioner's determination erroneous. Rule 142, Tax Court Rules of Practice and Procedure.Petitioner, Oren F. Potito, relies heavily upon his own testimony which lacks credibility because of numerous evasive statements, misstatements and statements which conflict with testimony of disinterested witnesses. Accordingly, except as noted below, we sustain the200 Commissioner's determination. See Stein v. Commissioner,322 F.2d 78">322 F.2d 78 (5th Cir. 1963), affg. a Memorandum Opinion of this Court. Issue 1. Deposits to the Account of the ChurchThe Commissioner determined that petitioners omitted from taxable income for the years 1963, 1964 and 1965 the sums of $1,100.68, $2,702.65 and $1,632.40, respectively, deposited in a checking account maintained by the Church of Jesus Christ-Christian. Conceding that the deposits were includible in income, petitioner contends that such deposits were included in gross receipts reported in each of the years in issue and that if sustained, the Commissioner's determination would result in taxing this income twice. After examining petitioners' returns and listening to the testimony of the return preparer, we are convinced that during each of the years in question, the income reported was derived solely from Continental Engineering and no other source. And, since petitioner failed to adequately explain expenditures greatly in excess of reported income, we are satisfied that he received unreported income taxable in the years 1963, 1964 and 1965. Accordingly, we hold for respondent on this issue. 201 Issue 2. $2,920 Deposited to the Account of National Engineering Co.In response to representations that he could develop an automobile air conditioner which would yield huge profits, Mr. and Mrs. Whitman, in 1963, placed $2,920 at petitioner's disposal in a checking account at a local bank. Petitioner was to organize a corporation called National Engineering to develop, manufacture, and market the air conditioner. The corporation was never organized and, therefore, the Whitmans never received any National Engineering stock. Although the funds were to be used in developing the air conditioner, petitioner was secretive about expenditures from the account resulting in the Whitmans' decision to close the account in 1964 or 1965 and withdraw the $1,300 balance which remained. The Commissioner determined that the entire $2,920 deposited for National Engineering constituted income to petitioner in 1963. The evidence does not support respondent's contention that petitioner enjoyed exclusive control of the funds in issue or that disbursements from the account were made without the knowledge or approval of the Whitmans. However, petitioner refused to account to the Whitmans and failed202 to explain to this Court how much of these funds was paid to whom, when and for what purpose. Accordingly, petitioner's uncorroborated testimony that none of the expended funds was appropriated to his own use and benefit and that all such funds were properly expended for development of the auto air conditioner is insufficient to rebut the presumptive correctness of respondent's determination. Accordingly, we hold that $1,620 of the $2,920 made available to petitioner to develop the air conditioner was properly taxable to petitioner in 1963. Issue 3. Purchase of SilverIn May 1963, petitioner received $1,000 from the Whitmans to purchase silver for the Whitmans who never received it. Mrs. Whitman's testimony convinces us that petitioner misappropriated these funds for his own benefit and was properly taxable thereon in 1963. Issue 4. The Boat, Motor and TrailerIn 1964, petitioner received a boat, motor and trailer which the Commissioner determined were includible in his income for the year 1964 at a value of $2,500. Petitioner did not offer the testimony of the persons who allegedly made the gifts. Petitioner's uncorroborated testimony that these items were gifts from203 members of his congregation is insufficient to overcome the Commissioner's determination which is fully sustained in view of petitioner's failure to present any evidence of the value of the boat, motor or trailer. Wichita Terminal Elevator Co.,6 T.C. 1158">6 T.C. 1158 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Issue 5. Business ExpensesFor the taxable years 1963, 1964 and 1965, the Commissioner allowed petitioners business expense deductions of $3,018.52, $3,659.99 and $4,931.90, respectively. Petitioners contend their business records show they were entitled to deduct business expenses of $4,169.41, $5,844,28 and $6,470.11 in the years 1963, 1964 and 1965, respectively. Petitioners' records contained duplicate checks and vouchers in the same or different categories of expenses, documents reflecting personal or capital expenditures, and were generally incomprehensible. Having failed to prove they were entitled to business expenses in each of the years in issue in excess of those allowed by the Commissioner, petitioners cannot prevail on this issue. Issue 6. Depreciation DeductionsThe Commissioner disallowed all depreciation claimed by petitioners204 on their returns for 1963, 1964 and 1965. Petitioners argue that the record shows they are entitled to those deductions and that the Commissioner's determination was arbitrary and erroneous. We disagree. Petitioner's uncorroborated conclusive statement that the items shown on the returns for the years in issue are correct does not establish the right to the depreciation deductions in issue. Except for one item, petitioners failed to prove the cost of the assets in question. Moreover, without exception, petitioners failed to establish the extent of personal use, the useful life and salvage value of each of the assets involved. Accordingly, respondent's determination was not arbitrary or erroneous and must be sustained. Issue 7. Negligence PenaltyPetitioners' system of record keeping, based on bank records only, requires all business receipts to be deposited in the bank. Yet, petitioners failed to deposit all income earned during each of the years in question. Moreover, petitioners' records are generally unintelligible, fail to support the income reported and expenses deducted, and resulted in substantial understatements of taxable income for each of the years in issue. Having205 failed to satisfactorily explain these shortcomings, petitioners are subject to the negligence penalty imposed by section 6653(a) for the taxable years 1963, 1964 and 1965. See Marcello v. Commissioner,380 F.2d 499">380 F.2d 499 (5th Cir. 1967), affg. a Memorandum Opinion of this Court, cert. denied 389 U.S. 1044">389 U.S. 1044 (1968). Decision will be entered under Rule 155.Footnotes1. All statutory references are to sections of the Internal Revenue Code of 1954 in effect during the taxable years in issue, unless otherwise noted.↩*. $374.00 Salvage Value deducted↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623563/	NEVADA-MASSACHUSETTS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Nevada-Massachusetts Co. v. CommissionerDocket No. 101240.United States Board of Tax Appeals43 B.T.A. 1127; 1941 BTA LEXIS 1411; March 25, 1941, Promulgated 1411 A contract provision that out of the net proceeds of operation of specified property and other moneys available for the purpose a taxpayer would pay certain notes does not support a credit under section 26(c)(2), Revenue Act of 1936, since the noteholders are the shareholders and directors, and with their consent in the practical administration of the contract no payments on the notes or interest have ever been made, the notes have been frequently renewed, there is no showing of net proceeds from the particular property, and the other money available for the purpose was in practice subject to the discretion of the president. Louis Janin, Esq., for the petitioner. Harry R. Horrow, Esq., for the respondent. STERNHAGEN 1127 The Commissioner determined an income tax deficiency of $22,752.16 for 1936 and of $12,326.10 for 1937, by disallowing any credit under section 26(c), Revenue Act of 1936. Petitioner assails the determination, contending that it was bound by contract to apply earnings and profits to the payment of notes. FINDINGS OF FACT. Petitioner, a Maine corporation with principal office at Sonora, California, was organized by creditors1412 of the Pacific Tungsten Co., pursuant to an agreement executed by them on December 24, 1924, amended by a supplemental agreement of February 16, 1925. One of the creditors, Charles H.Segerstrom, has been its president which the agreement The creditors held interest-bearing notes of Tungsten since organization. ment recited were overdue and uncertain of payment, and as action by one or more might result in bankruptcy proceedings by Tungsten, the parties agreed to form a corporation with a capital stock of $100,000, divided into 100,000 shares, to which each would transfer the notes 1128 and collateral held by him and receive in exchange shares of the new corporation and a promissory note for the unpaid amount of the note s0 assigned. The said new corporation shall further agree that out of the net proceeds of the operation of the said mining property of the said Pacific Tungsten Company, in the event that the said new corporation shall acquire the same at execution sale in actions to be brought, if necessary, against the Pacific Tungsten Company, and out of any other moneys which the said new corporation may have available for that purpose, it will first pay to The First1413 National Bank of Boston and The National Shawmut Bank of Boston together the sum of Five Thousand Dollars ($5,000) and after such payment, it will pay one-half of such moneys to the First National Bank of Sonora, until said promissory notes so to be delivered to the said First National Bank of Sonora, with interest thereon, shall have been paid in full, and the remaining one-half of such moneys shall be applied pro rata on account of payment of the respective notes held, as aforesaid, by each of the other parties hereto; and when the said notes held by said First National Bank of Sonora shall have been fully paid, theereafter such moneys shall be applied pro rata to the payment in full of the promissory notes of said new corporation, together with interest thereon, held by the other parties hereto. Should the said new corporation require funds for the operation of the said properties of the said Pacific Tungsten Company which it may acquire on the said execution sale or saled, then each of the parties hereto willcontribute from time to time when and as called for by the directors of the said new corporation, a sum or sums amounting in the aggregate to ten per cent (10%) of the principal1414 amount of the promissory note of said new corporation by it or him held, and the moneys so advanced to the new corporation shall be evidenced by the demand promissory notes of the new corporation, bearing interest at six per cent (6%) per annum, and such notes shall be paid pro rata by said new corporation before any other payments are made, as herein provided, by said new corporation. In the event that the said new corporation should require funds for the purposes aforesaid in excess of the amount to be contributed by the parties hereto as hereinbefore provided, the matter of furnishing such funds shall be the subject for further discussion among the parties hereto. On February 18, 1925, this agreement was "accepted" by petitioner as its own. The Tungsten noteholders on February 20, 1925, transferred their notes and collateral to petitioner and received the following interest-bearing notes of petitioner, equal in face amount to the unpaid principal and interest, respectively, of the Tungsten notes and the following shares of petitioner's stock: PrincipalInterestSharesFirst National Bank of Boston$153,233.33$37,686.5437,396National Shawmut Bank51,666.679,798.4412,599First National Bank of Sonora25,000.0019,808.97Charles H. Segerstrom36,064.381,868.7542,500George W. Johnson10,501.49677.927,5001415 Petitioner, at a sheriff's sale, in June 1925 acquired the Tungsten assets, consisting of mining properties, mining claims, milling plants, shares in the Pacific Milling Co., and shares in the Mill City Tungsten 1129 Mining Co. These shares were security for the Tungsten notes and were acquired by petitioner, together with the notes. Petitioner engaged in mining operations and milling, and sometimes to fulfill contracts purchased foreign ores. To provide working capital, its noteholders were assessed for advances equal to 15 percent of the amount of their notes. By December 27, 1926, their advances had aggregated $63,104,47, of which $43,104.47 remained unpaid. For these advances the noteholders received additional notes. On April 1, 1929, petitioner issued new notes in exchange for the old notes, on which nothing had been paid. Prior thereto Segerstrom had acquired Johnson's notes (excepting a small one). Later in 1929 he purchased those of the First National Bank of Sonora. Separate notes were issued for the principal and the accumulated interest (inclusive of the interest accrued before February 18, 1925), as follows: PrincipalInterestFirst National Bank of Boston$153,233.33$84,780.10National Shawmut Bank51,616.6725,162.42First National Bank of Sonora25,000.0031,018.69Charles H. Segerstrom49,112.5512,286.33First National Bank of Boston, agent43,104.4711,318.941416 The two last named notes, issued to the First National Bank of Boston, agent, represented principal and interest of the aforesaid advances for working capital. During 1931 and 1932 Segerstrom voluntarily made advances of $43,050.99 to enable petitioner to continue in operation and make necessary repairs, and received petitioner's interest-bearing demand notes. On July 12, 1934, petitioner's board of directors voted to issue new notes for the outstanding notes, excepting current acceptances and a note for $18,000 held by the Bank of America. Three demand notes, dated June 30, 1934, were issued to the First National Bank of Boston - one for $177,008.74, representing principal then owed by petitioner to the bank; one for $124,303.17 representing interest accrued on petitioner's notes from April 1, 1929, to June 30, 1934; and one for $352,675.75, representing principal and interest accrued to April 1, 1929, on all petitioner's notes except principal due the First National Bank of Boston. On July 12, 1934, the directors also voted to pay $2,000 monthly until satisfaction of the $18,000 note and, in respect of all the others, including the notes for advances: On the first day of1417 September, 1934, and on the first day of each succeeding month thereafter until otherwise decided by the President and the Secretary to make payment in the amount of ten thousand dollars ($10,000) on account of note indebtedness of this Company, said payments to be distributed pro rata to the holders of such note indebtedness. * * * 1130 This resolution was rescinded on December 3, 1934, petitioner being unable to pay so much. Petitioner maintained a special and a general bank account with the First National Bank of Boston. Moneys received were deposited in the special account and transfers were made from that to the general account in such amounts and at such times as were judged by Segerstrom, the president, to be necessary for operating expenses. On petitioner's instructions, given by Segerstrom, the bank made withdrawal charges against the special account and applied the withdrawals in proportionate amounts on petitioner's indebtedness to creditors "evidenced by notes dated June 30, 1934," The notes were satisfied by the following proportionate payments: Dec. 3, 1934$30,000.00June. 20, 1935150,000.00Dec. 23, 1935100,000.00Jan. 29, 193667,455.43Apr. 1, 193625,000.00June 22, 1936$100,000.00Mar. 18, 193775,000.00Aug. 6, 193756,000.00Oct. 25, 193750,734.361418 The note for $177,008.74 was fully paid on January 29, 1936; that for $352,675.75 on March 18, 1937; that for $124,303.17 on October 25, 1937. Each time that petitioner's notes were remewed its creditors at directors' meetings discussed the effect of the contract of December 24, 1924, and more particularly the status of notes for operating advances, and it was agreed among the creditors that all would be covered "under the terms of the same contract and take their effect pro rata with the other notes that were outstanding." The board of directors consisted of Segerstrom, the bank's attorney, and five of the bank's employees. Segerstrom determined the amounts to be paid on the notes and, in so doing, endeavored to pay as much as possible, leaving to petitioner the minimum balance which he deemed necessary for operation. As shown by its returns, petitioner's taxable net income was $90,382.32 in 1934; $183,090.02 in 1935. The Commissioner determined an adjusted net income of $110,986.21 for 1936; $60,127.30 for 1937. During 1936 and 1937 petitioner extracted tungsten ore from its lands and milled it at its mill, which it had reconstructed about 1928. It also worked leased1419 mines at Mina, Nevada, on a royalty basis, but sustained losses from these operations, and about 1937 abandoned its rights to title upon payment of specified royalties. Receipts from the sale of concentrates from the Mina properties, amounting to $53,831.26 in 1936 and $47,312.21 in 1937, were deposited in the special account and commingled with other funds. Petitioner also worked a tract known as the Humboldt property under a lease made in 1927; it acquired title about 1933, after royalties which it had paid aggregated $75,000. Sale proceeds of ores extracted were likewise deposited in the special account. In 1934 petitioner purchased for $15,000 all the shares of the 1131 Mill City Tungsten Mining Co., Mill City Development Co., and Pacific Milling Co., which it had not previously acquired. Prior to 1936 it acquired all their assets. To replace a broken pipe line of the water system of the Mill City Development Co., petitioner expended $15,000 in 1936, drawn from the special account. OPINION. STERNHAGEN: The petitioner claims and respondent denies in each year a credit under Revenue Act of 1936, section 26(c)(2). 11420 To get as directly ad possible at the determinative factors, several propositions may be assumed arguendo, without deciding them: That the contract term "net proceeds from operation and other moneys available" is within the statutory term earnings and profits; that the interest accrued for which new notes were given is the sort of debt intended by the statute; that the original indebtedness of Tungsten, to cover which petitioner's notes were issued, was, although the creditors were shareholders, incurred under circumstances which bring it within the intendment of the statute. The credit provided by section 26(c)(2) is carefully set forth in the statute and is to be administered literally, ; (on review C.C.A., 8th Cir.); ; cf. (on review C.C.A., 6th Cir.). Here there was a written contract accepted (which arguendo we treat as executed) prior to May 1, 1936, expressly dealing with the disposition of earnings and profits. It1421 dates back to the beginning of the petitioner's existence in 1925. Since that time there have been circumstances from which it may be clearly inferred that it has not been treated by its parties as imposing the strict restraints upon petitioner as to the disposition of its earnings and profits as its language would indicate. The creditors were all shareholders ahd Segerstrom, one of the principal creditors, was petitioner's active president. There is no 1132 showing as to the net proceeds or other available moneys from year to year from 1925 to 1936, nor is it shown what in practice that term "net proceeds" has been interpreted to mean. Taking it, as we have, to mean earnings and profits, it would appear that there had been earnings and profits in the past and that they were used otherwise than to pay the notes as the petitioner urges that the contract requires. For example, in 1928 the mill was reconstructed; in 1933 the Humboldt tract was acquired after $75,000 royalties had been paid; in 1934 $15,000 was paid for the remaining shares of three corporations; in 1936 $15,000 was spent to replace a pipe line. All this time there was no payment of the notes but a periodical1422 renewal of them and an extension of the time for interest. Such a practical administration of a contract and the acquiescence therein of the obligees precludes a recognition of the contract as a stricture upon the corporation's use of its funds in any one year. Apparently the contract was not recognized by the parties as a binding requirement of payment from earnings and profits in any earlier year, and there is no more reason to regard it as requiring payment in the years in question. In fact, the notes were paid in 1936 and 1937. Another weakness in petitioner's position is that the 1924 contract provides that the notes shall first be paid not only out of the net proceeds of the operation of the mining property of the Tungsten Co., but also out of any other moneys available. The meaning of this was in practice left entirely to Segerstrom, the president and a noteholder. The petitioner is shown to have other activities and sources of earnings and profits besides the Tungsten mining properties, and upon its own conception of the statute it can not say that the earnings and profits other than the net proceeds of the Tungsten mines were required to be used for the payment of1423 the notes unless in the opinion of Segerstrom they were "available." If Segerstrom, even though in unquestioned good faith, regarded the other moneys as not available, they were not subject to any contract obligation and hence not within section 26(c) (2). Only the net proceeds from the operation of the Tungsten mines would then be left as subject to the restriction, and there is no telling from the evidence what the amount of such net proceeds was. It can not be held that petitioner was in 1936 or 1937 under any contractual requirement to pay within those years out of the earnings and profits of those years the amounts of the notes. The determination is therefore sustained. Decision will be entered for the respondent.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. - * * * (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 had 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/4653913/	IN THE SUPREME COURT OF PENNSYLVANIA EASTERN DISTRICT COMMONWEALTH OF PENNSYLVANIA, : No. 294 EAL 2020 : Respondent : : Petition for Allowance of Appeal : from the Order of the Superior Court v. : : : SAMIR PRICE, : : Petitioner : ORDER PER CURIAM AND NOW, this 20th day of January, 2021, the Petition for Allowance of Appeal is DENIED.	01-04-2023	01-22-2021
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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). 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https://www.courtlistener.com/api/rest/v3/opinions/4653915/	IN THE SUPREME COURT OF PENNSYLVANIA EASTERN DISTRICT COMMONWEALTH OF PENNSYLVANIA, : No. 242 EAL 2020 : Respondent : : Petition for Allowance of Appeal v. : from the Order of the Superior Court : IBRAHIM MUHAMMED, : : Petitioner : : : COMMONWEALTH OF PENNSYLVANIA, : No. 243 EAL 2020 : Respondent : : Petition for Allowance of Appeal v. : from the Order of the Superior Court : IBRAHIM MUHAMMED, : : Petitioner : : : COMMONWEALTH OF PENNSYLVANIA, : No. 244 EAL 2020 : Respondent : : Petition for Allowance of Appeal v. : from the Order of the Superior Court : IBRAHIM MUHAMMED, : : Petitioner : : : ORDER PER CURIAM AND NOW, this 20th day of January, 2021, the Petition for Allowance of Appeal is DENIED.	01-04-2023	01-22-2021
https://www.courtlistener.com/api/rest/v3/opinions/4623455/	John J. Kalbac and Dorothy Kalbac v. Commissioner. John G. Kiske and Clara Kiske v. Commissioner.Kalbac v. CommissionerDocket Nos. 79794, 79795.United States Tax CourtT.C. Memo 1961-47; 1961 Tax Ct. Memo LEXIS 299; 20 T.C.M. (CCH) 262; T.C.M. (RIA) 61047; February 24, 1961299 Under the will of the president and principal stockholder of a corporation by whom they had been employed for many years, petitioners were granted an option to purchase certain shares of the corporation's stock at prices which the president of the corporation regarded as favorable to petitioners. Petitioners exercised the option to purchase the stock after the death in 1952 of the maker of the will. In 1954, the corporation was liquidated and petitioners received for their stock considerably in excess of the amount which they paid to the executors of the estate. Held, that the basis for the determination of the long-term capital gain upon the liquidation of their stock is the amount which petitioners paid to the estate in the exercise of their option to purchase under the will. J. Gordon Mack, 3 T.C. 390">3 T.C. 390, affd. 148 F. 2d 62 (C.A. 3), certiorari denied 326 U.S. 719">326 U.S. 719, followed. Donald E. Fahey, Esq., 314 N. Broadway, St. Louis, Mo., for the petitioners. H. Tracy Huston, Esq., for the respondent. BLACK Memorandum Findings of Fact and Opinion These consolidated proceedings involve deficiencies in individual income tax determined by respondent as follows: Docket No.PetitionerYearDeficiency79794John J. Kalbac andDorothy Kalbac1954$26,25079795John G. Kiske andClara Kiske195426,250301 In Docket No. 79794 the deficiency results from one adjustment made to the taxable income shown on the return. That adjustment was: "(a) Gain on liquidation of James Mulligan Printing Company increased $55,494.33." This adjustment is explained in the deficiency notice as follows: (a) On your income tax return for the taxable year 1954, your reported taxable long term capital gains in the amount of $25,804.04 of which amount $24,853.89 resulted from the liquidation of 90 shares of your stock of James Mulligan Printing Company. You have agreed that the reported proceeds of said liquidation should be increased in the amount of $5,988.68 as a result of your understatement of the fair market value of good will of said corporation in the amount of $5,400.00, the understatement of the fair market value of life insurance received in the amount of $83.01, and the overstatement of liabilities assumed in the amount of $505.67. On your return, you claimed a basis for said 90 shares of stock in the amount of $147,088.94. The basis of said stock has been reduced to $42,088.95, since you paid $7,500.00 for one share of the stock and purchased the remainder of the stock from the Estate of Frances302 [Francis] J. Mulligan for $34,588.95. The recomputation of taxable long term capital gain which you received from the liquidation of James Mulligan Printing Company is as follows: [Here follows the computation, unnecessary to copy here.] In Docket No. 79795, John G. Kiske and Clara Kiske, a similar adjustment to the above was made by the Commissioner in his determination of the deficiency. The Commissioner explained this adjustment in his deficiency notice in a similar manner to his explanation of the adjustment made in Docket No. 79794. The petitioners in both docket numbers assign error as to the amounts of long-term capital gains which the Commissioner determined that they received on liquidation of James Mulligan Printing Company. Findings of Fact Some of the facts have been stipulated and the facts as stipulated are incorporated herein by this reference. John J. and Dorothy Kalbac are husband and wife residing in St. Louis, Missouri. They filed their joint income tax return for the taxable year 1954 with the district director of internal revenue at St. Louis. John G. and Clara Kiske are husband and wife residing in St. Louis, Missouri. They filed their joint303 income tax return for the taxable year 1954 with the district director of internal revenue at St. Louis. Prior to his death on June 10, 1952, Francis J. Mulligan was the president of the James Mulligan Printing Company, hereinafter referred to as the Company, a corporation organized and existing under the laws of the State of Missouri. Mulligan owned at the time of his death 198 of the 200 outstanding shares of the capital stock of the Company. Petitioners John J. Kalbac and John G. Kiske, hereinafter sometimes referred to as petitioners, on June 10, 1952, and for many years prior thereto were employees of the Company. The last will and testament of Mulligan was admitted to probate on June 26, 1952, and provided, among other things, as follows: ITEM TWELVE: To my faithful employee and associate, John Kiske, if he be in the employ of the James Mulligan Printing Company, a Missouri corporation, at the date of my death, I hereby give and grant an option to purchase from my estate ninety (90) shares (this to include the one share now in his name) of the capital stock of the James Mulligan Printing Company for a sum equal to one-half (1/2) of any debt which I may owe said corporation304 at the time of my death, but said sum or purchase price shall in no event be less than Fifteen Thousand Dollars ($15,000.00) nor more than one-half (1/2) of the book value of said stock at the date of the exercise of this option. The latter sum I feel will be the real value of said stock after my death. The purchase or option price of said stock may be paid in one cash sum or in monthly installments at the rate of at least One Hundred Fifty Dollars ($150.00) per month, evidenced by the unsecured note or notes, without interest, of said John Kiske, and such payment or payments may be made to my Executors, my Trustees, or said James Mulligan Printing Company, whichever in the opinion of my Executors shall be more convenient for my estate. In the event said John Kiske predeceases me or is not in the employ of said Company, or fails to exercise said option within thirty (30) days after my death, then John Kalbac shall have the option to purchase said stock under the same conditions. ITEM THIRTEEN: To my faithful employee and associate, John Kalbac, if he be in the employ of the James Mulligan Printing Company at the date of my death, I hereby give and grant an option to purchase from305 my estate ninety (90) shares (this to include the one share now in his name) of the capital stock of James Mulligan Printing Company, a Missouri corporation, for a sum equal to one-half (1/2) of any debt which I may owe said corporation at the time of my death, but said sum or purchase price shall in no event be less than Fifteen Thousand Dollars ($15,000.00) nor more than one-half (1/2) of the book value of said stock at the date of the exercise of this option. The latter sum I feel will be the real value of said stock after my death. The purchase or option price of said stock may be paid in one cash sum or in monthly installments at the rate of One Hundred Fifty Dollars ($150.00) per month, evidenced by the unsecured note or notes, without interest, of said John Kalbac, and such payment or payments may be made to my Executors, my Trustees, or said James Mulligan Printing Company, whichever in the opinion of my Executors would be most convenient for my estate. In the event that said John Kalbac predeceases me or it not in the employ of the James Mulligan Printing Company, or fails to exercise said option within thirty (30) days after my death, then John Kiske shall have the option306 to purchase said stock under the same conditions. ITEM FOURTEEN: Should either or both of the options granted by Item Twelve and/or Item Thirteen hereof be not exercised by John Kiske or John Kalbac for any reason whatsoever, then such undisposed of stock in the James Mulligan Printing Company shall pass and be administered as a part of the residue of my estate, free of any option. In the event that either or both John Kiske and John Kalbac shall exercise the foregoing option or options on said capital stock of the James Mulligan Printing Company, then, upon such exercise, he or they shall become the owner of the stock referred to, regardless of the fact that the same may or may not be delivered or transferred on the books of the corporation, and my Executors, or anyone claiming by or through them, shall be without right or authority to demand the transfer thereof to anyone other than to the optionee or optionees exercising such option or options, and shall be without right or authority to make any claim or demand against or to recover any sum from said corporation because of its refusal to transfer said stock to anyone other than said optionee or optionees. The optionee or optionees307 (but only in the event a majority of all the stock of said corporation has been acquired pursuant to the foregoing options) shall have the power of complete control and management of the business of said corporation, and my Executors, or anyone claiming by or through them, shall be without right or authority to in any way, by court action or otherwise, question or interfere with said power of complete management or control. At the date of his death Mulligan owed the Company the sum of $69,177.89 on open account. On July 1, 1952 Kalbac exercised the option granted to him in Item Thirteen of Mulligan's will. He then paid to the Mulligan estate the sum of $34,588.94, for which he received from the estate 89 shares of the capital stock of the Company. Likewise, on July 1, 1952, Kiske exercised the option granted to him in Item Twelve of the will. He then paid to the estate the sum of $34,588.94, for which he received from the estate 89 shares of the capital stock of the Company. Sometime prior to June 10, 1952, Kalbac and Kiske each purchased one share of the capital stock of the Company for which each paid the sum of $7,500. On December 23, 1954, Kalbac surrendered his 90 shares308 of stock in the Company to the Company and received a liquidation dividend from the corporation in the amount of $202,785.40. Similarly, Kiske surrendered on the same date his 90 shares of stock and received a liquidation dividend of $202,797.69. The fair market value of each share of Company stock at the time of Mulligan's death on June 10, 1952, was $1,250 per share. Petitioners were long-time business associates, employees, and close personal friends of Mulligan. Through the years of their association with him, Mulligan treated each petitioner with a close personal regard over and above ordinary employer-employee relationship in that: He employed each of them when they were very young; he taught them not only the ways of his business but also the ways of the business world generally, guided and advised them in their personal growth and maturity; through the years promoted them to positions of full responsibility for his business; and, in the later years of his life, Mulligan was in poor health and left most business decisions to their responsibility with statements to them that after his death the business would be theirs, or words to that effect. Opinion BLACK, Judge: It309 is the contention of petitioners that in Mulligan's will they were each bequeathed 89 shares of stock in the Company and that their basis upon the liquidation of the corporation which took place in 1954 was its fair market value at the date of Mulligan's death. It has been stipulated that the fair market value of each share of stock of the Company at the time of Mulligan's death was $1,250. Petitioners contend that the basis for their 89 shares of stock in the liquidation should be determined under section 1014, Internal Revenue Code of 1954, the applicable portion of which reads as follows: SEC. 1014. BASIS OF PROPERTY ACQUIRED FROM A DECEDENT. (a) In General. - Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent's death by such person, be the fair market value of the property at the date of the decedent's death, or, in the case of an election under either section 2032 or section 811(j) of the Internal Revenue Code of 1939 where the decedent died after October 21, 1942, its310 value at the applicable valuation date prescribed by those sections. (b) Property Acquired from the Decedent. - For purposes of subsection (a), the following property shall be considered to have been acquired from or to have passed from the decedent: (1) Property acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent; Respondent, on his part, contends that petitioners were not bequeathed any of the capital stock of the Company under decedent's will; that what they were in fact bequeathed under the will was an option to acquire 89 shares of stock each from decedent's estate after his death by paying to the corporation the amount of the indebtedness which Mulligan owed the corporation at the time of his death; that petitioners exercised the option granted in decedent's will and each paid to the estate the sum of $34,588.94 as the purchase price for the 89 shares of stock which he received. Therefore, contends respondent, petitioners' basis for the stock was its cost to them under the option which they exercised and their basis is determined, not by section 1014, 1954 Code, as petitioners claim, but is determined by section 1012, 1954 Code, which311 reads as follows: SEC. 1012. BASIS OF PROPERTY - COST. The basis of property shall be the cost of such property, except as otherwise provided in this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses). The cost of real property shall not include any amount in respect of real property taxes which are treated under section 164(d) as imposed on the taxpayer. We agree with respondent. We fail to see where petitioners acquired any shares of stock under Mulligan's will. What they acquired under the will was an option to purchase 89 shares of the stock of the corporation. They already owned one share of stock each; as to the cost to them of this one share, there is no dispute. An option to acquire property by purchase is certainly not the property itself. Helvering v. San Joaquin Fruit & Investment Co., 297 U.S. 496">297 U.S. 496. We have no doubt that Mulligan in his will intended to grant petitioners the option to purchase the stock at prices which he thought were favorable to them. It is clear from the evidence that petitioners had been faithful and trusted employees312 of the Company for a long time and that Mulligan, who owned all the stock of the corporation except two shares, esteemed very highly the value of the services of petitioners. But these facts do not change an option to purchase the stock to a bequest of the stock. Respondent relies, as a case in point in support of his contention, on J. Gordon Mack, 3 T.C. 390">3 T.C. 390, affd. 148 F. 2d 62 (C.A. 3), certiorari denied 326 U.S. 719">326 U.S. 719. In that case, under the will of his father, the taxpayer was given an option to purchase within a limited time certain shares of stock from the testamentary trustees at approximately one-half of their fair market value at the time of purchase. Exercising the option granted by his father under the will, the taxpayer purchased five of such shares from the trustees. Later, he sold them at a price considerably in excess of what he had paid for them in the exercise of the option which had been granted him under the will. The taxpayer, in his income tax return, claimed as a basis for the shares their fair market value at the date of the death of his father. The Commissioner rejected this basis and in his deficiency notice determined313 that the taxpayer's basis of cost for the shares was what he paid for them when he purchased them under the option. We sustained the Commissioner on the authority of Helvering v. San Joaquin Fruit & Investment Co., supra.The taxpayer appealed our decision to the Third Circuit and we were affirmed. The court, in affirming us, based its affirmance on Helvering v. San Joaquin Fruit & Investment Co. and, among other things, said: The taxpayer contended that its transferor had acquired the property, or an interest therein, prior to March 1, 1913, and that its basis for computing the gain was the March 1, 1913, value. The Supreme Court held to the contrary, deciding that the taxpayer's transferor acquired the property, not when the option to purchase was given in 1906, but when it was exercised in 1916, and further determined that the taxpayer's basis was the price paid on the exercise of the option, and not the value as of March 1, 1913. In this regard, the court said: "The capital asset, sale of which resulted in taxable gain, was the land. This was not an asset of the taxpayer prior to the exercise of the option. We think it clear that there was no combination of two capital*314 assets (the option and $200,000 of cash), to form a new capital asset (the land), which was subsequently sold at a profit." 297 U.S. at page 500, 56 S. Ct. at page 571, 80 L. Ed. 824. In view of the foregoing authority, discussion of the numerous cited cases from other state and federal courts, would be a work of supererogation. In their brief petitioners cite in support of their contention several cases which were decided prior to the San Joaquin Fruit & Investment Co. case and prior to our decision in J. Gordon Mack and its affirmance by the Third Circuit. We do not think these cases are in point, especially in view of the later decisions above cited. Therefore, we think it is unnecessary to discuss them. We decide this issue of the basis to be used in favor of the Commissioner. Decisions will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623456/	William A. Joplin, Jr., and Louella L. Joplin et al., Petitioners, 1 v. Commissioner of Internal Revenue, RespondentJoplin v. CommissionerDocket Nos. 31489, 31490, 31491, 31492, 31493United States Tax Court17 T.C. 1526; 1952 U.S. Tax Ct. LEXIS 245; March 19, 1952, Promulgated 245 Decisions will be entered under Rule 50. Petitioners William A. Joplin, Jr., Joseph F. Kohn and S. Crews Reynolds were members of a tax exempt farmers' marketing cooperative corporation, reporting their income on the cash receipts and disbursements basis of accounting. In the taxable years involved, the net earnings of the cooperative were allocated and distributed to its members in the form of credits to its capital reserve account and the issuance of certificates of its preferred stock having a par value of $ 25 per share. Held, petitioners received and realized income upon the receipt of the certificates of preferred stock to the extent of the fair market value of the certificates, which is determined to be equal to the par value thereof. Held, further, that petitioners did not realize income in the taxable years on the share of the net income which was merely credited to the capital reserve account of the cooperative. Don O. Russell, Esq., for the petitioner.Gene W. Reardon, Esq., for the respondent. LeMire, Judge. LeMIRE 1526 The proceedings were consolidated and involve deficiencies in income tax for the years 1946, 1947 and 1948, as follows: 246 Petitioner194619471948William A. Joplin, Jr., and Louella L.Joplin$ 4,200.12Joseph F. Kohn and Anna Kohn1,018.54Joseph F. Kohn$ 2,495.51$ 30,282.05S. Crews Reynolds and Gertrude Reynolds10,573.11S. Crews Reynolds3,370.5839,947.43The sole issue, common to all petitioners, is whether the respondent erred in holding that the part of the retained savings or net earnings of the Osceola Products Company, a tax exempt cooperative, for its fiscal years ended June 30, 1946, June 30, 1947, and June 30, 1948, which was allocated to its patrons on a patronage basis and distributed in the form of credits to the capital reserve account and issuance of preferred stock, is includible in the taxable income of the patrons.Some of the facts have been stipulated and are found accordingly.FINDINGS OF FACT.Petitioners William A. Joplin, Jr., and his wife, Louella L. Joplin, filed a joint return for the calendar year 1948, on a cash receipts and disbursements basis of accounting.1527 Petitioner Joseph F. Kohn filed a separate income tax return for the calendar years 1946 and 1947 and a joint return with his wife, Anna Kohn, for the calendar year247 1948, on a cash receipts and disbursements basis of accounting.Petitioner S. Crews Reynolds filed a separate income tax return for the calendar years 1946 and 1947 and a joint return with his wife, Gertrude Reynolds, for the calendar year 1948, on a cash receipts and disbursements basis of accounting.All the aforementioned returns were filed with the collector of internal revenue for the first district of Missouri for each of the respective taxable periods.The Reynolds-Joplin Cotton Company of Hayti, Missouri, a partnership, filed a Federal partnership return for its fiscal year June 1, 1947, to May 30, 1948, on the cash receipts and disbursements basis of accounting, with the collector of internal revenue for the first district of Missouri. The partnership interests were held as follows:S. Crews Reynolds51%W. A. Joplin, Jr49%The wives are parties to these proceedings by reason of the fact they and their petitioner-husbands filed joint returns in the year 1948.The Osceola Products Company was incorporated about August 1945 under the laws of the State of Arkansas providing for the formation and operation of agricultural cooperative associations. Its authorized 248 capital stock consists of 500 shares of common stock of the par value of $ 100, and 78,000 shares of preferred stock of the par value of $ 25. The common stock carries the voting rights and is non-dividend bearing. It can be held only by producers of agricultural products and only one share may be owned by each member of the association. The preferred stock has no voting rights and bears noncumulative dividends not to exceed 6 per cent per annum. Members of the Osceola Products Company must be producers and own one share of its common stock. The members are not limited in the number of shares of preferred stock they may own.The Osceola Products Company has a fiscal year accounting period. Its principal place of business is at Osceola, Arkansas. It engages in processing cotton seed and soybeans and marketing the oil and by-products produced therefrom for its member and nonmember patrons. It operates in the following manner: The farmer-producer patrons ship their cotton seed and soybeans to the association's mill and receive in payment the prevailing market price less a 10 to 20 per cent reserve which is retained by the association to cover any potential loss. These products249 are processed and sold by the association.1528 The Osceola Products Company is a tax exempt cooperative association under section 101 (12) of the Internal Revenue Code.The by-laws of the Osceola Products Company provide that an audit be made of its books and accounts after the close of each fiscal year to determine the net savings from the business operations. The by-laws further provide for the allocation and distribution of such net savings in the following order and manner: (a) An amount not exceeding six percent (6%) of the par value of the fully paid-up shares of preferred stock outstanding shall be set aside for payment of dividends on such stock.(b) The remainder of the net savings shall be allocated to all patrons of the association on a patronage basis. The basis of allocation shall be prescribed by the board of directors and may show the division of net savings of each activity, or business, of the association.(c) Before any distribution is made of the net savings after provision for the payment of the dividends on preferred stock, there shall first be reserved an amount equal to not less than five percent (5%) of the net savings for the purpose of establishing, 250 building up and maintaining an allocated reserve of not less than twenty-five percent (25%) of the aggregate par value of all outstanding capital stock. Such deduction shall be made from the net income of each activity or business of the association as prescribed by the board of directors.(d) From the balance remaining to the credit of non-member patrons, eligible for member patrons, eligible for membership in the association and approved by the board of directors, there shall first be deducted the par value of one share of common stock, or the unpaid balance due thereon, and when any such patron has complied with all the conditions for membership, a certificate from common stock paid for in this manner shall be issued to him.(e) An amount of the net savings determined in the manner provided for in sub-section (b) of this section, which amount shall be determined by the board of directors, shall be retained by the association for capital purposes and distributed to the patrons as credits on paid-in common or preferred stock. The amount so retained from each patron shall be in the same proportion to the savings allocated to him, as the total amount retained by the association bears251 to the total amount of savings allocated to all patrons; provided, however, that the board of directors shall have the right to waive the retention of such allocations for common stock to nonmember patrons, or to any one or more of them, and to distribute the same as non-voting preferred stock and/or credits for preferred stock. At the close of the fiscal year, the association shall issue certificates of preferred stock to each patron for all unissued full shares standing to his respective credit.(f) The remainder of the patronage allocations may then be distributed to the respective patrons in cash.In September 1945 the Osceola Products Company entered into a written loan agreement with the St. Louis Bank for Cooperatives under which the bank agreed to make long term loans to such cooperative association in an amount not to exceed $ 127,000. The agreement 1529 contained the condition that while long term loans under the agreement were outstanding the cooperative association would declare or pay cash dividends only upon written approval of the bank. As of June 30, 1946, the outstanding amount of such long term loan was $ 103,000. This long term loan was paid off by the252 Osceola Products Company during its next fiscal year ended June 30, 1947.For each of its fiscal years ended June 30, 1946, June 30, 1947, and June 30, 1948, by act of its board of directors pursuant to the by-laws, the net savings or net earnings of the Osceola Products Company, after payment of dividends on preferred stock, were allocated and distributed at the end of each such fiscal year to its member and nonmember patrons on a patronage basis by the association making credits to the capital reserve, issuance of its preferred stock, and payment of cash dividends. The allocation of such patronage dividends was made on the basis of the tonnage shipped to the cooperative association by each patron. Accordingly, S. Crews Reynolds, Joseph F. Kohn, and the Reynolds-Joplin Cotton Company were credited with amounts to the capital reserve, amounts allocated for payment in preferred stock, and cash dividends as follows:Association's fiscal year ended --Name of patronJune 30, 1946June 30, 1947June 30, 1948S. Crews ReynoldsCapital reserve credit$ 258.96$ 2,812.15$ 2,165.75Amounts allocated for payment in4,485.9152,795.33preferred stockCash dividend6,111.82Total4,744.8755,607.488,277.57Joseph F. KohnCapital reserve credit162.102,215.831,208.42Amounts allocated for payment in2,808.0141,599.94preferred stockCash dividend3,410.22Total2,970.1143,815.774,618.64Reynolds-Joplin Cotton Co.Capital reserve credit1,536.60Amounts allocated for payment in28,848.10preferred stockTotal1 $ 30,384.70253 The following schedule shows the amounts allocated to S. Crews Reynolds, Joseph F. Kohn, and the Reynolds-Joplin Cotton Company (a partnership) by the Osceola Products Company for its fiscal years ended June 30, 1946, June 30, 1947, and June 30, 1948, for payment of the association's preferred stock, the number of preferred shares issued to said patrons, and the total par value of such shares: 1530 Amount allocatedforNumberTotal parpayment ofof sharesvaluepreferredissuedstockS. Crews Reynolds$ 4,485.91179$ 4,475.00S. Crews Reynolds52,795.332,11252,800.00Joseph F. Kohn2,808.011122,800.00Joseph F. Kohn41,599.941,66441,600.00Reynolds-Joplin Cotton Co28,848.101,15328,825.00The following schedule shows the number of outstanding254 shares of common stock which were issued at $ 100 per share and the number of outstanding shares of preferred stock which were issued at $ 25 per share of Osceola Products Company as of June 30, 1946, June 30, 1947, and June 30, 1948:NumberTotal issuanceNumber ofTotal issuanceof sharespriceshares ofpriceFiscal yearof commonof commonpreferredof preferredstockstockstockstockJune 30, 194618$ 1,8001 4,011 1/2$ 100,287.50June 30, 1947232,3002 5,130 1/2128,262.50June 30, 1948252,5003 26,366 659,150.00The certificates of preferred stock provided on their face that they were transferable on the books of the association on the surrender of the certificate properly endorsed by the holder or by a properly authorized attorney.When issued the preferred stock had a fair market value 255 equal to the par value of $ 25 a share.OPINION.The question presented is whether income was realized by the taxpayers, in the respective taxable years involved, upon the allocation and distribution of the net savings or earnings of the Osceola Products Company to the petitioners who were members of the association, in the form of credits to its capital reserve account and the issuance of preferred stock of such corporation.The petitioners, William A. Joplin, Jr., Joseph F. Kohn, and S. Crews Reynolds, were members of the Osceola Products Company, a nonprofit cooperative corporation exempt from tax under the provisions of section 101 (12) of the Internal Revenue Code, in effect in the taxable years involved herein. All of the income tax returns of the taxpayers for the taxable years in question were filed on a cash receipts and disbursements basis of accounting.The taxpayers contend that the income of a tax exempt farmers' marketing cooperative represents income to the cooperative; that the 1531 portion thereof allocated to the capital reserve account and the portion represented by the issuance of preferred stock are not taxable income to a member reporting on a cash basis256 until the cash is realized therefrom; and, in the alternative, if the preferred stock represents the receipt of something of value to be reported as income in the year of receipt then the amount to be reported is the fair market value of the preferred stock at the time of its receipt. It is conceded by the taxpayers that the $ 25 par value preferred stock had a fair market value equal to one-half its par value.The taxpayers argue that the cases relied upon by the respondent such as United Cooperatives, Inc., 4 T. C. 93; Colony Farms Cooperative Dairy, Inc., 17 T. C. 688, involved nonexempt cooperatives and not the patrons; and that the cases of Harbor Plywood Corporation, 14 T. C. 158, affirmed per curiam 187 F. 2d 734; and George Bradshaw, 162">14 T. C. 162, which involved the question of realization of income by members of a nonexempt cooperative reporting on an accrual basis of accounting, are not controlling here.Since the filing of briefs herein, this Court has decided Estate of Wallace Caswell, 17 T. C. 1190,257 in which we held that members of a tax exempt cooperative on a cash basis of accounting realized income upon the receipt of certificates representing their interests in the capital reserve of the cooperative, which certificates they were free to sell, exchange or assign to the extent of the fair market value thereof.We think the Caswell case is controlling here on the question of the realization of income by the petitioners on the receipt of the certificates of preferred stock of the cooperative. We, therefore, hold that the petitioners realized income to the extent of the fair market value of those certificates in the years of their receipt.The respondent's determination that the petitioners are also taxable on their proportional shares of the net earnings of the cooperative which were credited to the capital reserves but in respect of which no certificates or other evidence of such interests were issued to the members can be sustained only on the theory of constructive receipt and reinvestment of such amounts by the petitioners. Since the cooperative had a right under its charter and its by-laws, and under the provisions of section 101 (12) of the Code, to retain a portion258 of the net earnings for operating capital reserve, such retained reserves were its income, although exempt from tax, and not income to the patrons until actually distributed, or made available to them. See United Cooperatives, Inc., supra;Harbor Plywood Corporation, supra; and Dr. P. Phillips Cooperative, 17 T.C. 1002">17 T. C. 1002.We do not think that the taxable or nontaxable status of the cooperative determines the tax liability of the patrons on such nondistributable profits. In no case should the constructive receipt theory 1532 apply, we think, unless at some time the earnings of the cooperative were made available to or were subject to the control of the patron.Therefore, with respect to the amounts credited to capital reserve we hold that the petitioners received no taxable income.There remains for determination the fair market value of the certificates of preferred stock. The charter of the Osceola Products Company authorized the issuance of preferred stock on the basis of a par value of $ 25 per share. It is a generally recognized principle of law that where a corporation is authorized259 to issue its shares of stock having a par value it can not issue such shares for a consideration less than par. When the certificates in question were issued, the net earnings of the cooperative were charged with the sum of $ 25, the par value of the shares. The certificates of preferred stock were transferable, bore 6 per cent noncumulative dividends, and could be redeemed upon call of the board of directors for cash at the par value plus dividends thereon declared and unpaid. Upon dissolution, the preferred shares were entitled to receive the par value plus declared and unpaid dividends before any distribution upon the common stock. The record further establishes that in each of the respective taxable years in question various amounts of preferred stock were sold and issued, for which the corporation received the par value of $ 25 per share.At the hearing, the taxpayers offered the testimony of two local bankers who expressed the opinion that the fair market value of the preferred shares was around 50 per cent of their par value. We regard such opinion evidence of little probative value in the light of the other facts and circumstances disclosed by this record. We hold that*260 the fair market value of the preferred stock was the equivalent of its par value, and have so found as a fact. Cf. Estate of Wallace Caswell, supra.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Joseph F. Kohn and Anna Kohn; Joseph F. Kohn; S. Crews Reynolds and Gertrude Reynolds; and S. Crews Reynolds.↩1. The Commissioner determined that $ 15,496.20 (51% of $ 30,384.70) and $ 14,888.50 (49% of $ 30,384.70) of the above total amount credited and distributed to the Reynolds-Joplin Cotton Co. during the latter's partnership year ended May 31, 1948, was includible for the calendar year 1948 in the taxable income of the partners, S. Crews Reynolds and William A. Joplin, Jr., respectively.↩1. 3,006 1/2 shares issued for cash; net savings allocated against issuance of 1,005 shares.↩2. Increase of 1,119 shares of outstanding preferred stock issued for cash.↩3. Of increase of 21,235 1/2 shares of outstanding preferred stock 484 issued for cash and net savings allocated against issuance of 20,751 1/2 shares.↩	01-04-2023	11-21-2020

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